A Tribute to Leo Melamed in Honor
of the Presentation of the
2005 CME Fred Arditti Innovation Award
By Thomas A. Russo,
Vice Chairman and Chief Legal Officer, Lehman Brothers.

April 20, 2006

deco line

When Leo Melamed asked me to spend a few minutes talking about him here tonight, I was honored. I have known Leo since the early 1970's and, in that sense, already knew enough to talk at length about his lifetime of accomplishments. I thought this would be a pretty straightforward exercise for me to simply get up here and tell you all about a great man. What I didn't realize, however, is that as I reflected on this man and all that I have learned from him, this would turn into a personal learning experience for me – and in that sense, hopefully for all of you.

I went about the task of looking into Leo's life and, among other things, reading his book, Escape to the Futures. I also spent three hours with Leo and Henry Jarecki reminiscing about the past at this year's Futures Industry Conference in Boca.

As I studied Leo's life, I realized that his is more than just a fascinating story. His life is one to learn from. Therefore, I am going to talk about not only what Leo has done in his life so far, but also try to extrapolate from it some basic lessons about creativity and innovation. Because, in terms of these two concepts – creativity and innovation – Leo has set a standard for how we should all approach our lives.

First, the basics. Leo was born in Bialystok, Poland in 1932. He had barely begun the first grade, when in 1939, Leo and his parents fled Poland to escape the onslaught of anti-Semitism that already tore at their homeland from both the Nazis and the Russians. Over 18 arduous months, Leo and his family outwitted and evaded both the Gestapo and the KGB and made a long trek across Siberia, only to arrive in Japan. After a brief stint in Japan, Leo's family was on the move once again, and they came to the United States in 1941 and settled in Chicago.

Leo went on to attend law school at the John Marshall Law School in downtown Chicago. During law school, he answered a classified ad for a part-time job at what he mistakenly thought was a law firm called Merrill, Lynch, Pierce, Fenner & Bean. Leo got the offer and soon found himself on the floor of the Chicago Mercantile Exchange. It was love at first sight.

Leo started out as a part-time runner, but he was a trader at heart. He borrowed money from his dad to buy a seat on the exchange while he was still in law school – an egg and onion trader by morning and law student by night. Without going into all the details, let's just say that the rest was history. Leo would eventually go on to lead the Chicago Mercantile Exchange for a quarter of a century.

As a true visionary, Leo is widely credited with introducing finance to an industry that had been dominated by agriculture. For example, as Chairman of the CME in 1972, Leo created the International Monetary Market, the first futures market for financial instruments, and implemented the first successful futures contracts on foreign exchange. Over the ensuing years, Leo continued to foster financial innovation at the CME, introducing Treasury Bill futures, Eurodollar futures and stock index futures. In 1987, Leo became the Founding Chairman of GLOBEX – the world's first electronic futures trading system.

I could go on and on listing Leo's achievements, but hopefully this is sufficient context to understand that tonight we are honoring a true pioneer: a visionary, a financial genius and a bona fide innovator.

Now, I want to focus on some of the highlights of Leo's career and try to extrapolate some lessons for our own careers and lives.

First, let's start with currency futures. As Leo explains it, the idea of having a futures market in foreign exchange did not "come all at once." There was no "eureka" moment for the idea.

As background, Leo had studied the Bretton Woods accord, which was named for the small town in New Hampshire where delegates of the Allied nations met and deliberated over the post World War II economic order. The Bretton Woods accord, in effect, tied the world's major currencies to the US dollar, and the dollar in turn, was pegged to the price of gold at $35 an ounce.

Leo had also read the works of Milton Friedman – an economist, who would have a dramatic impact on Leo's life. Friedman thought that the Bretton Woods system "was archaic and had to be replaced with [a] currency float." Leo's thought was very simple. If Bretton Woods were to fall, then currency futures would work.

Leo wasn't the only one who had the idea of a futures contract on currency. The International Commerce Exchange (ICE), the old Produce Exchange in New York, began offering futures on currencies in April 1970. However, the contract did not go over well. It was more of a forward contract. In addition, it came at a time when the Bretton Woods agreement was still in force, so there was no price movement in the market. Quoting Leo, he wrote of ICE: "The ICE was no test for what I had in mind. Its idea was more of a forward currency exchange than the financial futures market I thought was possible. Theirs was the wrong contract, with the wrong specifications, initiated in the wrong manner, at the wrong time."

As you can tell from that quote, I don't think Leo particularly liked the contract. What is interesting was that independent of one another, both ICE and Leo were thinking about the same thing. This is not so different from when Alexander Graham Bell and Elisha Gray, at about the same time, each independently invented the telephone.

A vital step in this evolution occurred on August 15, 1971, when President Nixon shocked the international finance community and announced that the US would no longer keep its promise to exchange US dollars for gold. With a record balance of payments deficit and declining US gold coverage of foreign reserves, President Nixon had no choice. Finally, on December 13, 1971, the leading industrial nations met in Washington, DC and came up with a new agreement to replace Bretton Woods. While this agreement too would fail, it allowed the major currencies to fluctuate more broadly against the dollar. The march to the end of fixed exchange rates had begun.

With all of this happening in the background, Leo decided that he needed some credibility for his ideas. Therefore, he approached Milton Friedman in November 1971 and asked if he would write a paper on what he thought about opening a foreign exchange futures market. Friedman agreed to write the paper, requesting $5,000 for his work, making it what is probably the best investment the CME has ever made. Friedman delivered his paper entitled "The Need for Futures Markets in Currencies" on Monday, December 21, 1971 – this was one week after the December 13 decision to abandon Bretton Woods.

Leo realized that the new contract would need a place to trade where it could thrive, and for this he envisioned a separate exchange. Thus, the concept for the International Monetary Market or IMM was hatched. On January 17, 1972, the Merc Board voted to make the IMM a separate exchange by a vote of 321 to 19. Initial seats for non-Merc members were set at a price of only $10,000 and by the end of the year, 150 seats would be sold. Leo thought that he had to get some new blood to trade the new contracts, so he set the initial offering of new seats at this low price. Leo also knew that he needed his new traders to be full-time traders in the foreign currency market and not be running around from one pit to another. As for Merc members, they would get access to the IMM for a mere $100. Leo knew right from the beginning that the name of the game would be liquidity, and he strategically set up the best mechanism to make that happen.

He also went around courting several of the larger wire houses and found some success, though many of the large brokerage houses did not want to participate.

Remember, Leo also had a law degree. He thought instinctively that somebody would probably need to approve this new contract. He sought legal advice at the Merc, and they advised him that he did not need approval and therefore tried to dissuade him from seeking it. Notwithstanding the advice of counsel, Leo decided to move forward with his plan to get somebody to approve the contract. Leo knew that even if he did not need approval from a legal standpoint (and, apparently, his lawyers were right that there was no such requirement), formal "approval" would give the IMM credibility.

So Leo went off to Washington, DC. He set up a meeting with George Shultz, who would become the Treasury Secretary shortly after the IMM launched. Shultz was a big believer in Milton Friedman, who had been a colleague of his at the University of Chicago. Before his meeting with Shultz, Leo arranged for Shultz to receive a pre-meeting call from Friedman to discuss the concept. After the meeting, Shultz simply said that he knew all about Leo and, "If it's good enough for Milton, it's good enough for me." Leo also met with Arthur Burns, the Chairman of the Federal Reserve, and Herb Stein, the Chairman of the Council of Economic Advisers. They both said, "Godspeed."

On May 16, 1972, the IMM opened and the world of financial futures, which we all consider commonplace today, began. Leo knew that the best way to teach was by example. On opening day, he was in the pit trading and putting his money where his mouth was. Unfortunately for him, he shorted ten Swiss franc contracts and the dollar went into a freefall. Since the franc was limit up for a period of days, Leo, who had created the product, ironically lost a substantial amount of money in the beginning. I guess this was Leo's way of giving back. Leo's friends, of course, responded to his call. For example, my good friend and Leo's good friend, Henry Jarecki, who is here tonight, delivered on a promise to "make markets" and indeed executed the first Mexican peso contract to be supportive of Leo.

There are two other noteworthy events that I will speak about briefly before getting to GLOBEX. The problem with Leo is that each of the major topics of his life is so enormous in scope, important in consequence and innovative in character, that it would take an entire book – much less a speech – to develop properly.

Leo knew from the get-go that there was going to be a world of interest-rate futures. Therefore, the Merc, through Leo, introduced the first short-term interest rate future on the T-bill. At that time, I was at the CFTC, and I watched and participated in this development. I vividly remember the fights with the SEC and the nitty-gritty of our discussions. For example, the lawyers were worried about the exclusive jurisdiction section of the Commodities Exchange Act and how it applied to the T-bill. Leo, however, had to worry about the more basic thing, namely: What would the Treasury Department think of having futures contracts on one of its instruments?

Knowing this, Leo spoke with Bill Bagley, the Chairman of the CFTC, who suggested a visit to the then Secretary of Treasury, Bill Simon. Sandy Weill, who was the chief of Shearson & Company at the time, made the introduction to Simon. In fact, Sandy agreed to go to the meeting. Leo, who knew a working strategy when he saw one, also asked Milton Friedman for help again. Once again, Friedman called ahead of Leo's meeting. When Leo and Sandy showed up for the meeting, Simon was already so impressed that he said, "Where do you want me to sign?"

Leo also met with industry leaders including Billy Salomon of Salomon Brothers. Billy had made a staged whisper to Tom Strauss, executive vice president at Salomon, who was with Billy, to "get these _______ guys out of my office." After the T-bill futures began doing well, Salomon Brothers called Leo and asked if it was too late to join and trade. The answer of course was that it was not too late, and Salomon Brothers became one of the biggest traders.

The S&P futures contract is another innovation that came to the Chicago Mercantile Exchange under Leo's leadership. He lobbied for it, and he negotiated to get it. Today, trading index futures has become commonplace. But rather than drilling down on more products such as index futures, I want to go into another innovative concept, that of computerized trading.

In a 1977 edition of the Hofstra University Law Review, Leo Melamed wrote a piece praising the open outcry system. Coincidentally, in that same edition, I wrote an article explaining the importance of the exclusive jurisdiction section of the Commodity Exchange Act. There is no doubt that Leo was a proponent of the open outcry system, as was virtually every trader on the floor of the Chicago Mercantile Exchange. However, Leo recognized that a technological revolution was fostering globalization and a fundamental change in financial markets around the world. Leo chaired the Merc's Strategic Planning Committee and decided to make its top priority finding the answer to the effects of globalization.

At that time, the Chicago Board of Trade was dealing with the same topic. The CBOT decided to extend trading hours with an evening session under the open outcry system. While no futures exchange had yet taken major steps in the field of automation, the New York Stock Exchange was making some progress. In 1976, it launched the DOT (Designed Order Turnaround) system, followed by the Super-DOT system in 1984. INTEX, an international electronic order matching system for futures products, was also announced in 1984. Finally, in 1986, the London Stock Exchange closed its trading floor in favor of an automatic stock quotation system – this was known as the "Big Bang." Meanwhile, Leo was writing his first book of fiction, The Tenth Planet, which was ultimately published in 1987. Writing proved to not only be perfect therapy for pressures in the market but, more important, it kept him technologically current. In fact, Leo started writing that book in pen and finished it on a laptop.

Leo knew that it would be hard to sell the floor anything dealing with a "black box." However, he thought that it might be possible to sell them the concept of trading through a computer after the market closed. By doing this, they wouldn't be threatened, and yet the camel's nose would be under the tent.

Leo needed to find a firm with the technological expertise to work on the system. Reuters was a logical choice since it had already purchased Instinet, an order matching system for stocks, and had introduced a system for foreign exchange. Reuters proved to be a willing participant in developing GLOBEX.

A humorous aside of all of this was that the original name for GLOBEX was PMT which stood for Post-Market-Trade. The name was chosen to make it clear that the market was going to be post or after the trading on the exchange. It was only after naming the new system, PMT, that Leo learned that the acronym had another meaning. When he was in the United Kingdom, he saw a sign advertising PMT. Ecstatic, he thought it was remarkable that this new concept had already made it into an advertisement in the UK. However, when he learned that the three letters also stood for premenstrual tension, the name got changed and, thus, we have GLOBEX (Global Exchange).

Proudly in 1987, the Chicago Mercantile Exchange membership overwhelmingly approved the concept for GLOBEX. In Leo's words, "It was the first embrace of an electronic screen-based system for futures anywhere in the world." Following the GLOBEX announcement, many other exchanges around the world followed suit, with their own electronic systems that would either extend existing trading hours or conduct the entire transaction process. Yet, GLOBEX had a long way to go before launching. Implementation proved challenging and it had to suffer through some bad times, such as the market correction of 1987. Ultimately, however, GLOBEX proved to be not only an innovation that changed the landscape of the financial services industry, but also an enormous success.

In 1995, Leo wrote, "Financial markets [had] become virtually unencumbered, continuous and worldwide. A company located anywhere in the world, can use resources located anywhere in the world, to produce a product anywhere in the world, to be sold anywhere in the world." That statement could easily have come from Thomas Friedman's 2005 book, The World is Flat, but it came from Leo, a decade earlier. More to the point, Leo also wrote in 1995, "Suddenly, every country on the planet is a competitor in the global marketplace."

When he talked about the use of new products and new ways of trading by using a computer, he stated that, "Risk management implicitly must include risk enlightenment." He said in 1995:

"Anyone who has not seen the handwriting on the wall is blind to the reality of our times. One can no more deny the fact that technology has and will continue to engulf every aspect of financial markets than one can restrict the use of derivatives in the management of risk. The markets of the future will be automated. The traders of the future will trade by way of the screen. Those who dare to ignore this reality face extinction."

Leo did state at the time that while he did "not advocate turning the lights off on existing trading floors," which he said "would be unforgivably stupid – it is equally suicidal not to seriously prepare for the technological tomorrow." He talked in 1995 about satellites soon allowing wireless communication anywhere on the planet. He also talked about the transfer of information "over thin air." I am sure that, with the Blackberry in mind, he stated in 1995, "The new technology will create a world which will result in not just a series of new technological marvels, but in spectacular lifestyle emancipation." Finally, he stated in that same year:

"Futures markets take heed! Complacency is the enemy. Tomorrow's futures traders grew up with Nintendo and Sega. They were given a keyboard for their fifth birthday; their homework was done on a computer; their recreation time was spent in video centers; the World Wide Web is their playground; Cyberspeak is their language."

He made these statements before they were as self-evident as they are today. He was then in 1995, he was before then and is now, a man of the future – a man with an eye for the future and the energy, confidence and wisdom to get us all there.

And what lessons have we learned from all of this? We obviously learned the lesson that we should be very happy and proud to know a man such as Leo Melamed. I have had that good fortune for decades. In learning about his life, you have a few key takeaways:

  • A man of poor means but high goals can achieve anything.

  • When you have a good idea, you have to do something about it. It is not good enough to merely state it.

  • Implementation of an idea is as important as the idea itself. The person with the idea won't necessarily be the same one who succeeds in implementation. The example of ICE, the former Produce Exchange, is a good case in point. The fact that ICE may have been first didn't mean that it would capture the market.

  • Implementation includes the physical facilities where the idea has to see its fruition. To do this, you might have to think out of the box. The IMM was exactly that. It was a nexus to the old world of agriculture, together with a vehicle to get new blood into an industry. The creation of the IMM itself was pure genius. It permitted an entire industry to get into the new world of financial futures in a way that assured the greatest likelihood of success.

  • Credibility comes not just from the product itself, but from others who can lend it validity. When Leo visited Arthur Burns, George Shultz, Bill Simon, and a host of others, he did so not just for approval, but perhaps more important, he did so to gain credibility for these ideas. He wanted the world to know that the very people whose jobs are to protect the country's financial integrity, had no problem with his product or market, but in fact had, encouraged the ideas. Leo didn't sit back and say, "Legally it is okay, that's enough." He looked beyond the law into the ingredients of what makes people believe in something and acted accordingly.

  • All markets have a starting point and a trading point. In the securities markets, the starting point is the public offering; the trading point is the secondary market. In futures, the starting point was the idea such as foreign currency futures, the trading points were the liquidity providers. Leo not only got the floor involved through the ingenious approach around new memberships to the IMM, but he also got the outside world involved by talking to the major firms, major banks and major central banks. Leo wanted to make them all knowledgeable about the product, knowing that if he could create liquidity, the players would know enough to be able and want to participate. The energy that he had in marketing a concept before the first trade was an important ingredient in the innovation of each product.

  • Do not be afraid of your idea. When Leo had the idea for GLOBEX, he didn't just say, "How could I possibly convince a floor-oriented exchange to get into the world of tomorrow?" This is a man who wrote about the benefits of floor trading, who was a floor trader, and yet he was able to go outside of his environment, outside of his constituency, and promote an idea whose time had not yet come. He was not afraid of his idea because he was not intimidated by his environment. Rather he used his environment and the credibility that he had gotten from it to convince a floor that the future would not be theirs without change. GLOBEX, which could have been a hard sell by any stretch, got the overwhelming approval of the Chicago Mercantile Exchange because one man was able to convince them that it was in their own self-interest, even though all of their instincts might have gone the other way.

I want to close with a poem that Leo wrote on the IMM's 10th anniversary entitled, "Who Were We!"

Who were we?
We were a bunch of guys who were hungry.

We were traders to whom it did not matter –
whether it was eggs or gold, bellies or
the British pound, turkeys or T-bills.

We were babes in the woods, innocents,
in a world we did not understand,
too dumb to be scared…

That the odds against us were too high;
That the banks would never trust us;
That the government would never let us;
That Chicago was the wrong place.

Well, here we are in 2006, and what did turn out to be the case? Chicago was the right place because Leo was the right person. And – not too dumb to be scared, but too smart to back down – too confident to give up – who saw the future and, most remarkably, made it happen against all odds. And – as a result, changed the culture – changed an industry – and made a lasting mark for which an exchange, a city, and a country should forever be indebted.

Thank you.

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