DEVELOPMENT OF FINANCIAL FUTURES IN THE UNITED STATES
By Leo Melamed
Presented at the Chicago Mercantile Exchange Seminar
Financial Futures for European Institutions
October 1, 1980
have come together at this conference to explore what I believe
can be justly called the leading edge of a new era in international
finance. That edge is, of course, the use by participants in
the world economy of the instruments known as financial futures.
Futures are, as we all know, distinctively American, products of
the perils and promise of American agriculture. Financial futures,
that is, futures contracts based upon currencies, metals and interest-bearing
instruments, have evolved from that background. For my part on
this program, I wold like to trace for you the development of financial
futures, believing that such a recital will be helpful to your
fuller understanding of the further presentations at this conference.
a decade ago, in 1970, financial futures were unknown in the
United States. There were no financial futures contracts on any
exchange anywhere. Such instruments simply did not exist.
Last year, in the final year of the decade, financial futures traded
on six exchanges represented more than 34 percent of record volume
on all exchanges combined, a total of 76 million contracts. From
zero volume in 1970 to a volume of 25.9 million contracts in 1979.
That record for financial futures represents growth -- impressive
growth in any language.
Yet, to get a sense of the strength surging through the financial
futures markets, it is necessary to know that this volume has come
quickly. It is not growth spread gradually across the decade. On
the contrary, 72 percent of the total volume of financial futures
transactions has occurred only in the last two years. In other
words, three out of every four financial futures trades ever made
were made during the past two years without even considering the
volume during 1980.
What I am attempting to convey is the fact, the very important
fact, that we are, at this very moment, in the midst of a development
which, by any standard, must be regarded as truly phenomenal. Within
less than a decade, a new kind of financial instrument, an instrument
unknown eight to nine years ago, is suddenly surging to the forefront
as a prime instrument of financial management. And, let me make
the further point that this is, in no sense, an exclusively American
We who represent the International Monetary Market are proud and
pleased, as you would expect us to be, that our pioneering venture
in financial futures -- the 1972 opening of the International Monetary
Market -- is successful on a very large scale. But, as pragmatists,
a trait necessary for traders, we are more stirred and more excited
by the growth and spread of the futures instrument, by the prospect
that new financial futures markets may soon be operating here in
London, on the continent, in Singapore, Hong Kong and elsewhere.
The omens tell us, as I am sure they also tell most of you in the
audience, that financial futures are, in every sense of the term,
the leading edge of international finance for the balance of this
century and beyond. We know futures, we believe in them, and we
are convinced that, for these times and the times ahead, financial
futures present an unparalleled potential for meeting the needs
of financial managers in an age of historic uncertainty and risk.
Hence, it is especially gratifying for all of us from the states
to be able to meet with you and to have this opportunity to introduce
you and to welcome you into the world of futures.
reciting the story of the swift and dramatic growth of the financial
futures sector, I recognize that those statistics fall against
a certain institutional reserve. Financial institutions and financial
managers must be, and are, by their very nature, cautious. Despite
the volume, despite the active presence in the financial futures
markets of a truly international spectrum of major banks and
businesses, I am sure the question persists in some minds: Can
new instruments and new markets, not yet ten years old, really
be trusted to serve your purposes? Are financial futures markets
fully and adequately tested? Is this phenomenon still, somehow,
in the experimental stage? Should we let it mature, let the Americans
work on it further, "get the bugs out," as we say, before we
enter the futures markets?
I am happy to say that questions such as these only serve to expose
the strength of our financial futures rather than any weakness.
A future is a future is a future. What underlies a futures contract,
whether it be an agricultural commodity or a financial instrument
or a currency or a precious metal, does not, in any way, alter
or affect the function of the future itself or the function of
the contract or market on which it is traded. Therein lies the
secret of the success of financial futures.
Americans have been at this business of trading futures and conducting
futures markets for a very long time. Futures were trading in Chicago
sixty years or more before the first automobiles were coming off
the assembly lines in Detroit. There were futures before there
were railroads or skyscrapers, even before there was baseball.
Very few financial institutions anywhere, in Europe as well as
the United States, approach or exceed the longevity and continuous
operation of our Midwest exchanges. The Chicago Board of Trade
began operations in the 1840s. The Chicago Mercantile is a relatively
young upstart, having come into existence in 1898. The average
age of the exchanges in Chicago and Kansas City is 100 years.
This emphasizes a very important point. While the futures community
in the United States is small, it harbors more financial expertise
and more cumulative financial experience than any other segment
of finance in the nation. In plain spoken terms, futures have been
tested by almost 140 years of active use. There is nothing experimental
about futures of any kind. The futures markets are mature. The "bugs" have
been out of the futures markets for a very long time.
The only new thing about financial futures, then, is the name.
What we have done, what we are doing, is simply to take our oldest,
most tested, most trusted, most reliable mechanism and offer it
for use in and by a new and far broader segment of the total economic
community, both in the United States and abroad. If there are reasons
why you should not use the futures markets, and it is hard for
me to conceive of what they may be, the supposed "newness" of the
instruments and the markets is not among them.
am committed, of course, to trace for you the development of
financial futures. Within the framework of what I have been saying,
I believe it is best to begin at the beginning...not at the beginning
of financial futures, but at the beginning of futures themselves.
As I have said, futures originated in Chicago. This occurred primarily
as a function of the transportation system within the interior
of the United States. Because of its location at the confluence
of East and West in the United States, Chicago was (as it remains
today) a hub of the transportation network bringing produce from
the rich agricultural belt of the Midwest to the markets of the
processors providing food for the populous eastern seaboard.
Where producers and processors met, there was, on both sides, a
strong common interest to protect against risks on future deliveries.
The inherent conflict between those interests had been present
in every agricultural marketplace since civilization began with
producers trying to sell "high," processors trying to buy "low," and
both sides being subject to the unexpected and unforeseeable risks
of weather, crop failure, economic panic and countless other perils.
The climate under which those transactions were concluded bore
many striking resemblances to the climate under which we all are
operating today on both sides of the Atlantic.
History does not accurately record who it was or when it was that
someone came forward with the idea of converting the dilemma of
producer and processor into an opportunity for gain and profit.
At some point, though, a third presence was introduced. The trader,
or, as he is more commonly called, the speculator entered the bargaining.
On the basis of his judgment regarding the supply or demand situation
at a certain time in the future, the trader offered to take the
position of the buyer or the seller at a price, committing himself
in the process to perform on the contract. In doing so, the trader
assumed the risk inherent in whichever position he might have taken,
buy or sell.
The assumption of risk was not undertaken, needless to say, out
of a spirit of benevolence or charity. The trader, or speculator,
expected market influences to have moved so as to enhance the profitability
of his position by the maturity of the contract. This was then
and is still the essence of futures trading. But there is another
The presence in the market of traders willing to take "buy" and "sell" positions
opened new opportunities for both producers and processors, or "commercials" as
we call them. Knowing their own future needs in the
markets, these participants were able to enter the market to establish
positions which served to hedge their future commitments. While
it was not possible to eliminate risk altogether, informed hedging
strategies functioned to minimize or cushion risk.
In consequence, the commercial participants in the markets, as
distinct from the traders or speculators, were able to stabilize
their balance sheets. This was achieved by the ability to "level" or "flatten" price
fluctuations, to plan ahead financially with more certainty and
confidence and to free their capital resources for the most productive
This has been, and is, the basic structure of our futures markets.
The futures mechanism came into being expressly and specifically
to permit better and more effective management of marketplace risks.
In this respect, it is fair to say that futures are designed for
let's look at the exchanges where futures markets are made.
Over the period which I have been describing, futures transactions
were most often accomplished along side railroad yards or other
open-air centers of transportation. In time, though, traders being
traders, it became the preference to conduct these transactions
under roofs and within walls. These sites became known, as they
still known, as "exchanges."
It is important to a correct understanding of futures markets to
know that today's exchanges are what they were in the beginning.
They are, simply, facilities providing a common site for the conduct
of trading. Exchanges take no positions in futures contracts and
hold no positions in commodities or financial instruments. Exchanges
are not-for-profit institutions. The expenses of the supporting
staff and space, as well as sophisticated computer and communications
equipment, are paid by clearing fees charged against futures transactions.
Fees are solely and strictly a function of volume and have no relationship
to the value of traded contracts. Thus, the single interest of
the exchange is to generate and maintain trading volume by offering
futures contracts of the widest appeal.
This interest, or perhaps, self-interest, of the exchanges had
its effect upon the creation by the Chicago Mercantile Exchange
of the International Monetary Market. The Mercantile Exchange began
as a butter and egg exchange and continued successfully on that
basis through World War II. Over the 1950s, however, technological
factors, such as refrigeration and air conditioning, functioned
to diminish the buyer interest in those commodities. In consequence,
at the start of the 1960s, the Mercantile Exchange began what was
to become a program or strategy of innovation unique among American
In the early 1960s, we introduced, first, a contract in pork bellies
which has become one of the most-actively traded of all futures
contracts. Next, we introduced the first futures contract ever
based on a non-storable commodity, that is, live cattle. This has
become--and is now--the largest contract on the exchange.
let me move on to the development of the financial futures.
I believe it is necessary to emphasize to you that, as a function
of the unique circumstances of the United States on the North American
continent, there has long been a certain remoteness from the financial
realities of Europe and the U.K. As one example, consider currencies.
In the United States, unlike any or all of the countries represented
here, there is no long history of currency trading. Facilities
did not exist for Americans to trade currencies, or to even convert
currencies, in the manner to which you have been accustomed for
centuries. With the value of the dollar fixed and supported by
the government, there was, in fact, little need and no incentive
for Americans to concern themselves with currencies.
1971, however, the pressures upon the dollar became basically
unsustainable and the President of the United States, by executive
order, acted to float the dollar, allowing its value to fluctuate
in relation to other
currencies. That was, and remains, an event of great consequence
United States. At the Chicago Mercantile Exchange, the floating
of the dollar gave encouragement to a rather daring venture: the
start, in 1972, of the International Monetary Market, offering
futures contracts in eight major currencies.
a nation wholly without experience in currencies, the start-up
of currency trading was excruciatingly slow. As recently as 1975,
the total volume of currency futures trading amounted to less
than 200,000 contracts. Today, currencies are providing some
45 percent of the volume on the International Monetary Market,
and in August of this year, the onemonth volume in currency futures
ran 38 percent ahead of the full-year volume in 1975.
In addition to the national inexperience in the realm of currencies,
the United States entered the 1970's under the 40-year-old moratorium
against ownership of gold by private citizens. After debating this
prohibition, Congress decided to permit gold ownership once again,
beginning on the last day of 1974.
the likelihood that strong public interest would develop in gold
ownership, most of the exchanges developed and on December 31,
1974, offered, futures contracts in gold. Slightly more than
6,000 contracts were traded in that one-day trading year. Over
the next two years, trading hovered in the range of 800,000-900,000
contracts. As the decade came to an end, the uncertain conditions
in the world sent gold prices and gold futures trading soaring.
In 1979, more than 10 million gold futures contracts were traded,
a volume exceeding all the trades in the previous years of the
By this time, the evidence was clear -- financial instrument futures
were vehicles with high potential for futures exchanges. Thus,
the Chicago Board of Trade prepared for its entrance into this
field. By 1976, both the CBT and the IMM had again broken new ground
by entering into the field of interest rate futures. First came
the CBT with its GNMA futures contract, and shortly thereafter,
the IMM with its 13-week Treasury bill futures contract. The interest
rate futures have subsequently been expanded to offer both one-year
Treasury bills and four-year Treasury notes. Again, the start was
slow, yet, again, the decade ended with these contracts surging.
The three-month Treasury bill which traded only 110,000 contracts
the first year, closed the decade in 1979 with a volume of 1.9
million contracts, the third most active contract on the Chicago
for the primary questions: Why have we done what we have done,
and why has it worked?
In answer to the first question, let me say this. At the start
of our venture into financial futures, we recognized, as did other
of our sister exchanges, that the changing economic realities of
the 1970s were creating (or likely to create) conditions of uncertainty
and risk for the business and banking communities very similar
to those on the agricultural sector. Instabilities were evident
in many directions -- and remember, if you will, this was before
the advent of oil pricing by OPEC. While it was technically possible
for managers outside of agriculture to utilize agricultural futures
for money management purposes, we knew that simply would not happen.
Corporate treasurers, pension fund managers, finance companies,
state and municipal comptrollers, finance officers of multinational
corporations, the whole array of financial decision-makers in the
business sector, simply were not likely to begin putting their
funds into futures based on live cattle, pork bellies or frozen
turkeys, commodities about which they were both richly inexperienced
and wholly disinterested. The limitation on use of the futures
markets was, we felt, a self-limitation imposed by the markets
themselves. Under the influence of our agricultural origins, we
simply were not offering futures denominated in instruments understood
by corporate America.
If we were to open, or perhaps to unlock, the vast resources of
the corporate world, we had to offer futures based on instruments
comprehensible to and trusted by corporate financial decision-makers.
This meant, as I have suggested earlier, that we should take the
instrument of the futures contract and underlie it with the various
financial instruments such as Treasury bills, currencies and metals.
The results have been, to an extent, beyond our expectations. We
did not initially foresee that the interest and response to these
financial futures would be worldwide rather than strictly national.
Neither did we, nor could we, anticipate fully the escalating uncertainties,
economic and political, which have dominated financial planning
and action during the last few years of the 1970s and these months
of the 1980s. As the farmers of the midwest like to say, though,
even a blind hog finds an acorn now and then.
Whether by accident or design, and it makes no material difference
which it may have been, the fact is that the futures exchanges
of the United States were fortuitously in position to offer a wide
portfolio of financial futures precisely at the time when those
futures were most needed, and most welcomed, by a new clientele
in the financial community.
let me return to the second part of the question which I posed
a few minutes ago. Why has what we have done worked? That is,
why has the offering of financial futures succeeded on such an
The question is subject to many different answers. In my own view,
though, a part (a very large part) of the answer lies on or with
the perspective which I emphasized at the beginning of my remarks
-- the age and experience of the futures markets.
As a function of that long history, the futures exchanges in the
United States have accumulated an impressive record of self- governance
aimed at assuring the absolute integrity of the operations of the
In speaking of this, let me emphasize that I do not intend to deal
in pieties or moralizing toward other financial institutions. Rather,
I only speak in the most pragmatic terms. Since the futures exchanges
are, as I mentioned, simply facilities -- places provided for convenient
and easy trading -- the individual members of such exchanges have
the highest order of self-interest in guarding and protecting the
integrity of those markets. Should a single member default or cause
a loss to customers, the entire membership would suffer severely.
As a consequence of these realities, the futures exchanges of the
United States have established for themselves, wholly and without
government intervention, remarkable provisions for self-governance
and self-policing, as well as equally remarkable provisions for
customer protection. As a
consequence, over the long history of these exchanges, not one
dollar of any public customer's funds has ever been lost as a result
of the insolvency of any clearing member. At the Chicago Mercantile
Exchange, resources totalling in excess of $2.5 billion exist to
assure against customer loss.
It is not possible, of course, for exchanges to prevent loss resulting
from customer poor judgment of the market. Nonetheless, all the
futures exchanges, drawing upon long experience, have in place
certain provisions and regulations aimed at limiting, if not absolutely
The exchanges establish daily limits on the movement of contract
prices. This functions to brake extreme fluctuations of price which
may be ruinous to customers. Similarly, when customers enter the
futures markets, they may establish a variety of standing orders
which serve to limit their adverse exposure. Limit orders or stop
orders or any number of other variations, all function to fix automatic
parameters on the market position. The exchanges further reinforce
this protection by keeping precise account of the time at which
price changes occur. Orders from customers are time-stamped at
each step of receipt and execution. If, after an order is received,
the market moves through the price set by the customer, and the
order is not executed, the customer is subject to indemnification.
Once a customer acquires a futures contract, the clearinghouse
of the exchange becomes the opposite party -- the seller for every
buyer, the buyer for every seller. This eliminates the concern
typically present in other types of markets about the ability of
the opposite party to perform.
Perhaps, most important of all, for those not acquainted with or
experienced in futures markets, the risk of a futures market customer
is limited to a single day's market fluctuation. All accounts are
kept current on a daily cash basis. If price movements yield a
profit, that profit is payable daily; if price movements are adverse,
the loss must be deducted immediately, or at least prior to the
start of the next trading day.
These provisions are complex and thorough. As I suggested earlier,
they reflect the age and experience of the futures markets. Compelled
as they are by the self-interest of protecting their reputations
for total integrity, the markets are aggressively jealous of their
repute among customers. The net result is a rare level of assurance
With all due respect to our friends in the banking community, I
know of no other sector of the financial community which takes
such extensive interest or such an active role in protecting customers
from loss as in the futures markets.
The point of this, in the context of my presentation, is that the
phenomenal success of the financial futures contracts lies, at
least in part, with the fact that these old, mature and fully-developed
markets in the United States are markets which can be, on the record,
This is a matter of highest importance to those of you attending
this conference. The bright promise of financial futures necessarily
entails your dealing with markets not only distant from you but
also markets totally unfamiliar to you. Certainly, as prudent and
cautious managers, you have questions about the trust-worthiness
of those markets. By what I am saying here, I hope I may bring
you a measure of reassurance that the futures markets are something
to be relied upon.
I previously mentioned, financial futures represent the leading
edge of a new era of international finance. The instruments themselves
were created expressly to serve the kind of economic climate
we all presently are facing. The application of financial futures
to the challenges now facing financial managers afford opportunity
for achieving stability and certainty in an era of risk and uncertainty.
Thus, I trust that in these sessions, and perhaps in other sessions
outside these settings, you will pursue your desire to understand
financial futures and that together we all realize benefit and
gain from this meeting.
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