FUTURES: THEN AND NOW

Published in Global Investment Management,
January 1991.

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It is quite difficult to comprehend the unbelievable changes the world encountered at the turn of the last decade of this century. The events came so fast as to make them incomprehensible and turned the world upside-down. Did we witness science fiction or was it reality?

It is important to review and analyze what happened—to put the events in focus, and attempt to apply the lessons they portend to the markets of tomorrow.

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On August 22, 1990, on the floor of the Chicago Mercantile Exchange, I had the distinct honor of playing a role in a new science fiction drama, a drama that has its versions everywhere in the world. On that day, I announced the formation of plans to create a futures contract on the Russian Ruble. If that's not science fiction, then I don't know what is!

Indeed, words other than science fiction fail us in the attempt to adequately describe the cataclysmic transformations of recent days. They are events difficult to fathom even if one had time to digest them properly. And yet overnight, changes so unbelievable that a few years ago would have been rejected as impossible—or at best as science fiction—are today accepted by the world as commonplace: the iron curtain lifted; the nations of Eastern Europe free again; the bust of Lenin removed from Moscow City Hall; the unification of Germany; and American troops in Saudi Arabia.

One needs instant replay to be certain that these events actually transpired. And yet, seemingly overnight we talk about them as if they were always so. It is because we live in an era when everything is accelerating and we have become immune to the incredible speed. We, the inhabitants of planet Earth, hardly have time to digest one set of startling revelations before we are exposed to the next. Surprise has become conventional while change has become routine: A decade ago, the U.S. was the world's wealthiest nation, today, it is the world's biggest debtor; a year ago, half the world lived under Communist tyranny, today all of Europe is free and Germany united; six month ago, Russia was the enemy, today it is our comrade; three months ago, the Dow Jones Industrial Average flirted with 3000 and the bull was supreme, today he is nowhere in sight and the bear freely roams Wall street; a month ago, oil was at 18, now it is 38; just the other day, Junk bonds were the darling of finance, today they are the pits; one day, Drexel Burnham is king, the next day it is history; and yesterday there was a Kuwait; tomorrow, who knows.

To some, such swift change is unacceptable. Slow it down they implore, bring back the good old days, they demand. Those days of yesterday when dancing was slow, when earrings were for girls, when hedging was the work you did on Saturday afternoons around your yard, and when program trading was switching TV channels. The days when one could leisurely digest the news, discuss it with experts and friends, listen to different opinions, and make a financial decision slowly over time. When you were certain who was your friend and who your enemy, when the U.S. dollar was supreme, when the New York Stock Exchange set the direction for all global equity activity, and before there were futures contracts traded on the S&P, OEX, MMI, Nikkei, Topix, CAC, FTSE, DAX, or what have you. When the Orient was distant, inaccessible, and unimportant, when Communism was a threat, and Iraq insignificant.

Ah, the good old days! Unfortunately, those days are gone and will never be back. And those of us—particularly in the world of finance—who still do not understand the dynamics that altered the world forever—are doomed. What happened? What brought about today's science fictional world of constant change? More than any other single factor, it was the inexorable march of technology, the telecommunications revolution of the last two decades, or what the former Chairman of Citicorp, Walter Wriston, dubbed as the "information revolution." That revolution dictated a permanent and fundamental change in both the political and economic order of our planet. And its greatest impact was on the markets: It interconnected the planet with telecommunications and computers; it transported information instantaneously and impartially; it transformed the world from dozens of scattered national economies into a linked, inter-related, inter-dependent world economy; it initiated a new system of international finance; it forced a new market discipline upon internal political decisions of all nations; it revolutionized investment strategy; it demanded trading decisions at lightning speed; it introduced the need for sophisticated risk management tools and created the need for institutional management; it made it impossible to continue the charade and hide the unmitigated bankruptcy of the Communist order; and it even gave us program trading.

Indeed, the consequences of the telecommunications revolution are felt, and will continue to be felt, in every facet and niche of civilized life. As John Naisbitt describes in his book Megatrends, "In Times Square, in the Ginza and on the Champs-Élysées, sushi bars, croissant shops, and McDonald's all compete for the same expensive real estate. Tex-Mex, he notes is "all the rage" in Paris, and can also be had—Kosher—in Israel. And now you can get pizza even in Beijing! And just as palates have gone international, recklessly disregarding arbitrary impedimenta such as cultural differences, so too has the telecommunications revolution dramatically changed the nature and structure of financial markets which no longer have any allegiance to geographical borders or time of day.

And the markets of futures and options were the first to read the handwriting on the wall and discern the meaning as well as potential of the new information standard. The financial futures revolution, launched in Chicago in 1972, blazed the trail for much of what has since followed in world capital markets. It established that there was a need for a new genre of risk management tools responsive to institutional money management and modern telecommunication technology. It led to the acceptance and integration of futures and options within the infrastructure of the financial establishment, it became the catalyst for the development of futures markets worldwide, and, most importantly, it induced risk management as a regime.

It is the latter consequence that will have the greatest impact on the use and expansion of futures and options markets during the coming years. Because more globalization, greater interdependence, instant informational flows, immediate access to markets of choice, more sophisticated techniques and intensified competition are the trends of the future, the management of risk is bound to be at the core of every prudent long-range financial strategy. And that is good news for the markets of futures and options.

Two decades ago, financial risk was apt to be defined by most in fairly simple terms. At that time, it was doubtful that many thought of risk management as a discipline. Nor is it likely that many outside of academia or the actuarial business spent much time tinkering with mathematical models in order to weigh different strains of strategic exposure; that is, a firm's sensitivity to changes in tax rates, interest rates, exchange rates, the price of oil, and so forth. Two decades ago, the identifiable risks were all the usual insurable hazards: fire, theft, natural disasters and so on. Oh yes, recessions came and went, but at the end of the day, it was an era in which Treasury instruments yielded about 5 percent and foreign exchange rates were fixed. The good old days!

However, defined in the context of the world of commerce as we know it in the 1990s, risk is not merely a potential drought, earthquake, gas leak or even oil spill. In today's interdependent information standard world, risk is radically more complicated, intensely more concentrated, and devastatingly swift. Risk today is any one of a myriad of contingencies that could negatively impact an enterprise, alter its value, its cash flow, or its future. Risk in the 1990s has no resemblance to risk of the previous decades. And, since the implicit counterpart to risk is opportunity, the complexity of the world of tomorrow is good news for the markets of futures and options.

Futures and options markets are ideally suited for a world where innovation and competition will intensify, where demand for tailored risk management strategies will increase, and where opportunities will rapidly appear and disappear on a constantly changing financial horizon. Indeed, while in the coming years the lines between exchange-traded and off-exchange traded products may become somewhat blurred, no markets other than futures and options offer a blend of so many credible instruments to safeguard or strengthen one's assets. This sophisticated mechanism—invented and developed in the U.S. and coveted and copied in literally every financial center the world over—has become an integral part of the economic landscape of the globe. It has become an irreplaceable American national resource that our industry and the Commodity Futures Trading Commission (CFTC) are duty bound to protect and preserve. For as we well know, there are many about us who for a variety of reasons— sometimes with malevolence, sometimes in ignorance—would allow these American markets to be weakened if not destroyed.

Indeed, futures and options markets are convenient scapegoats for most financial ills the world encounters. Ills that are often the consequences of failed policies by the very leaders who later search for someone to blame. If food prices rise, the fault surely lies with Chicago's grain markets—not supply demand economics; if the stock market declines, the fault surely lies with program trading—not macroeconomic causes; if crude oil prices soar, the fault surely lies with futures speculators—not the Middle-East crisis. Kill the messenger and surely the bad tidings will disappear as well.

In such a world, it is imperative that our industry be united and ever vigilant to the dangers of misguided national or local politics, unwarranted regulatory demands, regional jealousies, and competitive threats from abroad. Toward this goal, the Chicago Board of Trade and the Chicago Mercantile Exchange recently cast aside their traditional differences and took some giant strides toward doing exactly what their leaders have preached. The unification of Aurora with GLOBEX and the historic mission to explore consolidation of functions, procedures and operations is of monumental significance if our two exchanges and our respective memberships are to remain viable and maintain Chicago as the world capital of futures markets.

And in today's world, it is equally imperative that the CFTC be vigilant in its efforts at strict rule enforcement, as well as unyielding in its defense of our jurisdictional heritage and the unique values our markets represent—and to its credit, it has been. For our federal regulator recognizes as we have, that in the globalized, telecommunications interconnected world of today, the same changes that have made our markets so successful are the very changes that can cause them to be swiftly exported to another shore. There are many waiting with open arms.

Indeed, the value and indispensability of futures and options markets within a market-driven economic structure was quickly recognized by none other than President Gorbachev when he called for a break with the legacy of centralized Stalinist economics and the establishment of securities and commodity exchanges in the Soviet Union. In a very demonstrative way, Mr. Gorbachev confirmed that what we initiated here in Chicago two decades ago is of a structural nature and permanent. In a very real sense, our revolution caused theirs to fail.

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