Essay published by Global Investment Management,

deco line

The CME's official announcement of P-M-T, the after-hours electronic trading system—whose permanent name was later to become GLOBEX—sent shock waves through the futures industry. It represented a violent break with tradition, something to be feared and abhorred.

To those of us who had envisioned this revolutionary concept, it represented quite the opposite. To us, use of technology represented the recognition of reality. It embodied the use of mechanisms that could protect our market share from foreign competition as well as from competitive and hostile domestic pressures all about us. To us, the march of technology was a force one could not deny nor ignore.

But how does one convince the rank and file of an industry—one so committed to open outcry that the very thought of automation sent shivers down its collective spine—to accept technology? The task was not easy. The odds were long and the bets were against us.

The following represents the rationale for our action. It became the CME GLOBEX manifesto. It was imperative that it be understood and accepted by our members. It was imperative that it be heard around the world. It was imperative that the mechanism we proposed become the only international system for futures and options. Today, this GLOBEX rationale represents the orthodox view of the futures industry worldwide.

deco line

In a bold and far-reaching joint undertaking, the Chicago Mercantile Exchange (CME) and Reuters Holdings PLC (Reuters) entered into a long-range agreement to create a global electronic automated transaction system for the trading of futures and futures-options. The system, called P-M-T (Post Market Trade—its working designation) will operate worldwide before and after regular U.S. business hours. P-M-T will allow transactions to be matched directly against CME open positions and will be cleared by the CME clearing system. The undertaking was overwhelmingly approved by referendum of the CME membership on October 6, 1987. The concept embodied in P-M-T is clearly an historic milestone in the development of the futures trading. It embraces the realities brought about by the technological revolution of recent years and represents a giant step towards unification of the separate world's financial centers. It puts the CME light-years ahead of its competition.

Since the fundamental principle of the CME/Reuters agreement involves a significant departure from "established" futures industry philosophy, it is imperative to began this discussion by addressing its impact on the quintessential element of present-day American futures: open outcry.

It is fair to say that most observers and users of futures markets hailed the CME announcement with admiration and approval. Yet, it should be of little surprise to anyone that this view was not unanimous. There are many within our industry who are vocal critics of any movement toward automation, or (in some extreme cases) even the adoption of technological advancements. These elements argue that such reforms advance the black box and hasten the end of open outcry. Obviously, the CME feels differently. Although we too hold open outcry sacred, we do not agree that such a philosophy requires a blind adherence to status quo.

Futures and futures-options are dynamic and continuously evolving. As our markets became the standard tools for risk management the world over—as their applicability extended to new products, new techniques, and new users—we grew from a 1976 volume of approximately 37 million contracts to a 1986 volume of 216 million contracts. Today the futures industry is not in any way, shape, or form the same industry that spawned the financial futures revolution in 1972. Nor does this industry bear much resemblance to the one that fought to prove its merit during the formative years of its existence. We are today but a distant cousin to that which gave us life and, while we must respect our heritage, we must not be held back by its limitations.

Throughout our dramatic metamorphosis and expansion, the open outcry system for execution of futures has been the only proven system for achieving the degree of liquidity necessary to produce and maintain a viable market. This is still the case and it would be futile for anyone to argue otherwise. However, to blindly assume that it will always be so, is to be lulled into a false sense of security and forgo any opportunities to enhance or advance our way of doing business. Such a policy is both foolish and dangerous.

Open outcry, for a multitude of reasons, is under attack. Whether it is because of the system's inherent limitations, new and more efficient technologies, new users and uses, competing securities exchanges, foreign pressures, or competitive off-exchange applications, the fact is that open outcry is being scrutinized and its efficiency and necessity is increasingly being questioned. Those who close their eyes to this truth do the open outcry system a severe disservice.

Indeed, in order to preserve open outcry, it is imperative that we examine the state of our industry in light of current demands on our markets and in the context of those very competitive and technological pressures that attack the present system's viability. We must not only examine these issues, we must be willing to respond to them in a manner that is consistent with the findings. At a minimum, this means we must be ready to accept those aspects of technology as well as those transaction modifications that can be integrated with and applied to open outcry without materially detracting from its inherent values. While this may not by itself guarantee the continued life of open outcry, it will certainly enhance its chances and serve to protect the future business flows to our exchange floors.

Open outcry is predominantly an American phenomenon. With few exceptions, other world centers have not long had this tradition nor had much success with its application. Consequently, many foreign centers have opted for either a partial or total automated execution system. For example, the Japanese Government bond futures market—often cited as the most successful foreign futures market—was not established on an open outcry foundation and is destined to become fully automated within a year or so.

While the futures market pits remain the single most important source of present-day liquidity, they are no longer the only source. Today, there exists an army of upstairs traders whose trading methodology is not dependent upon eye-to-eye pit contact, but rather on two instruments: the computer-screen and the telephone. Using these instruments, upstairs traders buy and sell in rapid fashion throughout the day and provide a continuous flow of orders to the market. They represent a liquidity-source nonexistent just ten years ago. While upstairs traders cannot, in the near future, replace the liquidity source of pit traders, there is no denying that the former is a growing universe with no visible limitation on its expansion. More important, upstairs traders are especially well-suited for the automated execution process.

In foreign centers this new source of liquidity is likely to develop more quickly than would its open outcry counterpart. Consequently, an automated execution system is much more likely to succeed in non-U.S. time zones especially if the foreign system were interlocked with its successful American open outcry counterpart.

The recommendation to create P-M-T stemmed from a comprehensive, year-long study undertaken by the CME's Strategic Planning Committee which is charged with reviewing fundamental industry issues and problems. Not surprisingly, the Committee determined that there are three critical issues facing the futures industry: globalization, automation, and off-exchange expansion. Its recommended solution was a single response embodied in an automated after-hours transaction system.

The marriage of the computer chip to the telephone changed the world from a confederation of autonomous financial markets into one continuous marketplace. No longer is there a distinct division of the three major time zones—Europe, North America and the Far East. No longer are there three separate markets operating independently of external pressures by maintaining their own unique market centers, product lines, trading hours, and clientele. Today, users of every market come from around the globe because news is distributed instantaneously across all time zones. When such informational flows demand market action, financial managers no longer wait for local markets to open before responding. Rather, they have the capacity to initiate immediate market positions—a capacity that has come to be known as globalization. With globalization, each financial center has become a direct competitor to all others, offering everyone new opportunities and challenges.

During the past several years, exchanges have attempted to meet the globalization challenge by searching for alternative solutions to preserve local business flows and attract business generated on foreign shores. With varying degrees of success, these actions involved either electronic linkages with foreign exchanges or, more recently, extended trading hours. While it is still too early to fully evaluate the long-term effectiveness of these alternatives, neither appear to represent an adequate response to the opportunities and perils of the 24-hour trading day.

Electronic linkage, via a system of Mutual Offset (MOS), was pioneered in 1984 by the CME and the Singapore International Monetary Exchange (SIMEX). It proved that markets in separate time zones can be linked to allow safe access to each other's open interest, thereby giving both markets the advantage of the other's non-regular trading hour business flows. Although successful, the CME/SIMEX experiment and other similar linkages that followed, identified certain limitations to their overall effectiveness: that linkage is not useful or successful for every type of financial instrument; that regulatory and legal complications make it uncertain whether electronic linkage can be achieved on a worldwide basis; that competitive considerations between different market centers complicate the implementation of a worldwide linkage system; and that no single link-up can cover the entire 24-hour trading period.

The concept of extended trading is not new. From time-to-time, all exchanges have restructured and extended their regular trading hours (RTH) to accommodate new business flows. Such past trading extensions have more or less proved successful. However, extensions of RTH beyond the parameters of normal business hours, as was recently instituted by the SIMEX, the Chicago Board of Trade and the Philadelphia Stock Exchange (with other exchanges planning to follow suit), are far different in scope than RTH extensions in the past. The problems of these new RTH extensions are considerably more severe. There are the human issues: the ability to attract a sufficient number of capable night-time market makers, the strains on personnel, the disruption of traditional life-patterns. There are the liquidity concerns: will domestic night-time business flows be sufficient to maintain a liquid market until the anticipated foreign business is developed? There are the monetary considerations: the cost to member firms in maintaining night-time trading and back-office facilities until the operations become profitable. Nevertheless, on the surface the night session seems successful; transaction volume has been good and, some say, better than expected. Moreover, these sessions have and will benefit from sporadic surges in volume whenever events occurring after RTH warrant market action.

However, some fundamental concerns about these night sessions remain unanswered: Extended night trading, as a response to globalization, addresses only a small portion of the hours of the foreign business day; It is highly unlikely that the session can be successfully extended the full 16-hours necessary to cover the other two principle financial time zones; The extended night session at best, can only be applied to selective instruments of trade and will become increasingly more difficult as additional products are attempted; It is highly doubtful extended night sessions in the U.S. time zone will dissuade a foreign financial community from instituting its own exchange, in its own time zone, during its own RTH; Once a foreign RTH exchange has been successfully established, it will very likely become the dominant center for business from its own locale. It will then act as a strong magnet for all business flows during its own RTH, thus impeding the growth and purpose of a night market on a distant shore.

Consequently, while it is far too early to be definitive, unless unforeseen events intervene, the extended trading solution of a night market in the U.S. seems to have limited potential. While, undoubtedly, it will be a window of opportunity for the next several years, ultimately it can only hope to attain a secondary market niche by way of arbitrage and minor business flows.

P-M-T is the Chicago Mercantile Exchange response to the demands of globalization. It will be an after hours automated transaction system that will utilize the Reuter Dealer Trading System (RDTS). The P-M-T concept combines elements of electronic linkage with those of extended trading and integrates them with the open-outcry system. In effect, it draws the best from the present and marries it to the technology of the future. The ingredients of the new trading system will include all the critical elements of a viable trading environment: the liquidity and open interest of the CME financial markets—representing the comprehensive spectrum of instruments comprising the CME financial markets as well as selected foreign financial instruments; a communications organization with the largest international network of communications hardware as well as the technological capability to create and conduct an automated transaction system; and the capability, credit-worthiness and established financial integrity of the CME clearing system.

The international implications of P-M-T are self-evident and will be felt throughout the world financial community. It translates into opportunity and cost-efficiency whether you are a banker in Tokyo, a risk manager in London, an investor in any part of the world. P-M-T means that the financial markets of the Chicago Mercantile Exchange, with their operational capabilities, liquidity and safeguards, are open—not just during the regular trading hours of the CME trading floor, but around the clock. Unlike electronic linkage, P-M-T can be applied to every market equally. Its worldwide implementation will be simple when compared to the practical and legal complications of the electronic link-up alternative.

Clearly, P-M-T has universal application and appeal. Since our announcement, we have been approached by members from virtually every center of finance for information about how to participate in the global system we envision. It is well these questions are asked. For it is fully the intention of the Chicago Mercantile Exchange to extend its P-M-T concept to every center of trade and finance.

We intend and will devise methodologies that will accommodate direct access and participation for all communities the world over. It is not our intention to keep P-M-T so closely to ourselves that we exclude participants who can meaningfully contribute to the success of the concept. To the contrary, we have advised all that have come forward that the built-in flexibility of the P-M-T structure will allow for the participation of their community and individual members. We invite all other representatives from world centers of finance to join in this revolutionary concept and help us create a truly universal transaction system.

P-M-T is a bold and comprehensive response to the opportunities resulting from globalization as well as the dangers posed by automation and off-exchange expansion. It represents a global transaction capability whose time has come. When combined with CME's regular trading hours, it can provide the world with its first literal 24-hour trading system.

Reprinted by permission. Excerpted from Melamed on the Markets, by Leo Melamed. John Wiley & Sons, 1993

Return to top of page | Return to Index | Home Page



Page absolute bottom placeholder