SHAPE OF THINGS TO COME
at the Chicago Mercantile Exchange London Financial Symposium,
November 10-11, 1988.
1977, I wrote an article for the Hofstra University Law Review
on the mechanics of a commodity futures exchange. In it, I
concluded that an automated transaction process cannot supplant
the trading floor nor the open outcry system. That article
was used by detractors of GLOBEX in their attempt to discredit
my sanction and praise of an automated after-hour trading system.
attempt failed. First, because the Hofstra article was written
a decade before GLOBEX, for a world radically dissimilar to
present market realities. Ten years ago, globalization was
a mere theory, futures were but an American phenomena, their
scope, volume and application rather limited, and technology—as
we know it today—was in its infancy.
the Hofstra article did not suggest that the futures industry
would cease to evolve or stop its innovative processes. To
suggest this would have been the antithesis of beliefs I hold
sacred. Then as today, I recognized that the world of futures
is dynamic, continuously evolving, and that innovation is its
middle name. Our industry cannot ever stop inventing or ignore
GLOBEX does not propose to supplant the open outcry system,
rather it will complement and protect it. While open outcry
is the liquidity engine of futures markets—and will no doubt
remain so for many years to come—it does not serve us in the
current global competitive struggle. Financial futures cannot
be patented; our contracts are being copied by foreign centers
of trade. If we do not create a mechanism that can offer our
markets to participants on a 24-hour basis, we stand to lose
a substantial portion of our market share—business on which
we thrive and which was invented on the American shore. To
do so would be the height of folly.
the late 1970s, a favorite question of financial reporters was
whether financial futures could prosper in a non-inflationary
environment. To them it was clear, futures markets were successful
and our exchanges prosperous simply because the world was then
experiencing record-breaking inflation accompanied by record-breaking
interest rates. Ah, but since such financial turmoil cannot go
on forever, what pray will happen to financial futures in more
normal times? The implication was that futures markets were no
more than a momentary blip in economic history, a fashionable
craze that would go the way of the hoola-hoop as soon as sensible
times returned. That represented the conventional media wisdom
of the day.
truth, of course, futures did indeed do rather well during the
upheavals of the 1970s. U.S. futures volume rose from an overall
11 million transactions in 1969 to 76 million transactions at
the end of the following decade, an increase of approximately
600%. Then came the 1980s and more normal times. U.S. inflation
fell by 70%, and similarly interest rates were cut better than
in half. The abnormalities of the previous decade were behind
us. But guess what? Financial futures defied dire expectations.
Rather than diminishing in importance, futures exchanges became
coveted the world over. Financial futures became an indispensable
risk management tool of money managers everywhere. U.S. transaction
volume grew every year during the "non-inflationary" eighties,
reaching 275 million transactions in 1987. Similar growth was
experienced in every world center that futures are traded.
came the 1987 October crash. At first it again looked as if the
days of these markets were numbered. At least that was again
the conventional wisdom of many in the media. We were under attack
as seldom before. Some used the moment because they viewed futures
as a competitive threat; some, because they sought control over
this arena of market activity; still others, because they feared
what they could not understand; and finally, those who believed
our markets to be inherently evil. It was a frightening process,
more frightening than even the market's display of brutal power
during the crash itself.
ignorance, and misinformation are indeed powerful combinations.
But the investigatory process led to a most unexpected result.
For in the final analysis, as Alfred North Whitehead, the noted
British mathematician and philosopher stated, facts are irreducible
and stubborn. Indeed, the truth will out. After all the
studies were in, after all the evidence was presented, after
all the analysis was made, after all the misinformation was laid
to rest, futures markets were not only exonerated from blame,
they were vindicated by receiving the highest of praise from
most academic studies and from most knowledgeable experts. The
frightening process served to strengthen, rather than weaken,
futures markets worldwide.
one doesn't hear much these days about the imminent demise of
financial futures. Quite the contrary, new financial futures
markets have been instituted or are scheduled in every corner
of the globe. It seems as if the pronouncement by Professor Merton
Miller of the University of Chicago, that financial futures were "the
most significant financial innovation of the last twenty years," has
become accepted gospel.(1) Futures
markets have become establishment. Ah, but therein lies a greater
danger. One that, to me, is no less frightening than any of those
we have vanquished. For within success lies the seeds of complacency.
Worse yet, an overwhelming preference for status quo.
futures, in my view, have occasioned two milestones in their
short history, both of a revolutionary nature. The first milestone
was their creation itself. The departure by traditional futures
from their century old agricultural base and entrance into the
world of finance dramatically changed their direction and history.
By definition, no financial futures history could have ensued
without its conceptual inception. The second milestone was cash
settlement. Once financial futures shed the requirement of physical
delivery, they opened the curtain on instruments and concepts
which were previously totally unthinkable. Cash settlement represented
the gateway to index products and seemingly limitless potential.
Proudly, both milestones occurred on the floor of the Chicago
Mercantile Exchange: in 1972 when the IMM was launched with its
first financial contracts, and in 1981 when the Merc's Eurodollar
contract became the first to attempt cash settlement.
financial futures are at the threshold of their third milestone.
Not surprisingly it is again the CME that is leading the way.
And as was the case with the first two milestones, the third
one has generated a good deal of discussion and even controversy.
For all the milestones have a single common denominator—they
each represent a revolutionary departure from status quo.
the automated global transaction system of the CME and Reuters
Holdings PLC, represents a move toward automation in the transaction
process. Consequently, it touches the very nerve center of status
quo in our industry and has incurred the criticism of those
who would oppose any movement toward change that involves automation
or adoption of technological advancements. To them such reforms
advance the black box and hasten the end of open outcry.
world of futures is dynamic and continuously evolving. Innovation
and change are at the very heart of our success. As our markets'
applicability extended to new products, new techniques, and new
users, as they became the standard tools for risk management,
the changes we engendered were dramatic and revolutionary. 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.
our dramatic metamorphosis and expansion, open outcry has been
the liquidity engine for our success. This is still the case
and it would be futile for anyone to argue otherwise. The Chicago
Mercantile Exchange, like all other American exchanges, has a
continuing commitment to the preservation of this transaction
process. However, to blindly assume that open outcry is the perfect
system for all time is to be lulled into a false sense of security
and forgo any opportunities to strengthen or advance our way
of doing business. Such a policy is both foolish and dangerous
and could lead to disaster.
a 1977 Law Review article for Hofstra University(2) on
the mechanics of a commodity futures exchange, I concluded that
an automated transaction process cannot supplant the trading
floor nor the open outcry system. I still wholeheartedly support
this view. GLOBEX is not designed to replace the present transaction
process, but rather to enhance and secure it. Nor did my conclusions
of a decade ago intimate that our industry should ever, in any
way, shape or form, be precluded from experimenting with change.
in order to preserve open outcry, we should 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. Open outcry is
predominantly an American phenomenon. With few exceptions, other
world centers have not long had this tradition nor much success
with its application. As a consequence, many non-U.S. centers
have, from the outset, 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.
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 technological 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 virtually nonexistent a decade ago. 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.
is, by now, a cliche to explain that sophisticated satellites,
micro-chips and fiber optics changed the world from a confederation
of autonomous financial markets into one continuous marketplace.
We need no reminder that there is no longer 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's
capital flows know no allegiance to time zones or geographical
boundaries. Today, as we know too well, 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.
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, it is the CME's view that neither represent an
adequate response to the opportunities and perils of the 24-hour
Chicago Mercantile Exchange understood the globalization reality
when four years ago it instituted the mutual offset link with
SIMEX. It was the first successful attempt to link the trading
capability of two different markets in two different time zones.
It served as a model for others to follow and took the world
one step closer to the global market. What's more, this experiment
provided the CME with invaluable expertise and living proof for
everyone that world markets can be safely and efficiently linked.
linkage, the question of how best to respond to the demands of
globalization has resulted in an extension of trading hours.
This concept 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 instituted
by the Chicago Board of Trade and the Philadelphia Stock Exchange
are far different in scope than RTH extensions in the past. The
purpose of these new RTH extensions as well as the problems they
pose are considerably different from past trading hours adjustments.
To date, the CBOT experiment has met with some success, but it
has been applied chiefly to one instrument and for only a small
portion of the American night.
extended trading response begs these questions: Can a night open
outcry market be successfully devised to encompass the remaining
sixteen non-business hours of the North American time zone? Can
a night open outcry market develop sufficient liquidity for a
multitude of complex financial instruments? Can a night open
outcry market sufficiently respond to the needs of all world
participants from every center of finance? Will non-U.S. financial
centers be satisfied with a night market on the U.S. shore for
their RTH financial needs? Will non-U.S. financial exchanges
also respond to globalization by creating their version of night
say the least, one must consider the answers to these questions
with some degree of skepticism. Beyond that, there is the larger
question of reality. Is there not something inherently amiss
if in this day and age there is no attempt made at unifying the
global transaction process? And if such an attempt is made, can
it ignore technological applicability? Technology and automation
are the driving forces behind today's markets, its uses and users.
Chicago Mercantile Exchange has embraced reality and chosen a
dramatically different response to the demands of globalization.
We believe GLOBEX 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. At the same time it represents
a giant step toward unification of the separate world's financial
centers. We are convinced GLOBEX correctly envisions the global
marketplace whose time has come and embodies the manner in which
the world of tomorrow will function. We have invited every center
of finance to join us as partners in this endeavor.
H. Miller, Financial Innovation: The Last Twenty Years and
the Next, Graduate School of Business, The University of
Chicago, Selected Paper Number 63, May 1986.
Melamed, "The Mechanics of a Commodity Futures Exchange: A Critique
of Automation of the Transaction Process," Hofstra Law Review,
Fall 1977, Volume 6, No. 1.
by permission. Excerpted from Melamed on the Markets, by Leo
Melamed. John Wiley & Sons, 1993
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