Foreword to The Pacific Rim Futures and Options Markets,
October, 1991.

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Financial futures markets have been fully embraced by the nations of the Pacific Rim. This was of no small significance in the evolution of futures markets. The Pacific Rim accounts for nearly half of the world's population and represents an economic force equal to any region of the world. The actions of the Chicago Mercantile Exchange in 1984 in forging a unique link with the Singapore International Monetary Exchange was unquestionably a most influential event in hastening the acceptance and growth of financial futures in Asia.

Of similar influence was our continuous assistance and encouragement of the Japanese government to open its doors to our markets. Clearly, the potential of financial futures in Asia could not be fulfilled without complete Japanese acceptance of this market regime. Recent actions of the Japanese government— including its liberalization of commodity fund rules—is compelling evidence that Japan recognizes the importance of our markets in risk management and the need to allow its utilization by their citizens for investment purposes. Similarly, the Japanese Ministry of Finance express approval of GLOBEX for use by its nation's financial community can be viewed as a giant step toward the integration of world markets and of Japan's acceptance of this reality.

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"The Mediterranean is the ocean of the past, the Atlantic the ocean of the present, and the Pacific the ocean of the future," so said John Hay, the American Secretary of State at the turn of the Century. And while it can certainly be argued that the future took its good time getting here, make no mistake, the future of the Pacific Rim has arrived. Today the countries of the Pacific Rim represent a combination of developed and developing nations that jointly embody an economic force equal to any region of the world. "Today," states John Naisbitt, in his Megatrends 2000, "the Pacific Rim is undergoing the fastest period of economic expansion in history, growing at five times the growth rate during the industrial revolution."

The geographic area involved is as large as it is diverse. By its all-inclusive definition, it accounts for two-fifths of the world's surface and nearly half of the world's population. By any standard, the nations that encompass the Pacific Rim are dissimilar in many fundamental respects, with differences ranging from culture to political systems to economic orders. Their differences also run the gamut from those, in the words of the Economist, that are "as rich and stable as Japan and as poor and turbulent as China, as big and open as America and as small and closed as North Korea."

Japan is the financial colossus of region, encompassing a vast and complex business infrastructure which includes some of the world's largest securities firms and banks. Australia and New Zealand provide the anchor on the South. Australia, almost as large as the continental United States, is more British than Asian but its location makes it imperative for the continent to think Asian. The newly industrialized countries (NICs) include Singapore, Hong Kong, South Korea, and Taiwan. Hong Kong will revert to China in 1997 and become a uncommon segment of this vast and underdeveloped giant. Then there are the members of the Association of South East Asian Nations which include Indonesia, Malaysia, the Philippines, and Thailand.

Although there are many ties other than geographical between these nations, there is a sufficient common denominator based on a similar economic evolution that brought some of these states to employ or consider employing the markets of futures and options. While their current experience with these markets is of recent vintage, futures markets are not new to the region. Indeed, it was in Japan during the Edo period (1600-1867) that centralized futures markets were born. The locale was Osaka, where feudal lords established warehouses to store and sell rice that was paid to them as land-tax by their villagers. In 1730, to protect themselves from wide price fluctuations between harvests, these merchants established the Dojima Rice Market, the first organized futures exchange.

Over two hundred years later, futures markets officially returned to the Pacific Rim with the birth of the Sydney Futures Exchange (SFE) in 1960. The SFE was also the first Asian futures exchange to launch a financial contract in 1979. However, the critical catalyst in the modern development of futures and options markets in the Pacific basin was the revolutionary link in 1984 between Singapore's SIMEX and the Chicago Mercantile Exchange (CME). It served to spur the race for financial futures dominance in the region. A year later, Japan re-entered the futures markets arena when the Tokyo Stock Exchange (TSE) launched its successful Japanese Government Bond contract. This important event was quickly followed by the inception of futures trading at the Osaka Securities Exchange (OSE) and the birth of the Tokyo International Financial Futures Exchange (TIFFE). There was no stopping the process now. The community of nations of the Pacific Rim had fully embraced the financial futures revolution.

Nor could it be otherwise. The vibrancy and native talent of the Pacific-based populations, the wealth achieved as a consequence of decades of successful manufacturing and export, and the resulting potential of their financial centers all combined to make the region a vast store of financial strength and a force equal to any in the world. This expanding base of capital markets could not continue very long or compete on a global scale without the development of futures markets. The advent of globalization, greater interdependence, modern telecommunications capabilities, instant informational flows, immediate recognition of financial risks, and opportunities and intensified competition made the management of risk an essential prerequisite of success for every financial community. To address this new financial imperative, it was mandatory for the nations of the Pacific Rim to turn to the unique mechanisms provided by futures and options markets.

It was axiomatic. The financial futures revolution, launched in Chicago in 1972, blazed the trail for much of what has since followed in world capital centers. The CME was the first major exchange to recognize the significance of the demise of the Bretton Woods Agreement, the post World War II pact that instituted a fixed exchange-rate regime for the major world nations. To capture the potential of the free market epoch that was about to ensue, the CME created the International Monetary Market (IMM), the first futures exchange for the specific purpose of trading in financial instruments. The era of financial futures was thus born. While the new wave of futures began with currency contracts, it was quickly followed by futures contracts on U.S. government securities—Treasury bills at the Merc, and Ginnie Mae certificates and Treasury bonds at the Chicago Board of Trade (CBOT). Later, when in the early 1980s the concept of cash settlement in lieu of physical delivery was instituted, the stage was set for the CME's introduction of Eurodollar futures. This paved the way for stock index futures and initiated the era of index markets.

The financial futures revolution was destined to profoundly alter the history of markets. It established that there was a need for a new genre of risk management tools suitable for sophisticated strategies and responsive to professional and institutional money management. It proved the necessity of futures and options within the infrastructure of finance and alongside other traditional structures of capital markets. From their inception, the markets of futures and options understood and embraced the common denominator of recent world upheavals—the spectacular advances in technology. Clearly, no other single factor was more instrumental in influencing political and economic change than was the technological revolution of recent years.

On the political front, modern telecommunications fostered instant informational flows in total disregard of national boundaries, offering a stark, uncompromising comparison of political and economic life and making it near impossible for governments to hide the truth from its people. On the economic front, modern telecommunications made instantaneous price information available globally and fostered massive capital flows in an unencumbered fashion. It dramatically changed the nature of global capital markets forever. The markets of futures and options recognized this march of technology, understood its inexorable impact on commerce and trade, and willingly adapted to its demands. Thus it is no accident our markets represent one of the greatest growth arenas of the last two decades.

Events in Eastern Europe and the Soviet Union during the last several years have dramatically confirmed the significance of the financial history of the last two decades. The bankruptcy of command economic order, the downfall of communist rule, and the collapse of the Soviet Empire serve as undeniable testimony to the value of capitalism and market-driven economics. The markets of futures and options are integral to that victory. Indeed, what markets better epitomize price determination by virtue of the free forces of supply and demand than do the markets of futures and options? During the past decade, beginning with the 1982 establishment of the London International Financial Futures Exchange (LIFFE), new financial futures exchanges have opened in virtually every major world financial center, including the Marche A Terme International de France (MATIF) in Paris, the Swiss Options and Financial Futures Exchange (SOFFEX) in Zurich, the Deutsche TerminBörse (DTB) in Frankfurt, not to mention the exchanges in the Pacific Rim itself. The dramatic success of this history prompted Nobel laureate Merton Miller, University of Chicago professor of finance, to nominate financial futures as "the most significant financial innovation of the last twenty years."

Indeed, if financial futures and options were not yet invented, they would need to be. They are indispensable in a world that demands the ability to swiftly institute complex strategies or to cost-effectively adjust portfolio exposure between securities and cash. They are ideally suited for a world where tailored risk management strategies is on the increase and where opportunities rapidly appear and disappear on a constantly changing financial horizon. They are a vital option in a world in which it is often imperative to utilize a credit-worthy mechanism that preserves credit lines. They are without equal in providing a vast array of products combined with an envious measure of liquidity and an incomparably narrow bid/ask spread. They are the avant garde of market innovation and soon, as a consequence of GLOBEX—the after-hours electronic trading system being developed by the CME and the CBOT in conjunction with Reuters PLC—will achieve market coverage on a 24-hour basis. And most significantly, they are well-positioned for a world where professional money management is the wave of the future. What was imperative for the financial structures of other global regions has become equally imperative for Pacific basin. And this process is not yet complete. Some of the Pacific Rim communities are just beginning to emerge from their formative development stage. More to the point, the vast financial potential of mainland China is yet to be unleashed. Is there any doubt that the same forces that brought about the downfall of command order economics in the Soviet Union will achieve a similar result in China? Is there any doubt that its highly competent people will someday join the market rebirths occasioned by the other Asian populations? And when it happens, it will exponentially effect the strength and vitality of the Pacific Rim.

Although there are some heavy macroeconomic clouds overhead, the long-term direction in the evolution of global markets is unmistakable. In a world—where the distinctions between the major time zones has vanished, where geographical borders that once could limit the flow of capital are but history, and where traditional internal protections that could insulate ones' citizenry from external price and value influences are no longer valid—a market-driven economic order is quintessential and futures and options are a critical component. For the expanding region such as the Pacific Rim—with its vast and diverse cultures and infrastructure, and with its still untapped and developing potential—there can be no other course.

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

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