25 CHICAGO ICONS
Futures force: Leo Melamed
is the former Chicago Mercantile Exchange chairman who, more
than anyone else, personifies the institution.
Formed in the shadow of the Chicago Board of
Trade, the Chicago Mercantile Exchange has since
eclipsed its crosstown rival. But challenges remain.
BY STEVEN R. STRAHLER
Contemplating a new futures contract in 1961, Chicago Mercantile
Exchange officials wondered if there might be a better name for,
uh, pork bellies. How about . . . bacon?
No way: That's what the government called them, and pork bellies
it would have to be.
For decades, no other product was more closely (and often derisively)
identified with the Merc. Pork bellies helped revive an institution
that was nearly fatally wounded in 1958 when Congress, reacting
to Merc abuses, outlawed, of all things, onion trading.
The Merc had been left with exactly one, equally sexless, product:
It was a laughable situation for an institution known as the Whorehouse
of the Loop--a backwater pit at 110 N. Franklin St. where market
squeezes and corners were the order of the day.
Chicago's real futures exchange stood at the other end
of the Loop--the mighty Chicago Board of Trade (CBT), almost as
old as the city itself, in a signature building that helped define
the face of LaSalle Street's financial district.
It took the Merc, founded in 1919 as a successor to the Chicago
Produce Exchange (1874) and the Butter and Egg Board (1898), more
than 60 years--until it had broken ground on its current home at
10 and 30 S. Wacker Drive--to trade 100 million contracts.
Last year's volume, in contract, topped 550 million, more than
half again as much as the CBT's and enough to make the Merc the
second-largest futures exchange by that measure and No. 1 by several
'Little exchange' on NYSE
The triumph of the Merc, (which, of course, did not mean the end
of chicanery in its pits) is one of the wonders of the last 25
years in Chicago business history. Last fall, defying market
doldrums for initial public offerings, it became the first U.S.
futures exchange to go public, albeit in limited fashion, as
Chicago Mercantile Exchange Holdings Inc.
Leo Melamed, the former Merc chairman who more than anyone is
the personification of the institution, exclaimed, "That
little exchange is listed on the New York Stock Exchange. My God!"
makeover, Craig Pirrong, professor of finance at the University
of Houston and director of its Global Energy Markets Institute,
says, "If I had to characterize it in one word, it
would be innovation--being a thought and product leader for the
derivatives industry worldwide."
Fueled by financial futures, which now account for 99% of exchange
business and dwarf those pork bellies, Merc volume has zoomed since
1999 by a compounded 40% a year. Annual expense growth meanwhile
has been just 10%, allowing operating margins to hit a lush 34%.
Earnings last year surged 25% to $91.4 million on a 17% rise in
revenues to $453.2 million.
Timing and luck--two friends of any trader--blessed the Merc.
Within a year of the dawn of flexible exchange rates in 1971,
the Merc established a separate (later integrated) International
Monetary Market to trade currencies.
A decade later,
just as the stock market began to roar, the Merc was ready with
a pioneering stock index product based on the Standard & Poor's
The electronic edge
Today, it is still in the sweet spot with interest-rate-sensitive
eurodollar contracts and a junior version of the S&P 500
contract designed to appeal to increasingly sophisticated retail
investors. In March, daily volume in that electronic "e-mini" product
hit 1 million contracts for the first time.
Overlaying it all is the promise--and menace--of electronic trading.
The Merc is
the local leader in computerized "upstairs" trading,
traditionally viewed as a threat to the livelihood of "open outcry" practitioners
in the pits.
Its Globex system, introduced more than a decade ago, gave the
Merc a huge jump on the CBT in tapping into overseas markets, where
trading hours don't mesh with pits operating under a Chicago clock.
For the first time this year, the Merc's electronic volume, 35%
of the total last year, is likely to surpass floor volume.
However, electronic trading also has spawned powerful competitors,
namely Germany's Eurex AG, now the world's top-volume exchange,
which early this year broke off a relationship with the CBT and
said it would start a competing U.S. exchange.
Over the next 25 years--or a lot less--according to industry seers
like Mr. Melamed, the business will go all-electronic and a natural
duopoly of two exchanges is likely to emerge. Will the Merc be
one of them?
It has the currency, in the form of publicly traded stock, to
do deals. But since the IPO encompassed only 15% of Merc shares,
its board remains dominated by insiders wary of diluting their
"Nothing's changed--just that they have an extra $117 million
to play with," grumps former Chairman Larry Rosenberg, referring
to IPO proceeds, and concerned about perennial governance and management
succession issues that dog the Merc.
'Joined at the wallet'
Throughout its late success, the Merc has been shaped by two egotists
sharing a complex, practically codependent relationship: Mr.
Melamed, an edgy immigrant who fled Poland with his parents ahead
of the Nazis, and the equally hyperactive and hypersensitive
Jack Sandner, a former amateur featherweight boxer, and like
Mr. Melamed, a non-practicing lawyer.
"It wasn't just a smooth, Ozzie-and-Harriet relationship through
the years," acknowledges the pugnacious Mr. Sandner, conceding
that he has led too often--literally as well as figuratively--with
a right hand.
The Leo and Jack Show has, at times, flared into outright hostility,
only to be fused anew during times of crisis, like when Wall Street
tried to blame Chicago's exchanges for the Crash of '87. A subsequent
government sting aimed at pit practices had Mr. Melamed accusing
Mr. Sandner of lying about his role in one of the brokers associations
"Although he didn't commit a rule violation, he violated my trust
and endangered the exchange," Mr. Melamed wrote in his 1996 autobiography,
recalling a shouting match near the elevator banks between their
offices. "I was furious." (Mr. Sandner says he doesn't remember
Mr. Melamed's complaint.)
in anticipation of the IPO, they engineered a board revolt that
dumped Scott Gordon as chairman in favor of someone more to their
liking. Now, according to a former insider, Mr. Sandner--the
exchange's largest inside shareholder--and Mr. Melamed "are
once again joined at the wallet."
For all the infighting, the Merc has enjoyed a consistency of
leadership that fostered growth, particularly in comparison with
the fractious CBT, where a retrogressive chairman was elected in
1999 and tossed out two years later by a combined margin of 27
Helping governance is the fact that the Merc's chairman is elected,
parliament-like, by the board and not (as is the CBT's) directly
by an always-restive membership.
Moreover, says former CBT Chairman Leslie Rosenthal, who simultaneously
served on both exchange boards from 1974 to 1978, Merc leaders
relished pouring their energies into the underdog institution,
often at the expense of their own businesses.
"You got that right," says
the 61-year-old Mr. Sandner, who felt compelled to match the
globe-trotting Mr. Melamed step by step. "There's no way I could show weakness, no matter how tired
From time to
time, Mr. Melamed, now 71 and senior policy adviser, would say
he was retiring from exchange politics, only to come back. "I love the power, the decision-making. That's hard to
let go of," he confessed in his hagiography, "Escape to the Futures."
No event better illustrates the shift in Merc fortunes than the
eventual acceptance of the S&P contract, first by S&P
itself and later by pension fund managers and other institutional
customers interested in lower-cost leveraging or hedging of their
"Futures on a quality index? It was sort of a dirty thing, if
you will," recalls Ira Herenstein, a former S&P president,
recounting ambivalence about the the Merc's reputation before a
difficult-to-value deal was struck in 1980.
The parties agreed on 10 cents a contract with an annual cap that,
as the product caught on, turned out to be a steal for the Merc.
"I told Leo we needed a better deal, we needed more money," says
Mr. Herenstein, recounting a spur-of-the-moment phone call from
the Atlantic City boardwalk. "It turned out to be a very difficult
Despite its contractual rights, the Merc in 1984 agreed to higher
payments under a longer-term arrangement.
"It changed our whole image about the Chicago Merc, about futures,
about those trading vehicles," says Mr. Herenstein, now an assistant
to the chairman of New York-based economic consulting firm Global
Exclusive access to a branded contract (the CBT has a less successful
deal with the Dow Jones index, and the Merc has another with Nasdaq),
coupled with a captive unit through which all trades must be cleared,
gives the Merc pricing power that fattens margins and makes big
"As long as business has been business, people have been complaining
about prices," retorts Merc Chairman Terrence Duffy, who dismisses
any suggestion of protected monopolies. "You could start a eurodollar
True, but the Merc's brand name (and intensifying efforts to promote
it) confers a prohibitive advantage. Once liquidity is established
by a futures exchange, it's difficult to dislodge.
Eurodollar volume, for example, not only has remained with the
Merc, but all but 4% is still traded in the pits, because the multifaceted
10-year contract, spread over 40 trading quarters, is too complex
Globex successor called Eagle, launched in January, aims to address
those limitations. "It's out there, but we don't
know yet," concedes Mr. Sandner. "If it works, we'll switch.")
is not long on sentiment. If something doesn't work--such
as a dot.com b-to-b effort--the search is on for the next dollar
sign. Shrugs Mr. Duffy, "No different than the tech market: When
that bubble burst, so did b-to-b."
'Someone from the ranks'
Last spring, restless Merc directors ousted Mr. Gordon because
various opponents on the board felt, rightly or wrongly, that
he sided with management over member interests and would have
a hard time articulating the case for an IPO. (Mr. Gordon,
who remains one of the Merc's 20 directors, declined to comment.)
The 44-year-old Mr. Duffy is a smoother-talking, flashier-dressing
hog trader with political blood in his veins: His grandfather,
John J. Duffy, was a 19th Ward alderman and president of the Cook
County Board, and his father John J. Duffy Jr., worked in the county
"I think I was a stronger candidate, to be honest with you," says
Mr. Duffy, whose credentials include being a "local," or independent,
trader--unlike Mr. Gordon, president and chief operating officer
of Tokyo-Mitsubishi Futures Inc. "It needed someone from the ranks
to take it to the next level."
A particularly contentious issue--but one on which Mr. Duffy says
he was on the same page as Mr. Gordon--was a lucrative contract
for President and CEO James McNulty, paying as much as $2.5 million
annually, plus stock options worth $34.3 million as of Dec. 31.
Some think that Mr. McNulty, hired three years ago from a Wall
Street firm, is now expendable after having shepherded the IPO.
Mr. Duffy is noncommittal about a contract renewal.
He's no more
specific about the Merc's next, IPO-fueled move, though globalization
is more than just a cliché for an institution that has been signing "memorandums of understanding" for
joint initiatives with exchanges in the Far East.
as usual, Mr. Melamed says: "We have not
yet gone into the galaxy, but we're thinking about it."
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