CHICAGO FUTURES IN THE TWENTY FIRST CENTURY?

Submitted to Crain's Chicago Business
Op. Ed.
May 15, 2000

The world of futures that I encountered when I came to the Chicago Mercantile Exchange as a runner in the 1950s is long gone. Our technology then was chalk, black boards, and the teletype. In few places has the impact of the computer and modern information technology, which effected every nook and cranny of life on this planet, been more pronounced than in the financial markets. Alas, U.S. financial exchanges, especially US futures markets, have been slow to grasp the full implication of these transformations—their neglect eclipsed only by the inertia of U.S. regulators. The consequence of this compounded inaction might very well serve to validate the recent Chicago Tribune lead editorial of April 23, 2000, which spoke of the imminent demise of Chicago—and as a result the US—as the capital of futures markets. But the editorial, as Mark Twain might have said, is a bit premature—maybe even dead wrong. Besides, it hardly touches the surface of the complex issues involved.

It is now within the grasp of most financial institutions to acquire and operate trade execution systems that duplicate the trading function of exchanges. As a result, every dealer is poised to create an exchange or join and expand the operation of an existing exchange. There is a major story almost every day announcing a new alliance to operate an exchange or a quasi exchange. There is no technological barrier to cross-border operations, and foreign exchanges want their share of the U.S. transaction business.

All the while, American traditional exchanges have been kept in a regulatory straight jacket. Antiquated rules and product restrictions have made it nearly impossible for them to compete in the altered financial landscape.

Not only must they meet a revolutionary transformation, they are in a battle for their lives in Washington DC. Indeed, the new entrants are aghast that they might be subjected to CFTC jurisdiction and regulation if they create their own electronic exchanges. Thus we have been treated to a bizarre spectacle as every segment of the derivatives industry tries to explain why its proposed or projected exchange is not really an exchange and should not be treated like the CME, CBT or NYMEX.

The efforts of new exchange entrants to avoid a consistent, logical definition of exchanges that would subject them to CFTC jurisdiction have been matched only by the efforts of SEC regulated securities exchanges to keep futures markets from competing in turf they have reserved for themselves. Seventeen years ago, the Shad-Johnson Accord resolved a jurisdictional conflict between the SEC and the CFTC. It was not intended as a permanent barrier to innovation and growth. Today, Shad-Johnson is being used as a weapon against competition. Stock index futures, invented on futures exchanges, have matured into vital financial management tools that enable pension funds, investment companies and others to manage the risk of adverse stock price movements. Futures exchanges have been frozen out.

Further, while the SEC and its clients are fighting to constrain the ability of U.S. exchanges to trade equity derivatives, foreign exchanges and the OTC market are eager to fill that gap. Foreign exchanges are pouring into the U.S., but no guarantee of reciprocity has been extracted that would permit U.S. exchanges equivalent treatment in foreign jurisdictions. Thus, traditional U.S. exchanges are being squeezed by the combination of their own immobility, technological advances, and U.S. regulatory inertia.

The foregoing realities are driving nearly every traditional exchange to consider a transformation of its structure. For centuries financial exchanges have been member-owned organizations. But nearly all of them are considering a change from a non-profit, member-owned structure to a for-profit entity with publicly traded stock. The shift toward electronic trading of stocks, futures, and options changes not only the manner of how these instruments are traded but also the organization, governance, and finances of the exchanges on which they are traded. At the Chicago Merc this transformation is nearly completed. We expect to be the first American exchange to achieve this objective.

By way of historical context, the CME, in juxtaposition to other American markets and contrary to the broad brush of condemnation used in the Chicago Tribune editorial, anticipated the impact of advances in information technology. We embraced the changes brought about by globalization and recognized the competitive demands of OTC derivatives. In 1972, we initiated the idea of financial futures. A decade or so later, our GLOBEX concept first introduced the world to the idea of electronic trading in futures. We spent years negotiating with foreign regulators to secure access to offshore markets. We spent tens of millions rewriting our clearing system, making it the standard for the industry. We consistently updated our contracts to reflect new competitive realities. We used technology to expand the capacity of our existing trading floor. Sadly, the CME too for a long time lost precious ground in a fierce tug-of-war between the certainty of an open-outcry past and the insecurity of a technological future. Nevertheless, about two years ago the process righted itself.

We took some bold measures dictated by technological challenges and prepared to reshape our corporate structure to a for-profit composition. We are ready to defend our franchise.

But the hour is late. Nothing we do internally will suffice unless we also achieve regulatory reform. The issues are before Congress as we speak. While we support relief for the OTC market and the opening our markets to foreign competitors, we cannot support a package that gives relief to one segment of the derivative market at the expense of domestic exchanges. Congress must lift the single stock futures ban and repeal Shad-Johnson this year. If the clock strikes midnight before the futures markets of Chicago—the very entities that created the primordial soup from which evolved today’s modern derivatives market with its $80 trillion derivatives contracts—do not complete their modernization agenda or are not allowed to compete equally with every other derivatives counterpart, whether foreign or domestic, then Chicago may indeed lose one of its great economic engines. I pray not.

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