LIFFE

Presented at the World Financial Futures Conference,
London, England,
September 14-15, 1982.

The creation of the London International Financial Futures Exchange (LIFFE)—aside from offering an endless possibility of puns—was an enormous compliment to the concept of financial futures and a valuable boost to its short history. Indeed, many of us in the U.S. futures industry encouraged the process in Great Britain and gave our time, advice, and assistance to the Bank of England and the organizers of this endeavor—principally John Barkshire.

Consequently, it was no accident that LIFFE was modeled after the IMM. In fact, Barkshire and I—who became good friends—both believed in the possibility that one day there would be a system of mutual offset between our two exchanges similar to the system the IMM was working toward with the SIMEX. While this did not materialize, we nevertheless recognized the value of new financial futures markets around the globe: that they would validate the concept, spread the gospel, and in turn create users and uses for all futures markets.

The opening of the London International Financial Futures Exchange (LIFFE) underscores the internationalization of financial futures markets. It embodies a dual achievement: the realization of a dream for this center of finance and a clear signal that the idea of financial futures—born in Chicago—responds to a global necessity. The stage is now set in London. For those who labored these past years, the creative process is over; the many hours, the frustrations, the plans, negotiations, and the myriad of problems are now behind you. The one critical question remaining is whether LIFFE will succeed.

The financial futures community in Chicago shares your pride and your excitement. We are acutely aware of the difficult process you have just completed, and we understand your anxieties only too well. After all, it was just ten years ago that we at the Chicago Mercantile Exchange (CME) suffered similar formative pains in our creation of the International Monetary Market (IMM)—a move destined to vault a group of pork belly and cattle traders into the center of the world finance and an effort that resulted in revolutionizing our industry.

In one major respect the work of LIFFE creators was much simpler than ours. At the birth of the IMM and the conceptual introduction of financial futures, it was necessary first to convince the world financial community that financial futures are a necessary adjunct in the management of risk. It took years of late nights and early mornings, an incalculable amount of traveling, unceasing gospel spreading, arm twisting and ear bending. LIFFE has a much easier task before it than did the IMM a decade ago. Financial futures are now an accepted fact of life on our shore and undoubtedly the realistic appraisal here as well. That will not guarantee your success but at least it will make your work easier since you do not have justify your existence.

The world entered the 1980s after enduring a decade of financial turmoil never before experienced. Inflation, energy costs, changing values between currencies, volatile interest rate movements and extreme swings of commodity prices combined to create a business climate fraught with danger and one demanding new programs and mechanisms for the management of risk. It represented the emergence of a new economic order, one bound to stay with us for the foreseeable future and one for which financial futures are ideally suited. Indeed, if we had not already done so, we would need to invent financial futures all over again.

Success, however, cannot be assured simply because the idea is right. Success is the result of hard work. We hope to be here ten years from now to share with you the pride of equal success.

Allow me to offer a brief historical sketch of the growth of our Chicago markets these past ten years in order to suggest a goal for your market. During that decade, the IMM set the industry standard for growth in volume and contract diversity. The autumn of 1982 has not yet even fully arrived and already it is clear that financial futures volume at the CME will smash all previous annual records. In the first eight months of this year, IMM financial futures volume totalled 12.6 million contracts, a 40% increase over the same period in 1981 and just 2 million contracts shy of the record-breaking 1981 total.

So far this year, nearly 6 million contracts have traded in our short-term interest rate futures complex of Treasury bills, Certificates of Deposit (CD), and Eurodollars, while currency futures topped 5.7 million contracts. In both cases, volume is almost two-thirds above the 1981 pace. And figures show our new contracts performing even better. The S&P 500 stock index futures contract pierced the one million contract level in August, after just four months of trading. It is a statistic of such wonderment that it is difficult for us who experienced it to believe it. Additionally, in May, just ten months after opening, the Certificates of Deposit futures contract likewise topped one million contracts. These are the first two contracts in the history of the Chicago Mercantile Exchange to trade one million contracts in less than four years time.

Already in 1982, yearly volume records have been broken in the Canadian dollar, Japanese yen and Swiss franc futures. Swiss francs, our second most active contract in August with a record monthly volume of more than 313,000 contracts, has traded nearly 1.8 million contracts on the IMM so far this year. These transaction statistics in a wide array of futures instruments have justifiably propelled the IMM to its place as the number one financial futures market in the world.

As a direct consequence of this success, there has been a meteoric rise in exchange membership prices over the years. IMM seats were originally sold to the public for $10,000, of late it has taken well over $250,000 to purchase this membership. And the IMM growth helped to push the full CME seats to a high of $380,000—the highest seat price ever attained on any futures exchange. The high membership values and the willingness of individuals and institutions to pay the price for them is strong evidence of the widespread confidence in the stability, integrity and future of the International Monetary Market.

The overriding strategy that has been central to our success has been the effort to diversify the exchange. Calculated and exhaustive research efforts have preceded each new contract introduction. At each juncture we sought to balance user demand for diverse and sophisticated contracts on the one hand with the necessity for liquid markets and manageable overall exchange operations on the other. The IMM has consistently attempted to strike a correct balance between those who implored for more and more futures instruments and those who cautioned we not over-extend our capabilities. Indeed, those capabilities were stretched to the limit recently when, in just ten months, we introduced an unprecedented series of new financial futures contracts: the 90-day domestic Certificate of Deposit—the first futures contract based on private short-term debt instruments—introduced July, 1981; the 90-day Eurodollar time deposit contract—which, in my opinion has the potential of becoming the most successful futures instrument ever devised—introduced December, 1981; and the revolutionary S&P 500 Stock Index contract—which we believe will become the bellwether for equity futures—introduced April, 1982. That all these contracts have proved successful is something of a minor miracle.

It is incumbent to underscore that the opening of the Eurodollar futures contract represents an important milestone in the history of futures. This contract initiates the revolutionary concept of cash settlement, a dramatic departure from the age-old physical delivery procedure of futures markets. Cash settlement paved the way for the S&P 500 stock index futures contract as well as for other potential futures concepts and instruments never before thought feasible.

Another predominant consideration at the CME in the development of new contracts is floor liquidity. Liquidity demands that we have on hand a pool of skilled, professional traders and brokers. This subject was and continues to be of similar concern to the organizers of LIFFE. To this end, we pioneered a divisional concept at the CME. The creation of the IMM division a decade ago served to infuse our institution with new members. We have since applied similar programs to achieve similar results. During the last year, the CME adopted two separate plans to expand the trading floor population. The first was the Membership Rights program which expanded the number of floor brokers and traders by 25% while maintaining the value of existing memberships. At the close of 1981, we again unveiled the creation of a new division—the Index and Options Market (IOM). The IOM division is designed to provide a marketplace for contracts based on indices and options on futures contracts. We anticipate over 1200 members to become floor participants of this new market.

The diversity and growth at the IMM is only half the story. Of even greater importance has been the resulting elevation of our markets and market professionals to a position of integrity and credibility. Initially when we proposed the idea of futures contracts based on money, many New York bankers laughed at us. Yet these same bankers are now vying for spots on Chicago's trading floors. Some have even applied for and received approval to become futures commissions merchants (FCMs) so that they can act on behalf of clients in futures contracts of currencies, interest rates and stock indexes. These include such respected financial institutions as Morgan Guaranty Trust, Continental Illinois National Bank, Bankers Trust, First National Bank of Chicago, the Republic National Bank of New York, and others are waiting in the wings. This is compelling evidence of our raised stature in most traditional investment circles. It is a trend that has spread to Europe and is very visible here where banks from around the world intend to maintain operations at LIFFE.

What has become evident to banks and other financial institutions is that financial futures are an essential risk management tool and that their presence on the trading floor is a necessary adjunct to their business. This consequence was achieved because the futures industry has been successful in responding to the needs of the business world. Indeed, the IMM has become very skilled at pinpointing the specific market requirements and developing contracts to meet those needs.

The IMM Treasury bill futures contract and the Chicago Board of Trade's Treasury bond futures contract are excellent examples of responding to a market demand. These contracts have more than lived up to their roles as hedging and price discovery mechanisms and have become integral parts of the immense U.S. government securities market. Indeed, the hedging and price discovery aspects of the Treasury bond and bill futures permanently altered the old fashioned negative view about futures markets that many held. Similarly, the introduction of stock index futures is already changing the trading habits and techniques of those involved with the stock market.

The CME is not the only exchange introducing successful new contracts. Early in May, the Chicago Board of Trade began trading a 10-year Treasury note contract which was heralded in with the largest ever first day volume—33,502 contracts. Though volume has been at lower levels on a day-to-day basis since then, open interest has grown as participation in this important intermediate range interest rate contract broadens.

There is ample evidence of the increased professionalism and sophistication of financial futures industry outside the exchanges. Major American universities—Columbia University in New York, Chicago's Loyola University, and the University of Illinois—have established institutes for the academic study of futures markets. In addition, a pool of talented legal experts specializing in futures has emerged as well as a law bulletin and an academic journal discussing current issues of importance in the expanding futures industry. But the best example of the professionalism that now surrounds the futures industry is the emergence of an industry-sponsored organization designed to ensure the industry's strength and integrity—the National Futures Association (NFA). I am proud to have played a role in the long and arduous birth of the NFA, an organization which holds the key to the continued growth of the futures industry in the United States.

Federally sanctioned and authorized by the Commodity Futures Trading Commission, the NFA is designed to play many regulatory roles: it will audit the financial condition of FCMs outside the purview of exchange surveillance; it will regulate sales practices of futures firms; it will arbitrate disputes between customers and FCMs; it will eliminate regulatory duplication between government and exchanges regulatory programs; and it will lessen the cost of federal regulation of the futures industry by self-funding itself. NFA membership will be drawn from all sectors of the industry: exchanges, FCMs, commodity trading advisors, pool operators, and banks. Consequently, the NFA will become a national unifying body and the industry's focal point.

The traditional lines and barriers that so clearly defined the U.S. financial services industry in the past are becoming blurred; i.e.. the separation between banking and brokerage firms, S&Ls competing with banks for funds; banks pressuring to compete on a more level playing field with other financial institutions; the weakening of demarcations of the Glass-Steagall Act that have guided the U.S. over much of the Twentieth Century; and mergers of such diverse organizations as Sears Roebuck with Dean Witter Reynolds, Prudential Insurance with Bache, and American Express with Shearson reflect these deep-rooted alterations in the fabric of the financial services world.

The IMM, from its inception, recognized that the financial futures concept was of a global nature and thus in January 1980 opened an IMM office here in London—the first of its kind by an American exchange. The London office proved to be most instrumental in the education process for our markets. We are now taking direct steps at the possibility of developing a market link with the Singapore International Monetary Exchange (SIMEX).

That is the IMM's record of its first ten years. Impressive, I hope you will agree—and a goal for LIFFE. Most important: today's global environment makes LIFFE's creation highly appropriate. Your success will be beneficial to us and all markets. It will foster growth, better understanding, more participants and deeper breadth for all futures markets. We wish you success and offer our continuing assistance. Our purpose is common.

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

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