THE FUTURE OF FUTURES

Presented at the New School for Social Research,
New York, New York,
October 28, 1983.

To predict the future is both dangerous and difficult. This is especially true for those of us in the futures industry. Still, we are often asked to do so and we must make the attempt. It is gratifying to find that at least some of the time our predictions were not far from the mark.

The following address was presented at a time when many from within and outside of our industry were lamenting the proliferation of new contracts. Proliferation, they said, represented a dangerous trend that would ultimately crush our industry. It was an old theme by those who distrusted the market's inherent ability to determine which products are necessary and which are not. These nay-sayers proposed a legislative solution to the perceived problem. Fortunately, we repulsed this onslaught. One must be forever vigilant or we will surely either regulate ourselves out of existence or hand over our destiny to others.

"It is the present that matters. . .Those who talk about the future are scoundrels." Those sentiments, espoused by the French novelist, Louis Celine, a bit of a scoundrel himself, epitomize a mind set embraced by many. Indeed, while it is true that the present matters, to someone who represents an industry so intertwined with the future that it has the audacity to call itself futures, it is a rather disheartening contemplation. Instead, equally true and perhaps even a bit more profound is John Galsworthy's declaration: "If you do not think about the future, you cannot have one."

Galsworthy's admonition is of particular significance to us within the futures industry—an industry whose dynamics are in constant flux and whose evolutionary changes are dramatic. In our industry, perhaps more than any other, there is abundant evidence that those who fail to contemplate and prepare for the next step in our expansionary journey will be swiftly left behind and faced with the impossible task of catching up.  Our historical scrap heap is replete with examples of those who forgot this truth. For in our industry, to think about the future of futures is the quintessential element for survival.

With so much at stake, how can we prepare for that exclusive domain of providence? How can we predict the unpredictable? How can we harness this elusive prize, so effected by consequences over which we have no control? What are the guidelines? Which crystal ball should we use?

The philosophers tell us that the future is simply a consequence of the past and therefore one should look backwards for guidance. As Patrick Henry put it: "I have but one lamp by which my feet are guided, and that is the lamp of experience...I know no way of judging the future, but by the past."

History does repeat itself and past reference can be an excellent preview of coming events. But can such conventional wisdom be valid in our case; can our past be a guidepost to our future? The answer is disconcerting. In the span of twenty years, less than a blink from a historical perspective, futures markets experienced a metamorphosis of such dramatic proportions that it defies comprehension. Our recent revolutionary experience represents a phenomenon with few equals in the business arena. And most of the significant changes occurred in the last decade.

Our markets, which since time immemorial were the unique and exclusive domain of agriculture, seemingly overnight became an integral mechanism of finance. Our markets, which for more than 100 years were strictly limited to tangible and storable products, suddenly shed these fundamental requirements and embraced live animals, foreign exchange and government securities. Our markets, whose defined boundaries precluded entry into the sphere reserved for securities, brazenly transgressed the dividing line by inventing instruments which blurred the age-old distinction. Our markets, whose birth-right necessitated a system of physical delivery, broke their genetic code and engendered products without a delivery. Our markets, whose universe was so insignificant that in 1962 they could generate only 5 million transactions, experienced a 2200% increase a decade later. Our markets, which only yesterday were viewed with scorn and considered barely at the edge of respectability, are today an indispensable member of the financial family. Our markets, whose merits for decades were recognized by the users from but a handful within the U.S.A., are suddenly attractions for a multitude of financial centers around the globe.

Can we in all honesty expect that our markets will, in the next twenty years, equal or even approach the futures revolution of the past two decades? It is doubtful at best. I therefore caution that Patrick Henry's formula for forecasting the future by virtue of the past may not be quite applicable to our industry.

The next twenty years should be an era of enhancement, entrenchment and maturation of our markets. The conceptual breakthroughs and inventions of the futures revolution desperately demand time for our markets to explore their new territories, to fortify their new bases, for their new identities to mature. Thus, if the futures revolution of the past two decades can be defined as representing a horizontal advancement, the next two decades will be of vertical dimension, capitalizing on the conquests of the sixties and seventies.

The new directions we have assumed, the new inventions we have produced, deserve and will receive our full attention. Indeed, it would be an unconscionable disservice to the labors of the past if we did not now spend the time to explore and exploit their full potential.

Cash delivery unshackled futures from its most burdensome constraint, one that represented an insurmountable wall around its existence. Cash settlement in lieu of physical delivery enables us to contemplate and explore the market applicability of concepts and intangibles never before possible for futures trade. This unlimited potential will no doubt challenge the minds of even the most provocative market innovators.

Allow me to state for the record that this new era would most likely never have transpired without the existence and courage of the Commodity Futures Trading Commission (CFTC). The concept of cash delivery—so simple and universally accepted a methodology for settlement of contractual obligations (one that is commonplace in every other field of business or walk of life)—was obstinately and irrationally barred to us and would have remained so were it not for the CFTC. It was only by virtue of the public faith placed in the wisdom of a congressionally-ordained entity that the issue of cash delivery had a chance to be resolved in our favor. It is to the CFTC's everlasting credit that this was accomplished and unquestionably will be recorded as one of its paramount achievements.

The first wave of index futures is but a sample of what lies ahead. Indexes have become the ubiquitous tools of management in every form of enterprise; they run the gamut from the private to the public sector, from finance to agriculture, from the very specific to the very general. Currently contract markets are discussing, or developing indexes on corporate and municipal bonds, insurance and freight rates and consumer prices, agriculture and components of agriculture, real estate, retail new car sales, and others too numerous to mention. In some cases, the index proposed is already in existence and compatible with the mechanics of futures; in others, refinement is needed; still, in others, the index must yet be created. However they are chosen or constructed, there is little doubt that in the coming years many will be tested. Options on indexes will also be attempted. Obviously, not all indexes will take to options; some will do better than the traditional futures vehicle while others will function best in parallel fashion. Still, the specter of options on futures exchanges goes far beyond the index markets. The very nature of the option mechanism is so different from the traditional futures contract, it spells yet another new dimension for our market potential. In similar fashion to indexes, options will run the gamut from agriculture to finance, and from the specific to the general. Options will offer market applications never before possible and will attract participants who never envisioned using a futures broker.

Our new markets will not be limited to index and options. The futures industry thrives on change and responds quickly to new opportunities. As a need becomes apparent, our markets will have the foresight and competitive motivation to respond, just as energy futures resulted from a sudden crisis in the world oil supplies and as currency futures were spawned by the breakdown of the Bretton Woods Agreement. And each new invention will spur yet another idea.

Not all new contracts will succeed. There are bound to be failures along the way as there have been in the past. That is the price of success and competition. We should ignore those who fret about proliferation. The marketplace itself is the only and best determinant of which ideas are viable and which are not. Those products that are flawed will fail quickly enough; those that are redundant will find it most difficult to compete; those that do not answer a specific need will find few users. The market should make this determination rather than some regulator or industry committee. The dynamics of our industry are such that it must continue to explore, experiment and invent in order to respond to a current or prospective need—either real or imagined.

In the coming years, futures will continue to produce new contracts of trade that will represent extensions of inventions and advances already achieved. The new era will also harvest the fruit of past labors which produced today's futures new stature and astonishing growth in transaction volume—two highly significant achievements. The initial volume surge resulting from the first series of index contracts is but a preview of the quantum leap in transactions for our markets. The eventual exponential result will catapult futures to a level of prominence never before contemplated.

The transaction increases will not necessarily be uniform or across the board. Instead, we should expect the expansion process to be selective, favoring one sector at a time, then moving to another and back again. Nor should one expect each successive year to consistently beat the previous year's record. There is bound to come a period of relative price stability or world depression during which the need for futures is diminished with an attendant drop in transaction volume. Such periods will no doubt find doom sayers who will gleefully say that our industry is finished. These voices will quickly be stilled during the next period of uncertainty or price upheaval that will surely follow. This leads to the inevitable conclusion that those exchanges having the most diversified product mix will be best-placed for continued prosperity. Those contract markets with but a limited product base must bear this in mind or face the consequences.

It is also imperative to underscore the value of our agricultural roots. Our nation's international role as a primary food producer is not about to diminish, nor will the world's demand for these products. Similarly, the cyclical supply of these markets is not likely to change. One era of oversupply and low futures volume will surely be followed by its opposite. Consequently, agricultural futures—like their financial counterparts—will experience periods of prominence and their necessity both as a hedging mechanism and as an investment tool will continue.

And with the expected transaction explosion will come its consequential counterpart—prestige. This represents the culmination of a process that began just ten years ago with the introduction of financial futures. Since their inception, our markets gained more acceptance and respectability than during the first 100 years of their existence. The coming era will, at long last, witness attainment by futures markets of stature-parity with the most-revered temples of finance.

Unfortunately, success on this scale will also bring commensurate problems and dangers. The federal bureaucracy will increase its internal struggle for jurisdictional control. There will be congressional demands for stronger enforcement policies, stronger regulations and stronger federal agencies. As the definition between futures and securities markets continues to blur, the SEC and CFTC will argue over our turfdom and their composition and division of authority may dramatically change—especially as the lines of definition between futures and securities markets continue to blur as they are bound to. Alas, there will also be scandals and failures and surely there will be new legislation.

Our external successes combined with internal pressures will also change our infrastructure. Exchanges will become more alike as rules and practices of trade become much stricter and more standardized. A tougher and higher qualification standard will be established for members—both brokers and traders. Although the present auction order execution system will survive for the foreseeable future, it will become more mechanized and subject to new technologies. Our present system of separate clearing entities may ultimately vanish and be replaced by a central clearinghouse for all the exchanges. A comprehensive mechanism for financial integrity will be established to adequately protect all member firms and perhaps even a national insurance program for their customers. Toward this end, the National Futures Association (NFA) will play a central role as it becomes an additional source of industry strength, unification and oversight.

The present trend of complementary arrangements between different exchanges—both futures and securities—will continue. One should also expect mergers between some markets. Surely, most of the New York markets will one day unify. Similarly, mergers and acquisitions of member firms will continue, resulting in a reduced family of clearing members who are members of every contract market.

During the coming era, our futures markets will complete their long international journey as different world centers of futures trade join the ranks of their North American counterparts. Clearly, LIFFE should remain the dominant European market, while Southeast Asia will most likely be represented by markets in Singapore, Sidney and Hong Kong. Someday, of course, futures will come to Japan. Most important, we will finally realize futures trading on a 24-hour basis. Not only will futures participants include institutions and investors from every corner of the globe, ultimately most of our markets will have a single offset system.

Thus, the future of futures is promising, secure and challenging. If the next era is less dramatic than its predecessor, blame it on the successes of the past. At the same time, we are grateful the futures revolution we started and successfully consummated gave us new scope, dimension, strength, and extraordinary potential.

These predictions carry the same qualification as do all my market prognostications: They are only good till cancelled—normally valid for a full 30 seconds.

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

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