GLOBEX: The Logical Extension of the Financial Futures Revolution

Published as a GLOBEX brochure,
1989.

Convincing the membership of the Chicago Mercantile Exchange that GLOBEX was a promise rather than a threat to the continued viability of futures markets was but the first—albeit the most important—battle in the struggle on behalf of after-hour market automation. The next round required acceptance of this idea by the financial community at large.

The following was our official explanation to the world and became the manifesto for the revolutionary concept. As it proclaims, GLOBEX is inevitable because the CME recognizes "that innovation is our middle name; that complacency is our enemy; that those who ignore the march of science and technology will soon be history; and that those who fear to embrace reality will quickly earn oblivion."

Seventeen years ago, the Chicago Mercantile Exchange (CME) sponsored a revolutionary concept that was destined to change the world of finance and become an indispensable risk management tool the world over. Indeed, the invention of financial futures has been hailed by academics as the most significant business innovation of the last two decades.(1)

Alas, hardly anyone in 1972 recognized that event as significant. Indeed, hardly anyone believed it to be of any consequence at all, and few gave it any chance of success. Pundits and critics of that day mocked the idea, regarding it as no more than a joke or, at best, a quixotic dream. Some simply thought it ludicrous that a "bunch of pork belly crapshooters" would dare to contemplate treading on the hallowed ground of foreign exchange. In the words of historian Tuchman, the idea did not fit in with the plans of the establishment nor suit its prearrangements.

But succeed it did. As Victor Hugo once explained, no general was smart enough and no army strong enough to suppress an idea whose time had come. The idea was simply a recognition that the world had entered an era of great financial uncertainty, that uncertainty breeds risk, that risk seeks insurance. Financial futures and options offered the type of insurance that responded to that need. As a consequence, these markets are today utilized by investment bankers and broker-dealers, by foreign exchange traders and government securities dealers, by banks and insurance companies, by pension funds and mutual funds, and by corporations and financial institutions of every sort.

While it is not the purpose of this brief historical footnote to document the positive impact of financial futures and options on the business world, nor to explain their value to U.S. national interests, it would be remiss not to mention some their acknowledged benefits. Allow me to relate the findings of a two year study mandated by the U.S. Congress and conducted primarily by the Board of Governors of the Federal Reserve System, with assistance by the Commodity Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC), and the U.S. Department of Treasury .(2)

Briefly, the study found that financial futures and options serve a useful economic purpose by providing a more efficient way to manage risk; that the liquidity of related cash markets such as those for U.S. Treasury securities and common stocks have been improved by the presence of futures and options; that the Fed's ability to conduct open market operations in an orderly manner across a range of maturities in government securities has been enhanced by futures and options contracts; that this also means that the Treasury's ability to conduct debt management operations is similarly enhanced; that the improved liquidity in the Treasury securities market means interest rates paid by the taxpayer on debt incurred by the Federal government is lower than it would be without financial futures markets; and from interviews with investment banking firms, it is clear that the ability to hedge corporate bond underwritings results in a lower all-in cost of funds for the private sector as well.

Nothing has occurred since these findings were made—including the analysis of some 77 studies conducted in the wake of the 1987 stock market crash—that detracts from the foregoing conclusions. Indeed, speaking on behalf of the U.S. Treasury, George D. Gould, the then Undersecretary of Treasury, in his testimony before the House Subcommittee on Telecommunications and Finance, stated:

...benefits of active futures markets are real: for example, they apply directly to the Treasury securities market. Treasury futures are used as hedging vehicles and as a cost-saving means to adjust positions in the underlying securities. These risk-reducing benefits of futures markets lead to a reduction of the risk premium investors require on the underlying Treasury securities and thus to lower interest costs for the Federal Government.(3)

However, the best proof that financial futures and options are vital to the overall economy and represent indispensable risk management tools in today's business environment is not found in studies or statements. It can be found in the compelling fact that since their introduction in 1972 at the CME's International Monetary Market (IMM), financial futures experienced a transaction explosion that rivals any new product on the business scene. U.S. volume on these instruments of finance, inclusive of their option market counterparts, reached a total of approximately 171 million contracts in 1988, compared with only 445,000 in 1973, a growth factor of 38,000% for the last fifteen years.

Federal Reserve Board Chairman Alan Greenspan, succinctly noted the foregoing in his testimony on futures markets before the House Subcommittee on Telecommunications and Finance on May 19, 1988, when he stated, "What many critics of equity derivatives fail to recognize, is that the markets for these instruments have become so large not because of slick sales campaigns but because they are providing economic value to their users."(4)

Not only has the success of these markets been evidenced in transaction growth, but the markets themselves have multiplied with offspring all over the world that attempt to replicate the capabilities once found only in Chicago and New York. During the last decade, new financial futures exchanges have opened or been announced in London, Paris, Hong Kong, Sydney, Toronto, Singapore, New Zealand, Brazil, Zurich, Dublin, Frankfurt, Osaka, and Tokyo. Clearly, where once it was sufficient to have a large bank and a stock exchange in order to establish a financial center, today a financial futures exchange is needed as well.

Those same pioneers who conceived the financial futures revolution have now promoted yet another revolutionary idea. On September 2, 1987, in a far-reaching joint undertaking, the Chicago Mercantile Exchange and Reuters Holdings PLC entered into a long-range agreement to create GLOBEX, a global electronic automated transaction system for the trading of futures and futures-options.

Pundits and critics again mocked the concept. "It is unnecessary," they stated. "It will never work," they told us. "It violates our sacred oath to open outcry," they lamented. But it will succeed and what's more, it is inevitable. In initiating the idea, the Chicago Mercantile Exchange recognizes the fundamental truth that innovation is our middle name; that complacency is our enemy; that those who ignore the march of science and technology will soon be history; and that those who fear to embrace reality will quickly earn oblivion.

The world is increasingly becoming smaller. What were once dozens of scattered national economies are inexorably becoming linked into one global economy. The world's financial markets are quickly following pace. In many instances, they are in fact setting the pace, demonstrating the ease with which capital can follow the sun, seeking out investment or risk management opportunities regardless of geographical boundaries or time zones.

The change that has washed over the world is the telecommunications revolution. It is, by now, a cliche to explain that sophisticated satellites, micro-chips and fiber optics changed the world from a confederation of autonomous financial markets into one continuous global marketplace. We need no reminder that there is no longer a distinct division of the three major time zones—the Far East, Europe and North America. No longer are there three separate markets operating independently of external pressures, maintaining their own unique market centers, product lines, trading hours and clientele.

GLOBEX recognizes and embodies that change. It acknowledges the effects of the information revolution and responds to its reality. It consummates a marriage of state-of-the-art technological capabilities with established markets. It provides the international business community with the means to respond effectively and quickly to the hazards and opportunities of continuous financial changes. It both reflects and facilitates the new globalization of capital and markets.

GLOBEX is an international automated order-matching system for use before and after regular business hours. It will extend the business day of financial futures and options to a virtual 24-hour capability. It will act as a communications system bringing buyers and sellers together to participate in a competitive market.

GLOBEX combines the vital features of the CME—its products, its liquidity, its trade clearing capability, its credit-worthiness—with state-of-the-art computer-generated screen technology. The system will facilitate competitive prices, a centralized marketplace, access and a continuous flow of price information to the public. All orders will be transmitted through the facilities of exchange members to the GLOBEX electronic book and will have an equal opportunity to compete based upon price and time of entry. GLOBEX quotations and price information will be available to all investors throughout the world through the CME's quotation vendor networks.

Ultimately, GLOBEX envisions the linkage with a number of other world markets, affording these markets the capability to list their unique product lines on a single unified system. Such discussions are now underway. Each exchange on the GLOBEX system will use its own rules, clearing facilities, contract market designations, information dissemination, surveillance, auditing and compliance systems. Each exchange will be subject to the rules and requirements of its own governmental regulator. Reuters will provide the communications network and the computer program that will be used to match bids and offers that are entered into the system.

GLOBEX will offer the world a transaction capability that is as advanced as the imagination will allow and as far-reaching as the future itself. In our opinion, GLOBEX represents the avant garde of the financial services arena and the precursor of market systems that will, in the future, serve every segment and every facet of the financial world. It is the logical extension of the financial futures revolution that began in 1972.

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     (1) Merton H. Miller, Financial Innovation: The Last Twenty Years and the Next, Graduate School of Business, The University of Chicago, Selected Paper Number 63, May 1986.

     (2) A Study of the Effects on the Economy of Trading in Futures [and] Options, Board of Governors of the Federal Reserve Board, Commodity Futures Trading Commission, Securities and Exchange Commission, Pursuant to Section 23(a) of the Commodity Exchange Act as amended December, 1984.

     (3) George D. Gould, Treasury Undersecretary for Finance, Testimony before the U.S. House Subcommittee on Telecommunications and Finance of the Committee on Energy and Commerce, May 19, 1988.

     (4) Alan Greenspan, Chairman, Federal Reserve Board of Governors, Testimony before the U.S. House Subcommittee on Telecommunications and Finance of the Committee on Energy and Commerce, May 19, 1988.

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