GLOBAL 24-HOUR RISK MANAGEMENT

Presented at the Pacific Rim Futures Conference,
San Francisco, California,
September 12, 1991.

The 1991 Conference on Global Risk Management was of particular moment. It came at a time when markets had experienced momentous changes in the economic/political landscape of the world. It was thus appropriate and necessary to put these upheavals in perspective, explain how and why they occurred, and establish the role of technology in the process.

Only as a consequence of such analysis, can we begin to understand the new world order we had entered and the indispensability of futures markets in that world. Only by comprehending what happened, can we adequately prepare for the coming demands on our markets: the ability to swiftly institute complex risk management strategies; the ability to utilize mechanisms that offer 24-hour global capabilities; the ability to include managed futures as a component of overall balanced portfolio management.

Those of us fortunate enough to be present at the latter end of the Twentieth Century are privileged to have witnessed some of the most monumental events of this era—events equal to any celebrated milestones in the history of mankind. We were spectators at a near-global insurrection that unshackled the chains of political and economic systems; the very systems that threatened the sanctity of world peace and enslaved a full third of the world population. In a matter of years, we were eyewitnesses to the fall of the Berlin Wall and the unification of Germany, to the beginning of the end of apartheid, to the forceful rebuff of a Middle-East tyrannical aggressor, to the liberation of nations imprisoned for decades, to the end of the cold war, and as a finale, to the absolute wretched demise of Communist rule in the Soviet Union.

It was the last act of this breathtaking drama that epitomized the cataclysmic nature of the revolution that swept like wildfire across the world. For Moscow represented the very epicenter of the ideology whose doctrines caused the freedom of three generations to be confiscated, economies of scores of nations to be disabled, and the destiny of the entire planet misdirected for seven decades. In three historic days, the inexorable forces of freedom crushed the last pitiful attempt by blundering apparatchiks of a past era—the State Committee for the State of Emergency—and completed a revolution that will forever change world order and the destiny of mankind. What a magnificent triumph of democracy and freedom. What a glorious victory for capitalism and market-driven economic order. What a majestic tribute to Thomas Jefferson, Abraham Lincoln, Adam Smith and Milton Friedman. What a divine time to be alive.

The events that transpired are not the result of single influence but rather the confluence of a multitude of factors. Nor did the explosion we witnessed occur by virtue of a random spark. The underground fire that ultimately overpowered the forces of tyranny took years to foment. Clearly, the roots of the revolution are to be found in the denial of fundamental human rights born to everyone. Clearly, the central element in the failure of the Communist ideology is the fact that a dictated economic order is doomed from the outset. Clearly, the success of free world market-driven economies became a standard impossible to ignore. Clearly, there were human faces whose brave opposition to status quo was indispensable to the process. The likes of Andrei Sakharov, Mikhail Gorbachev, Lech Walesa, Vaclav Havel, Boris Yeltsin, and, no doubt, countless others, deserve a substantial measure of the credit.

There was yet another human endeavor that played a pivotal role: the technological revolution of the last two decades. Telecommunications was without a doubt the quintessential component in the process. It made it impossible to maintain dictatorial rule, it made it hopeless to hide the unmitigated bankruptcy of State-ordained economics, and it made it futile to resort to coup-d'etat of by-gone eras. The would-be putschers forgot to take out the fax lines.

Indeed, the common denominator of recent world upheavals was simply modern telecommunications capabilities. It fostered instant informational flows in total disregard of internal prohibitions or national boundaries. It offered a stark, uncompromising comparison of political and economic systems. It gave the people of the world the unprecedented ability to judge their government, compare their economies, scrutinize their moral codes, examine their individual freedoms, and weigh them against that of their neighbors. Not only could governments no longer hide the truth from its people, the people knew how to revolt—having learned it from others on television.

Technology once again was instrumental in dictating revolutionary change in the political and economic landscape of our planet. Clearly, its effects will be felt in every nook and cranny of civilization. But just as clearly, the influence of the technological march of recent years will be nowhere felt more than in world financial markets.

Those of us in futures markets long ago read this message. It is no accident that our markets represent one of the greatest growth arenas of the last two decades. We recognized the march of technology and understood its likely impact on world markets. Telecommunications and technological advances fostered and will continue to foster globalization, greater interdependence, instantaneous informational flows, immediate recognition of financial risks and opportunities, continuous access to markets of choice, more sophisticated techniques, and intensified competition. These are the unalterable trends of the future. As a consequence, the management of risk is at the core of every prudent financial strategy—a reality that will have the greatest impact on the global and 24-hour use and expansion of futures and options markets. Indeed, if financial futures and options were not yet in place, they would have to be invented.

Futures and options are indispensable in a world that demands the ability to swiftly institute complex strategies or to cost-effectively adjust portfolio exposure between securities and cash. They are ideally suited for a world where tailored risk management strategies are on the increase and where opportunities rapidly appear and disappear on a constantly changing financial horizon. They are a vital option in a world in which it is often imperative to utilize a credit-worthy mechanism that preserves credit lines. They are without equal in providing a vast array of products combined with an envious measure of liquidity and an incomparably narrow bid/ask spread. They are the avant garde of market innovation and soon, as a consequence of GLOBEX, will achieve market coverage on a 24-hour basis. And most significantly, they are well-positioned for a world where professional money management is the wave of the future.

The growth of institutional investment funds and the trend for managed futures is as strong as it is unmistakable. Its momentum will continue to accelerate because scientific and technological advancements are forcing investors to continue to become highly specialized, expertise-oriented, and professional. In turn, professional fund managers will increasingly utilize our markets not only because of competitive demands for higher returns, but also in response to the need to diversify in an uncertain world.

During the last decade, the money invested in managed futures accounts grew from less than one billion dollars to nearly twenty billion dollars. In the last several years, more and more public and private pension funds are utilizing futures not only as a hedge mechanism but as an asset class. In the last year, many financial centers—including Japan and the Pacific Rim—began to adopt regulations that will allow and foster the use of managed futures. Simultaneously, the exchanges have applied for a variety of new contracts and trading applications that are structured for the use of managed funds. Indeed, GLOBEX is particularly designed to be attractive to the fund manager. Simply stated, the markets of futures and options again see the handwriting on the wall and are prepared to embrace the opportunities that will emanate from the new world order.

But lest we conclude that our world is in a relatively stable state, its future secure, and its horizon bright, allow me to inject a note of realism. Neither are financial futures and options a panacea, nor is the new world order free from change or the possibility of serious economic storms ahead.

The Soviet Union is in chaos—to say the country is bankrupt is to misconstrue the actual desperation of the situation. The Soviet Union is among the least-developed and poorest countries in the world, and its economy grows poorer every month. Even by the official exchange rate of 32 Rubles to the U.S. dollar, an average monthly Soviet salary is $15, and its GNP per capita about $100 last year. The Soviet national income declined by 12 percent during the first half of 1991 and the fall is accelerating. According to Newsweek, "a real slump of 20 percent seems likely for 1991, presenting the world with the worst economic catastrophe in Europe after World War II and surpassing the Great U.S. Depression."

The problem may be generational. Seven decades of Leninist indoctrination does not easily dissipate. To millions of Russians, Capitalism remains a dirty word, a profit motive is immoral, there is no work ethic, and a market economy is an unknown and distrusted entity. To achieve a market economy, they would have to abandon price controls, break up state monopolies, allow land ownership, privatize industries and agriculture, grant people freedom of movement, create a banking system, remove government controls on business, open the economy to world trade, and make the Ruble convertible, just to name a few. The reform process is estimated to need between 15 to 30 billion dollars per year for the next decade. It is bound to be a painfully slow process. Conditions will get much worse before they get any better—there may be hunger and even famine; there will be purges and continuous outbreaks of civil unrest.

Such a backdrop of economic misery for 180 million people cannot bode well for the rest of the world. Nor are the problems of the Soviet Union confined to its borders. The economic repercussions caused by the revolution will be felt worldwide. Independence for the Baltic states will not automatically or easily translate to peaceful coexistence or good economic times. The ramifications stemming from the unification of Germany are still to be felt. The economic and political woes of emerging East-European nations will continue to be serious for many years to come. The implications for the remainder of Europe cannot be underestimated, recessions in some parts are already evident and can easily spread.

Nor is the rest of world free from potential difficulties. China sits like a giant time bomb. There are ample worrisome signals from the American economy—our monumental public and private debt is a critical weight on our ability to fully utilize our vast economic engine, and our recession will continue to have negative effects in the years ahead. Japan is in the 57th month of its longest post-war continuous growth period. Will its prosperity continue when some of its best customers are in recessions? Any downturn in Japan coupled with a weakened American economy will severely limit the financial capabilities of these two economic super powers at a time when the world will desperately look for American and Japanese financial assistance.

The foregoing realities do not, however, diminish the magnitude of the monumental events of recent history. The latter part of the Twentieth Century was a breathtaking tribute to freedom and free markets. Our world will never be the same. Still, realism requires that we stay on guard. For we are all too well acquainted with how quickly things can change. But that is the very point.

If economic change, dislocations and uncertainty is what I suggest, is that not exactly why you are at this conference? Is it not uncertainty that gave rise to our markets in the first place? Is it not uncertainty on which these markets thrive? In this world, there seems to be no lack of it. Thus, whatever lies ahead—if the future includes financial risk and commensurate rewards, includes fast-paced changes that require instantaneous reactions, or is anything like the past—the markets of futures and options will continue to play a increasingly significant global 24-hour role.

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