OPENING COMMENTS BY LEO MELAMED

The Futures, Derivatives and Public Policy
Roundtable Program
February 25-26, 1999

It is probably hard for most of the people in this room to fathom that a mere thirty years ago, for all intents and purposes, there was no futures industry. Oh, don't get me wrong, in 1969 there were corn and pork bellie pits, as well as a variety of other agricultural products traded at the CBOT and CME, not to forget Maine potatoes in NY, but to suggest that those futures markets compared to today's futures industry is like equating the Hoboken little leaguers to the New York Yankees.

Thirty years ago our federal governing agency had but a few small offices in the basements of the Department of Agriculture and the CBOT, and operated on a budget that today wouldn't even pay for the meager space they occupied. The exchanges operated basically in a self regulatory environment and were allowed to make all the appropriate business decisions without securing approval from the dozen or so people that made up the Commodity Exchange Authority of that day. No contract approval process, no economic justification, no jurisdictional issues.

And yet, as history bears witness, that time frame represented the most fertile and innovative period in the history of our markets. Arguably, one of the most innovative periods in the history of American markets. In just four years, between 1972 and 1976, a financial revolution occurred in Chicago which, I dare say, changed the course and history of world finance.

The International Monetary Market of the CME for the first time in the history of markets brought financial products to the futures floors, an event hailed by Nobel Laureate Merton Miller as the most important innovation in finance of the 20th century; the Chicago Board of Trade created the first organized securities options exchange, and later extended the reach of financial futures with the introduction of the long bond. It is not a terrible stretch to claim that the global financial derivatives explosion that followed during the next two decades, sprang from the ideas fostered by the Chicago revolutionary innovations. And all of that occurred at a time either before the CEA was constituted with present day authority, or before the CFTC could formally initiate its newly ordained powers. One cannot help but wonder whether the strength and magnificence of the American financial service sector would have been what it is today had the federal government been just a tad quicker in coming to our rescue in Chicago.

In the years that followed this financial revolution, the futures industry not only become an indispensable member of the American financial structure, it has grown and prospered. But at a tremendous cost. A cost which allowed vigorous competitors, ones who did not have equivalent regulatory burdens, to succeed far and away faster and better than did the industry that fathered most of the original ideas. The regulatory burden we suffered, ordained with the best of intentions, not only impeded our potential by virtue of unnecessary bureaucratic demands, but failed to keep up with the dramatic changes that technology and globalizations were causing.

Indeed, our market applications became so materially different from the ones which prompted the creation of the CFTC, our customer base became so materially different from the "mama-papa" clientele of the 1970s, the financial world so different that even if there was a legitimate case for the regulatory authority we endured in the past, it has no place in the present and certainly no legitimacy in the future.

Allow me just three brief slides to illustrate what I have been saying:

I. In 1974, at the time of the CFTC birth, the total global volume on all exchanges for both futures and options was approximately 28,287,995, of which approximately 99% was agriculturally or metal based.

In 1998, the total global volume and all exchanges for both futures and options, was 1,691,295,945, of which approximately 89% was financial. It represents an astounding growth of 5,879%. A figure that could easily be used in an attempt to prove how productive the federal regulatory authority has been.

Not so fast. Better than 50% of that growth occurred on foreign exchanges where the regulatory burdens are considerably less. American futures exchanges were able to grow by a rate of 2,174%. Still, that doesn't sound to shabby, but unfortunately that's not the whole story.

For a complete appraisal of the value of regulations we must compare the growth of exchange traded derivatives with that of off-exchange derivatives, the so-called OTC markets, where the regulatory discipline is considerably less. To do that I used 1987 as a starting date since prior to that there is a lack of accurate derivative statistics.

II. The 1987 global financial derivatives volume on futures exchanges (I used financial contract volume for this comparison because the vast majority of global derivatives contracts are financial in nature) was approximately 322,303,070.

In 1998 that figure had grown to 1,454,514,513, an impressive increase of 351%.

III. By comparison, the 1987 notional amount of outstanding contracts off-exchanges was $865 billion.

In 1998 that figure had grown to $70 trillion (BIS figures) an increase of 7,992%.

While contract volume compared to value of outstanding contracts is not a perfect comparison, it can serves as a fairly accurate proxy for the picture it is telling us. In other words, off-exchange derivatives -- without the formal regulatory structure or self-regulatory discipline of exchange traded financial instruments -- grew something like 23 times faster in just the last 11 years.

I am here to make this plea and this point. The exchange markets and the OTC world are rapidly converging. We are quickly approaching the day when seamless integration between electronic interdealer brokerage and derivatives exchanges, on a common technological platform, via interconnected networks, will be the standard application rather than the dream for the futures.

The OTC market has already adopted many of the traditional risk management techniques used in exchange clearing houses, namely collateral/margin deposits, regular margin calls, bilateral and multilateral netting. Similarly, exchange clearing houses are beginning to offer a variety of clearing services to OTC markets: swap clearing and hybrid markets that will support integration of derivatives, cash and repos. Our customers are the same and are products are similar. Gone are most of the mama-papa speculative accounts that needed protection from the sharks --- most of our customers are now the sharks.

.Give us a level playing fields so that we can compete.

.Repeal the Treasury Amendment. It is appropriate to treat all derivative contracts the same. This means adopting a rational, comprehensive regulatory program and treating currency, interest rate, and equity derivatives in identical fashion.

.(With but one minor exception relating to nonexempt securities) Repeal the Shad Johnson Accord.

.Give legal certainty to the OTC derivatives markets.

.Modernize Exchange Regulation and Increase Exchange autonomy by making the Commission a true oversight agency, no more no less. Its power to control and/or prescribe contract terms, trading rules and surveillance procedures on derivative exchanges should be limited to remediation of deficiencies and statutory violations. New contracts and rules, as well as changes to existing rules should not require advance CFTC approval. Each exchange should be free to define its own trading practices and procedures.

.The Commission has the tools to prevent fraud and manipulation and to cure bad rules and bad contracts if such occur.

The new cyberspace world will bring real empowerment to the investor. Information technology will be to the 21st century what electricity has been to the 20th century.

Cultural, national, and economic borders will dissolve. Fortunately, American institutions and exchanges are best positioned to lead in such an environment because we have the knowledge and mechanisms to use capital efficiently. To compete in the globalized world that is at hand, the chains on futures exchanges must be removed.

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