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Markets for the Digital Generation

Then you could do worse than adding David’s blog to your RSS feed or favorites. I’ve had the privelege to work with David for the last 6 years and he is one of the most knowledgeable people in this space, especially when it comes to fixed income markets. Welcome to the blogosphere David!

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Peter Bennett (HCL Technologies) opened the afternoon session with ‘Capital Markets – What next?’ or ‘Where are the gorillas?’:

- exponential growth (in trading), this is a positive feedback phenomenon
- unchecked this can be very dangerous for any system and can lead to instability (bubbles and crashes)
- did a neat simulation using iThink modelling tool
- by 2010 most trading will be computer-to-computer
- order-to-trade ratio is growing exponentially, transaction rates are becoming more granular (order-book changing constantly) – will lead to high risk of running out of capacity

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This was followed by a panel discussing the viability of exchange traded credit derivatives:

Richard Stuart-Reckling (Morgan Stanley)
- claims operational risk issues are being solved
- is customer financing more or less advantageous? (OTC vs ET)
- still some important technical issues are not yet resolved (devil is in the detail)

Gary Smith (ICAP)
- welcomes new products, increasing volumes benefit all
- would need to be supported by the dealers to be successful

Robert Ray (CBOT)
- US is behind with respect to the development of listed credit product
- market needs more transparency
- US dealers very much against the introduction of a listed product
- opportunity exists to introduce clearing into OTC markets
- is ultimately inevitable

Brendan Bradley (Eurex)
- focus is on credit indices, already low margin/high volume
- exchange traded contracts are complimentary to OTC markets
- very close to launching a contract

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The last panel of the day - and the conference - was ‘Sports trading revisited - coming of age?’ and included yours truly (!)

We were extremely fortunate to have Michael Mainelli moderate the panel. His seminal paper “Betting on the future: Online gambling goes mainstream financial” published in 2004 is required reading for anyone who wants to understand the interelationships between betting, trading and insurance and the potential of these new online betting markets to fundamentally transform financial markets over time. I was joined by Mark Davies (Betfair), Chris Shillington (Cantor Spreadfair) and Dr. Jorg Franke (Berliner Effektengesellschaft AG) who was the driving force behind creating the Deutsche Terminbörse (German Futures and Options Exchange, later becoming Eurex after merging with the Swiss derivatives exchange.) He reminded the audience that when he was launching DTB 16 years ago, he met significant resistance with many people accusing him of “running a casino” (obviously with a pejorative bent!) Today, Eurex is one of the most successful financial exchanges in the world and I think you would be hard pressed to find anyone in the market who thinks the markets would be better off without it (well excluding perhaps the folks over at Liffe! ) For those of you not familiar with financial futures markets, the long term government bond future known as the Bund contract is one of the most traded contracts in the world; indeed in 2005 Eurex traded over 1.25 trillion contracts.

I tried to make two main points. One is that gambling vs trading is an irrelevant frame insofar as the distinction between the two is made as a function of the underlying (sports, shares, commodities, …) and so the emotive response to condemn ‘casinos’ is not based in rational reasoning. The second was that ‘betting markets’ were better placed (than traditional financial markets and exchanges, mini contracts notwithstanding) to aggregate individual/consumer/SME risk appetite and that the granularity and heterogeneity gained by including these participants in global risk markets was beneficial for everyone. Indeed, I see betting markets as potentially highly complimentary to the major financial exchanges as they could act as aggregators and increase interest, liquidity and volumes for all.

There was also a question as to the virtue / value of sports as an underlying. The panel made the point that there were very real economic benefits to providing markets in sporting outcomes and Michael cited a number of specific real world examples (sponsors hedging performance risk, etc.) Like it or not, sports is a multi-hundred billion dollar business around the globe.

One member of the audience made a very good point that perhaps it would be useful to try and reframe the debate away from ‘moralistic’ or values based judgements to educating the public as to the potential benefits and drew a very interesting parallel to the NYSE who, according to him spent 50 years (from 1920s to the 70s) gaining acceptance for the value of secondary equity markets. Hopefully this time it won’t take 50 years!

I hope that the established financial and exchange community will embrace our arguments and help rather than fight the development of these new event markets. It is intellectually bankrupt not to. Indeed fantastic initiatives like the CME’s successful launches of weather and property derivatives should help underline the hypocrisy latent in the hostile attitudes that continue to exist - especially in the US Congress - to ‘betting’ exchanges and markets. I’m sure the folks on the hill will listen to the CME, will they be enlightened and take leadership on this? I’m sure a CME Super Bowl contract would be a success…

But given recent events, there is obviously some work to do. And someone needs to tell Congressman Frank Wolf that you can trade shares in your bathrobe (click here to watch Jon Stewart at his finest, you won’t be disappointed) too…

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