The man who saw the (new) futures?
(From Fortune:)
Leo Melamed, godfather of the Chicago mercantile exchange, changed investing forever with financial derivatives. Here’s what this market visionary thinks is next.
Way back in 1972, the head of the Chicago Mercantile Exchange had a crazy idea: If you could trade futures on pork bellies, wheat and beef, Leo Melamed wondered, why not on Swiss francs or deutsche marks? Or any other financial instrument for that matter? That notion has radically changed the way market risk is managed.
Way back in 2000, Andrew Black and Ed Wray had a crazy idea: If you could trade derivatives on financial instruments, why not on the outcomes of horse racing or soccer? or any other sport for that matter?
Here in 2007 (and for the past 2-3 years), I’ve been thinking about what I call particle finance, as analagous to particle physics. I firmly believe that advances in information and communication technology will allow us to reduce financial (and more broadly speaking) risk management to its smallest and most fundamental component parts. We are on the verge of discovering and being able to manipulate the quarks of the risk management universe. The ramifications (if my thesis is correct) are enormous and potentially highly disruptive.
In many instances progress will be hampered by powerful incumbents protecting the status quo via regulatory and legislative barriers. But ultimately I don’t think you can keep the genie in the bottle; the US in particular runs the risk of losing it’s pre-eminent position as an innovator in financial services and risk management unless they succeed in reforming their often parochial and restrictive regulatory environment. This in fact was the conclusion of Mayor Bloomberg and Senator Schumer in their recent report on the future prospects of New York as a global financial center:
The joint report stipulated that while many of the causes are due to improved markets abroad and sophisticated technology that has virtually eliminated barriers to the flow of capital, a significant number of the causes for America’s declining competitiveness are self-imposed. For instance, U.S.-based financial services firms are now unable to attract and retain many of the highly-skilled professionals they need because of caps on the number of visas available under U.S. immigration rules. A greater perceived litigation risk has also reduced the appeal of the U.S. market to many foreign firms. Finally, a complex and sometimes unresponsive regulatory framework has not only prompted many foreign firms to stay out of the U.S. markets, but also is forcing more business overseas because of the complexity and cost of doing business in U.S. financial markets regardless of where they are located. The joint report offered several recommendations, derived from detailed analyses of market conditions here and abroad, informed by interviews with more than 50 respected leaders drawn from the financial services industry, consumer groups, and other stakeholders. The recommendations focus on near-term administrative actions that can signal renewed U.S. focus on competitiveness, actions to level the playing field for both domestic and foreign companies doing business in the United States, and longer-term initiatives to address more complex policy, legal, regulatory and other structural issues affecting the U.S. position as the world’s leading financial center.
Their recommendations are straightforward and would indeed have a powerful liberating effect on American financial and risk markets, to the benefit not only of American individuals and corporations but also globally given both the size and depth of US markets and the proven American ability to marshall innovation (when allowed to do so - it is not a coincidence that the US is starting to fall behind in telecoms and financial services as these happen to be two of the most protected and regulated industries…), let’s hope they gain the grass-roots political traction they deserve and don’t get hacked into irrelevance by the dinosaur brigade:
Recommendations to sustain the nation’s and New York’s global financial services leadership:
Provide clearer guidance for implementing the Sarbanes-Oxley Act;
Implement securities litigation reform with particular short-term emphasis on leveraging the SEC’s existing authority;
Develop a common vision and a supporting set of shared regulatory principles;
Ease immigration restrictions facing skilled non-US professional workers;
Recognize IFRS without reconciliation for listing purposes and promote convergence of accounting and auditing standards;
Protect US global competitiveness in implementing the Basel II Capital Accord;
Form an independent, bipartisan National Commission on Financial Market Competitiveness to resolve long-term structural issues;
Modernize financial services charters and holding company structures;
Establish a public/private partnership to promote New York’s local agenda by acting as the high-level liaison between individual industry participants and the city, as well as by driving forward the partnership’s broader strategic plan for New York’s financial services development.
More actively managing attraction and retention for financial services;
Establishing a world-class Center for Applied Global Finance, and
Potentially creating a special international financial services zone.
Anyhow, to come back to the original point - Leo Melamed and the CME should indeed be celebrated for their role in bringing financial derivatives to life and developing and extremely important and robust set of markets that are now part of the very fabric of our global economy. At the risk of sounding presumptuous, I would love to be able to look back in 20 years on a legacy analogous to Mr. Melamed’s; as one of the people who were instrumental in bringing the benefits of particle finance - of ubiquitous and super-efficient risk management and risk transfer - to a global audience. I’ve often been thought crazy (by my managers or colleagues) but apparently I’m in good company here:
(Leo Melamed describing how he came upon the idea of financial futures) And then, finally, I came to the thought that Bretton Woods, the fixed-exchange-rate system, was coming apart. And when it finally comes apart, wouldn’t there be a need for foreign-exchange futures? Our board thought I was crazy, and very frankly I thought it was a little crazy too, because why hadn’t anybody else done this? I went to Milton Friedman, though, and he absolutely embraced the idea.
Well I don’t have Mr. Friedman but I was a syndicate manager and so I guess my challenge over the coming years will be to successfully syndicate my ideas. I’m still thinking about what the right structure might be…but good ideas, like good bonds, tend to sell themselves (but a good story always helps to get the ball rolling!)
