An increasing number of politicians around the world - in both developed and developing nations - are touting entirely analogous ’solutions’ in order to deal with rising commodity, especially food, prices. Stop transparent and efficient markets from functioning, from doing their job - ie aggregate vast amounts of information into an accurate and concise price signal - and voila problem disappears. Makes sense right? If we can’t see the price going up, it must mean that it isn’t. Brilliant.

As a bonus, let’s apply the same logic to climate change and instead of spending billions on developing alternative and more efficient energy technologies, or wasting time with the whole palaver of carbon markets and such; let’s just pass legislation that restricts those pesky thermometer manufacturers to stop making thermometers that go past 30 degrees. Of course you could apply for a special permit to produce say meat thermometers or gauges used in steel mills or nuclear plants that can show higher temperatures. And in order to enforce strict adherence to ‘authorized’ uses only (so no wise guy could hack a meat thermometer to discover it’s really 37 degrees in Hyde Park) you could of course set up a Federal Temperature Control Agency and in the bargain create a new bureaucracy and a lot of new jobs. Win/win!

Joking aside, the knee-jerk, supposedly populist policy reactions of too many governments seems to be to stop markets from functioning. I say “supposedly populist” because these policies ultimately (which is to say pretty damn quickly) hurt the most vulnerable to the benefit of a small elite who then control the distorting gates through which all commerce must pass. The greater irony is that at best it creates an ‘opportunity loss’ for those bogeymen the speculators (oooh!) who such politicians love to hate, and at worst creates even more lucrative opportunities for (especially the least ethical) of them. (See Oxonomics for an excellent and compact deconstruction of the evil speculator myth.)

Instead of shutting down or curtailing the activities of dynamic and empowering markets like the MCX in India:

India’s Forward Markets Commission, a regulatory authority, has banned trading in the four commodities for at least four months, according to media reports on Thursday.
Last year, India banned trading in rice and wheat futures…

…The four commodities, which were suspended from trading Thursday, account for a daily turnover of about $288 million on the Multi Commodity Exchange of India (MCX) and the National Commodities and Derivatives Exchange (NCDEX), the International Herald Tribune reported Thursday.

…governments should be encouraging them to develop even faster - especially in the developing world. Eleni Gabri-Madhin’s TED Talk from Arusha last June should be required viewing for any senior policy maker considering regulation of agricultural markets:

As Eleni points out, observed (agricultural) price volatility is higher in Africa than anywhere else in the world because there is no (or relatively very few) functioning ‘exchange’ markets. This is exactly contrary evidence to the fallacy propagated by so many politicians, that exchanges are the cause of price volatility. Yeah, just like thermometers are the cause of high temperatures, and barometers cause droughts or floods…

A big part of the solution is encouraging robust and transparent markets in agricultural goods (and inputs) and in particular facilitating access to these markets by producers everywhere. The thing is, for probably the first time in history - thanks to technology, in particular the mobile phone - this is a tractable problem even for small and relatively poor farmers in the rural developing world.

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Federal Reserve and Treasury officials said on Wednesday they were struggling to craft rules to ban bank and credit card payments to illegal Internet gambling sites because federal law is unclear about what type of gambling is illegal online. “That is something we’re really struggling with,” Louise Roseman, the Fed’s director of reserve bank operations and payment systems, told a House Financial Services subcommittee. “The challenge we have is interpreting … federal laws that Congress itself isn’t sure what they mean,” Roseman said.

But perhaps the solution is obvious: why not send all transactions to a Congressional sub-committee for prior vetting? I mean this is complex stuff, it depends on so many things! For instance, did the individual do the trade while wearing a bathrobe? Does it involve a counterparty who contributed to my general campaign? I mean there are so many subtleties - not the kind of stuff that is easy to write into a bill… It’s a big responsibility but Congress has a duty of care to certain incumbent operators and lobbyists citizens to make sure that they are protected from themselves.

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In the past, there was no practical way to price and manage this risk; the transaction costs and computational intensity of trading and managing such a granular and complex set of weather risks would have certainly outweighed the potential benefits. Today however thanks to accelerating technological advances in computing and communications, and taking inspiration from the creative application of technology to pricing, managing and distributing risk derivatives pioneered by innovative young companies like Weatherbill, this is clearly no longer the case. I would go so far as to posit that any CEO and/or Board of a commercial air transport business is at risk of breaching their fiduciary duty if they are not seriously contemplating how they can manage and mitigate weather risk in their operations. At the very least, it should be quantified and reported - much in the way fuel-price risk now is - and any hedging (or deliberate decision not to hedge) strategy articulated and explained to shareholders and any relevant regulatory bodies.

To help get this Boardroom debate started, Weatherbill has helpfully just published a white paper framing the problem and at a high level quantifying the risk of weather-induced delays for US commercial airlines (from the report summary:)

Between June 2003 and April 2007, over 25% of all flights in the United States were disrupted
(either cancelled or delayed). More than 55% of those disruptions (almost three million) were
due to weather- the leading cause of flight disruptions in the U.S. In an effort to educate airlines,
airports, and consumers about their weather risk, WeatherBill has identified the most sensitive
airports and airlines to adverse weather to facilitate reliable estimates of future flight disruptions.
Fifty-four major airports and sixteen larger airlines were studied. There are three main results:

1. WeatherBill can statistically quantify the relationship between weather delays and
observed temperature and precipitation at major U.S. airports and airlines
2. The study shows that disruptions are more common with precipitation than temperature
3. Temperature-linked delays are seasonal

We have included a list of the top five airlines and airports with the highest & lowest
percentages of weather disruptions at the end of this summary. Those lists are already widely
available. What follows immediately are lists of airlines, airports, and their delay sensitivity to
precipitation and temperature, in minutes. WeatherBill hopes this new data will help the flight
industry and travelers better understand their weather delay risk.

I would suspect that most (all?) of the airlines would have there own detailed data on this, so it is unlikely (I would hope!) that anything in this report will come as a big surprise but I would be curious to know how (if?) they apply this data in managing their business (setting schedules, pricing, etc.) Having quantified the risk, you might think the next logical step would be to initiate a risk management program to monitor and potentially manage (through trading granular weather derivative contracts) this risk dynamically. While I think this is a sine qua non for anyone managing an airline, I believe there is a much more exciting opportunity (than simply mitigating downside risk) that arises from the ability to measure and manage economic sensitivity to weather: the opportunity to build such an advanced knowledge of operational risks into the customer proposition. So what exactly am I talking about? Well, at the simplest level to illustrate, an airline could sell ‘weather-protected’ tickets: tickets offering for example a full or partial (or variable) refund for weather related delays or cancellations. Not only would this improve the customer experience, but would be very helpful in offering a differentiated price based on time-sensitivity of the traveler: a business person going on a day-trip for a critical client meeting vs a university student traveling home for the vacation probably have a different sensitivity to the ‘cost’ of a delay or cancellation. Or maybe not. The point is, let the customer pay accordingly. It wouldn’t be perfect - there is basis risk involved - and I suspect that from a marketing/adoption point of view there would be an optimal level of complexity (accuracy) vs simplicity in structuring these sorts of deals; and obviously it wouldn’t necessarily ‘change’ the outcome (weather is weather) but those customers who most valued their time would be compensated accordingly.

This dynamic (weather-) risk adjusted approach to pricing and management would also be relevant to airports and private charter or air taxi operators. Airports - especially those run ‘for profit’ - could build weather sensitivity into their landing and operational fees. For private aviation, while generally less subject to the negative weather-related knock-on effects endemic to the large commercial ‘hub’ airports, the relative importance of weather on flight disruptions is almost certainly higher than for commercial airlines (being less exposed to the other primary causes of flight disruptions (as defined by the US DoT): carrier delays, security delays, and late arrival of an earlier leg.) Also given the use of smaller aircraft, the sensitivity to adverse weather may also be greater in some cases (than for large commercial aircraft.) This approach would also be relevant for air cargo operators and given their concentrated hub operations and expertise in highly sophisticated logistical optimization, one could argue that implementation would be easier for companies like FedEx and UPS. (One problem however might be finding enough risk capacity on the ‘other side’ for Memphis…)

The Weatherbill study points out that (due to a lack of data and complexity beyond the scope of their paper) they did not consider ‘wind’ risk in their study, although they suggest that this is likely to some extent to be embedded in the temperature risk in some regimes (ie disruptions correlated with high summer temperatures may well reflect higher convective winds and/or thunderstorms related to these high temperatures.) However, there is no (technical) reason why over time sufficient (and sufficiently granular) relevant data on windspeed couldn’t be captured and used in pricing models up to and including in real-time. This would require data-capture not just at ground stations (airports) but in the air (aircraft) but the technology exists and the cost of transmission, storage and computation have (or will soon) declined sufficiently to make using what would be an incredibly vast and dynamic data set tractable (in a way that it would not have been even 5 years ago.)

You may recall I touched on this subject (dynamic outcome-driven air transport pricing) previously; and while weather risk management would be a good start in terms of bringing airlines into the 21st century, in my opinion a much deeper and more fundamental reappraisal of their business model is called for. Fundamentally, airline seats (or on any carrier for that matter) are substantially fungible - ie a ticket gives the right for one person to travel from point A to point B. Ok, Ok … before you get the pitchforks out - yes there is a difference in value between a seat on a Gulfstream V and the middle seat in row 34 on DiscountAirways… but the differences are relatively easy to understand and so I believe would be (mostly) efficiently priced in an open market. But ok, for the sake of simplicity, let’s set aside private or charter operations for the moment, and concentrate on scheduled commercial airlines. What you have today is a fragmented and reasonably opaque primary market* and no real efficient secondary market. (*Although the advent of the internet generally, and a number of innovative start-ups specifically has vastly improved the situation from that of a decade ago…) Why is this? Practically speaking it is because the airlines don’t want to allow transferability - they are unable or unwilling to embrace the fact that what they are selling is a commodity. That they are selling the transport of packets on a network. It’s an ego thing. They think they would lose out. Putting aside the fact that most of these companies have lost billions of dollars over decades (so I’m not sure what they think they have to lose), I am convinced that by encouraging a robust and complete secondary market in airline seats, not only would consumers win (through more transparent and rational (supply/demand) driven pricing) but the airlines - at least the well-managed ones - would be huge winners. First they would be able to save money by eliminating (or redeploying more productively) the boffins they currently pay to build ridiculously complex and customer un-friendly pricing schemes in the vain hope of optimising a priori load factors and revenues, and instead be able to focus on managing their assets, optimizing their routes and schedules and making their customers happy (insofar as they could see a return on this investment from a structurally higher secondary price for their seats.)

Stop for a moment and think how fundamentally this would change the paradigm of running an airline - load factor would disappear as a relevant metric because by definition, every seat on every flight would be theoretically ’sold’ - ie would have a market price (which in some cases may admittedly be zero…) - it would make explicit the fact that an airline is actually long a portfolio of options and could - using the feedback loop implicit in a robust secondary market - seek to manage this portfolio in such a way as to maximize the premium income. Part of this strategy would involve deciding when and how many seats to sell in the ‘primary’ market, and may in some cases involve also buying - yes buying - back seats in the secondary market as demand dynamics change. I sense that many of you are still uncomfortable with the heterogeneity of the market - ie the lack of fungibility - and the impact that would have on the liquidity of a secondary market. Perhaps this analogy will help: think of the (corporate) bond market - by definition it is much more complex and heterogeneous than the ‘equivalent’ market in common equity. Not only are there differences in the credit quality between companies (think different service levels, seat coverings, entertainment systems, airport lounges…) but even for the same company their are securities with different characteristics (maturities, seniority, coupons, etc.) (think flight times, class of service, changeability, etc.) - none of which inhibits the market from operating. Furthermore, the price signals this market sends with respect to these variables are important inputs for optimizing the management and balance sheet structure of these same companies. By allowing the CFO to see the relative cost and cost volatility of having a BBB vs a AA financial structure, she is much better able to make a decision as to which is best for her shareholders. In the same way, an airline executive would be able to better understand if his investments in customer service or in-flight entertainment provided positive returns to the shareholder (based on an average per-seat premium reflected in the market.)

I imagine that a further argument against such a market would be ’security’ (ie ‘identity’): the airlines (and various government agencies) need to know who is travelling in any given seat. Well again - thanks to technology - this is a red herring argument. There is no reason to believe that in a world of ubiquitous mobile phones, electronic payments and fulfillment that this ‘problem’ is not entirely tractable. Indeed, to take the securities markets as an example - due to various ‘know-your-customer’ and anti-money laundering statues - the days of anonymously trading bearer certificates are long gone; and yet the number of participants and transactions in financial markets has never been higher. So yes, any secondary market would need to robustly and accurately identify the ultimate ticket holder but this would not be a problem. (Additionally, in the first stage I would imagine it would probably make sense to start with a market that ended T-1 - ie not allow trading in the last 24hrs before a flight - which would significantly remove or mitigate a number of potential operational risk factors arising from such a market. Once these risks were better understood and engineered around, one could imagine eventually allowing trading up to the moment the flight closes for boarding.)

You may recall that in my earlier post, I mentioned Farecast as one of a variety of companies innovating intelligently in this space. This is a company that was on my “IRWIWHHTOTI” (I-really-wish-I-would-have-had-the-opportunity-to-invest) list (for reasons I hope would be clear to my regular readers…) Unfortunately, they have just sold themselves to Microsoft. Why do I say unfortunately? (1) There is now no chance to invest in or buy the company. (2) Microsoft has a long and not-so-illustrious reputation for buying really interesting and innovative companies (good) and then having their own big-corporate antibodies attack and often kill said innovation and energy (not so good.) (See here for more thoughts on Microsoft.) I hope this doesn’t happen to Farecast (in the same way I hope CBS won’t kill last.fm) but let just say I’m cautiously pessimistic. I am entirely sympathetic to the founders - liquidity is important (you can’t pay mortgages with ‘potential’ upside) and understand how the structural constraints of the mainstream VC business model drives the logic of this kind of exit. But the combination of these factors leads from time to time to what I would consider excellent opportunities to deploy smart, unconstrained capital. Since this is something I personally have limited amounts of (alas) I will be working to convince others of the merits of this view, with the goal of being able to act on a small number such opportunities when they arise in future…

Many of the issues that would be faced in creating such a market are very similar to those faced by secondary markets in live event tickets. Whilst, I wouldn’t want to distract the founders and executives of the companies pioneering in this space (against much hysterical and illogical reactionary resistance from some of the incumbent market participants,) I wonder if they might be available in a year or two’s time to sit down with me and my partners and construct a plan to turn this vision into a reality. Or I wouldn’t be surprised if someone were already working on it. If so I’d love to know more.

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I’m not suggesting that no economies of scale make sense in banking or financial services more generally, only that they are subsumed by complexity within these ‘integrated’ financial behemoths. I even have some sympathy for the seductive logic underlying integrated business models, however in my view the theoretical benefits of an integrated model - while possibly intellectually robust on paper - are impossible to exploit in reality. It ignores what I describe as corporate entropy: ie in any corporate process there exists an inherent tendency towards the dissipation of useful energy.

Indeed - sticking with the chemical analogy and without writing a book about it - it would be fair to say that giant bank mergers are at best an (intrinsically unstable) intermediate product in the reaction coordinate and to make any sense need to be followed by a subsequent division into multiple new end products (which individually release the benefits of economies of scale and synergy without the instability engendered by excessive complexity.) So Citigroup (or UBS or HSBC or RBS/ABN Amro, etc…) should naturally “decay” to form multiple specialist firms that are more focused and efficient than the multiple firms that had been combined first to form these giants. Until now however, it seemed that my point of view was not shared by many (any?) of the leaders of these mega-institutions, nor more generally by senior executives in the industry.

So I hope you will understand why I was exhilarated to read Luqman Arnold’s recent letter to the Board of UBS, in particular his thoughts on the integrated model:

Still, there are two clear disadvantages of the integrated model:

• Increased complexity, which places a greater demand on the competence of the Board and management, as has been amply demonstrated by the proprietary trading losses
• Conglomerate and complexity valuation discount and potential contamination of the valuation of the most valuable business, Wealth Management, by the lower rated and more volatile business, Investment Banking.

I’ve never had the pleasure of meeting Mr. Arnold but the little I know about his new venture Olivant (gleaned almost entirely from press coverage and their website) lead me to believe that we share (at least some significant) views of how both to best structure what I would call a modern merchant banking operation - combining operational advice with investments - and the latent problems and opportunities of the current financial services industry paradigm.

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Paulson’s plan would give the Fed regulatory authority over all financial institutions that operate with government guarantees such as deposit insurance for banks and would cover the insurance industry. A new regulatory agency would oversee consumer protection issues while the Office of Thrift Supervision, which supervises thrift institutions, would be folded into the Office of the Comptroller of the Currency, which regulates banks.

The plan is also understood to include merging the Securities and Exchange Commission with the Commodity Futures Trading Commission, and to provide for tightened regulation of mortgage origination.

The proposals are likely to generate intense scrutiny in Congress and within the financial services industry. Past efforts to change how regulation is handled have met with strong resistance, especially those affecting the insurance industry which has fought off past efforts to switch its regulation from state to federal level.

In the event, this was pretty close (via Reuters):

The proposals, in the form of a 218-page “blueprint” that was started before markets unraveled in August, offer no quick fix for the credit contraction that threatens to tip the U.S. economy into recession. The plan was already meeting some resistance from Capitol Hill and competing corners of the government bureaucracy as a potentially protracted debate took shape.

Under the proposals, the current patchwork of as many as seven federal regulators would be consolidated under three agencies: the U.S. Federal Reserve, a newly created financial regulator, and a third agency for consumer protection and business practices.

As a starting point (and without having read the underlying report), it would seem like this is a fairly sensible direction. Of course and unsurprisingly, the reactionaries in the room are already crying foul; in trading that’s called “talking your book.” Indeed if your competitive advantage and or your livelihood is predicated on maintaining and/or navigating a thicket of over-complex and over-lapping regulatory regimes, it is hardly surprising that you aren’t exactly going to enthusiastically embrace simplicity and transparency. I mean without the kafka-esque and byzantine system of state insurance regulation, you might get far too many upstarts innovating and competing…that wouldn’t do at all…and it is logical to assume that no one but the CFTC could properly regulate futures markets right?

While removing unnecessary complexity from the regulatory environment is a good thing in and of itself - a necessary but not sufficient - response to contemporary financial market stresses, it doesn’t really get to the heart of what drives most (if not all) systemic crises in financial markets. In my opinion, the combination of substantial leverage with significant hubris lies at the root of the excesses that are now being unwound. Of course I am not alone in articulating this opinion, and there are many who would in fact look to specifically target regulation with the goal of limiting both of these elements. I would strongly caution however the law of unintended consequences is likely to apply in spades and so would be loathe to try to manage either of these via legislation or prescriptive regulation.

That said, for any institution that is either ‘too big and/or complex and/or interconnected’ to fail (and thus subject to a de facto government or central bank bail-out) it would seem reasonable to expect them to have their leverage signed off by a regulator. The key is to make a distinction between allowing someone to blow themselves up (no problem, no need for outside interference) and allowing someone to start a chain reaction (due to their size/complexity and/or connectedness) - and this irrespective of what kind of institution they are (bank, securities firm, hedge fund, insurer, etc.)

Hubris is harder to manage or regulate. Mandating what bonuses are to be paid would be a fools game, solve nothing and almost certainly give rise to toxic unintended consequences (not to mention the ‘wasted’ creativity dedicated to navigating around whatever rules were invented.) If a private company wants to line it’s employees pockets in a highly asymmetrical fashion that is a matter for its shareholders to take-up with management… Instead, I would suggest that the only way to mitigate hubris in the financial markets is to allow creative destruction has to operate over time. Clearly the compensation paradigm of the investment banking industry is inappropriate to the nature of the business and risks that they run. The least worst form of organization and compensation structure for the industry is I believe the partnership. (It is not surprising that Goldman Sachs is consistently the most successful bulge bracket investment bank given that it was the last to end its formal partnership and still to this day maintains by far and away the culture and compensation policy closest to that of a traditional partnership.) It is also unsurprising that on average, the investment banks have fared far worse than hedge funds over the last year. So if this is true, why did partnerships largely disappear (or become marginalized) over the past 20-30 years? Firstly, the rise of OTC derivative markets and other facets of ‘modern’ finance required ever larger balance sheets and capital resources to the extent that these became out of reach for even the largest and most successful partnerships. Secondly, the sustained bull market (and quick intervention of the Fed in times of duress) papered over many of the intrinsic advantages of partnerships - ie banks (and bankers) could have their cake and eat it too.

I would speculate however that the next decade or so might see a return to prominence for small and medium sized banking and investment partnerships. Indeed to some extent this is already happening. Don’t get me wrong, I’m not suggesting that the giants are going to disappear, just that they will inevitably refocus on the elements of the business where large financial resources are a true sine qua non and/or competitive advantage and retreat from the elements of the business where these are just a license to take inappropriate risk. For example, instead of a monolithic Citigroup as we know it today, you might have a galaxy of small to medium size firms orbiting the core Citigroup balance sheet and banking functions (payments, deposit taking, etc.)

For a number of years I’ve been saying that fundamental change in the investment banking industry was inevitable; it was only the timing that was uncertain. As long as record profits kept rolling in (however fragile or unsustainable they may have been in the long term) nothing was likely to change. Unfortunate but understandable. But turbulence and losses typically catalyze change; this just might be the beginning of the new paradigm I’ve been waiting for.

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Canadian university faces off with digital generation

A Canadian university has instilled a culture of fear by threatening to expel a student for cheating because he set up an online study group on Facebook, critics said this week.

Toronto’s Ryerson University threatened to expel first-year computer engineering student Chris Avenir last week, arguing that his study group on the Facebook networking site might encourage cheating.

Ryerson decided to lift the expulsion threat on Tuesday, but Avenir will get zero credits for the course work discussed on the Facebook forum last autumn, and the university has put a disciplinary notice on his record.

Begs disbelief. Even better (worse), it was the Information Technology Management department (!):

But James Norrie, director of the School of Information Technology Management at Ryerson, said on Thursday the issue was one of accountability, whether online or offline.

I guess Ryerson must be focused on corporate recruiters who are looking for 1950s-style “organisation men”, bent on conformity and sympathetic to control-freakery. Let’s just say that I would be disinclined to recruit future Ryerson grads if this is representative of what they are being taught. Of course, I might make an exception for Mr. Avenir and the other members of his Facebook study group. I would however suggest to him, especially as he is a freshman, to get the hell out of there and transfer to a school that is in the 21st century!

(Finally I can’t resist commenting on the delicious irony of the student’s surname; how could Ryerson do this to Mr. Future?!?)

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For Immediate Release

Albuquerque, New Mexico—March 18, 2008—UtiliPoint® International, Inc. (UtiliPoint) has issued a new report at the conclusion of its survey on blogging and blogs in the energy and utilities industry. There are 112 million blogs growing at a rate of 175,000 per day according to industry sources. How many of them are focused on energy and natural resources is impossible to determine but it is a growing number. The study report provides findings regarding the use of blogs as information sources to support decision making and as coprorate communications vehicles.

“Blogs are having an increasing impact on information gathering and corporate communications,“ reports Dr. Gary M. Vasey, General Manager, UtiliPoint Europe. “This study sought to see what influence blogs are having on the energy and utilities space and it conclusively demonstrates that blogs have a growing importance there.“

UtiliPoint maintains its own blog sites including the UtiliPoint Europe blog (www.utilipointeuropeblog.com) and the ETRM Community (www.etrmcommunity.com/site/modules/wordpress/) which have seen tremendous growth in visitors over the last few months.

UtiliPoint can also offer services relating to blog creation and blog marketing in energy and utilities.

The report is available for purchase from UtiliPoint at http://www.utilipoint.com/rci/details.asp?ProductID=1165.

It costs $299 in case you were wondering…

To be fair, these guys actually seem to have a relatively modern “freemium” business model, and (although I’m not really competent to judge) seem to have good domain expertise. But when I see this kind of thing, it just drives home further the opportunity that exists to bring innovative tools, technologies and business models to the enterprise space. As the saying goes, in the land of the blind…

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…considering that 19% of U.S. employees have participated in a March Madness pool, according to a poll by CareerBuilders.com. It’s a bigger deal in some businesses than in others - 30% of financial-services workers are in on the betting, for instance, and 29% of salespeople. It’s also more popular in the Midwest than in the rest of the country: 25% of employees in Midwestern states say they participate, compared to 22% in the Northeast, 18% in the South, and just 11% west of the Mississippi.

Of course this is illegal (and I suppose if your company has offices across the country, potentially a federal offence) but nevermind as in this case it’s ok because no one is going to enforce the law:

As for the legality of office betting pools, you’re right: Betting on organized sports teams or events is illegal almost everywhere in the U.S. except Nevada and Atlantic City. But in practical terms, the risk of prosecution is almost nil. Your state attorney general’s office has far more important things to do than go after March Madness pools.

“Even if a sore loser decided to call in the authorities, saying, ‘I got cheated in my office basketball pool’ or whatever, that is not nearly enough to start an investigation,” says Steve Miller. “Alleging that the company is running a major booking operation, maybe…” But that’s not happening at your shop, right?

So relax. Amid all the bad news these days, your underlings could probably use the chance to let off a little steam. And just think: In a couple of weeks it will all be over - until next year.

Please Mr. or Mrs. Next-President-of-the-United-States, lose the hypocrisy: remember… land of the free… rule of law… free markets…

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According to a release from CME Group, the new contracts “will allow customers to directly manage their exposure to the government labor number or to offset positions in financial markets.”

The monthly U.S. nonfarm payrolls report is one of the most influential economic indicators globally as it is based on a survey of 375,000 businesses conducted by the U.S. Bureau of Labor Statistics that is usually released on the first Friday of each month.

“The Nonfarm Payroll report is typically the first major economic release of each month and speaks to the condition of employment from the prior month. It is closely followed as a way to gauge how the Federal Open Market Committee perceives economic growth,” the release said.

“There is a strong correlation between the nonfarm payroll report and CME Group financial futures contracts as well as other financial instruments,” said Rick Redding, CME Group’s managing director of products and services.

“Listed futures and options on futures on the nonfarm payroll are a transparent, straightforward and accessible way for our customers to offset unexpected financial market moves that often occur when this number comes out,” Redding added.

On the one hand, I can only applaud this initiative and I will watch with interest to see how successful these contracts become (in terms of volumes and liquidity.) Of course, on the other hand, it begs the question once more as to the logic of US anti-gambling laws and the resulting discrimination against a number of non-US players who could ostensibly compete in offering betting markets in economic outcomes.

Yes betting. The new CME contracts will allow people to bet on the monthly US nonfarm payroll number. Shocking I know… The optimist in me wants to believe that new contracts like these will further expose the latent hypocrisy implicit in the relevant US regulatory and legislative regimes and will ultimately lead to a more lucid and robust rewriting of these over the next several years. The pessimist in me fears that the growing power of the CME, combined with a knee-jerk reaction to anything vaguely associated with (financial) innovation due to the current market crisis, will mean any market innovation will need the explicit or implicit support of the boys in Chicago.

Of course in the world of financial exchanges, the investment banks just may have the lobbying power to face down the CME - their ‘consortium-backed’ futures exchange projects (see here and here) will be interesting to watch. On paper they should have no problem creating (a) compelling alternative(s) to the global oligopoly in listed futures and options; but getting a dozen bulge-bracket investment banks to work together is devilishly tough in the best of times. Like herding cats. In times like these, well we’ll just have to see… Of course a truly level playing field would open the flood-gates in terms of innovation (in technology, business models) and create enormous value for the ultimate consumers of financial exchanges (which is to say, any one with a savings or pension entitlement.) I would love to see this happen and despite the power of the entrenched status quo, I remain optimistic that we will see the levy break in the next few years. I’m sure AT&T seemed just as unassailable (as the CME does now), prior to telecoms deregulation.

In the world of futures and derivatives exchanges, I suspect the vector for regulatory-driven change lies in separating trading from clearing and settlement. It is this vertical integration - most famously practised by the CME and Eurex on each side of the Atlantic respectively - that is the greatest barrier to disruptive and innovative competition in this marketplace. By tying trading of the instruments they list to their own central clearing house, the exchanges create a ‘walled-garden’, locking in their customers. What the world needs is an open architecture - such that any market participant could chose both where to trade and where and how to clear. Indeed, Craig Donahue recently lambasted the investment banks for having continuously resisted clearing derivatives via a central counterparty:

“These problems exist in large part because investment banks traditionally have resisted a more centralised, transparent execution system for these products, preferring to maintain their dealer franchises and proprietary trading profits,” he said. “And they have tended to oppose central counterparty clearing services in these markets, worried that a mutualised risk structure will dissipate their credit and balance sheet advantages.”

While I have much sympathy for this view - he is correct in saying investment banks actively resist any moves to clear OTC derivatives via central counterparty fearing the effect of greater transparency on their margins - the catalyst for his outburst was a DoJ suggestion that the clearing and trading activities of the CME should be separated. A view for which I also have much sympathy. The alternative is to force big clearing houses to open up their platforms, much as telecom and utility regulators have forced the historical monopoly providers to open their infrastructures to competitors.

Disclosure: I have been trading a number of the large publicly listed exchanges (including both the CME and Eurex’s parent Deutsche Borse) from the short side over the last few months (although I closed out all my positions this morning after the big sell-off, but will be looking for opportunities to reset these short positions in the weeks and months ahead.) Unless…

Unless one of these big exchanges can actually kill the sacred cows and grasp the transformational opportunity on offer (before some or some number of upstarts beats them to it.) The thing is, the ‘incumbents’ have many significant advantages. Of course this is generally true in any industry, but it is especially true for exchanges: liquidity is the sine qua non of a successful exchange and for any new entrant, acquiring sufficient liquidity is a daunting (but not impossible) challenge. So the real question (if you are running an exchange) becomes: is it better to hide behind and valiantly defend these protecting barriers or do you leverage your intrinsic advantages, embrace change and re-invent your business model for a digital world?

It shouldn’t come as a surprise that I would favour the latter option, and indeed have a number of ideas as to how one might go about executing such a transformation successfully. All (or most) of which I guess would be anathema to the traditional exchange “seat holders” and admittedly might be very hard for a publicly listed company to effect (short term pain for long term gain.) It is ironic (given their relatively recent emergence as public companies for many) that perhaps the only viable way to transform an ‘incumbent’ exchange would be under private ownership…now I just need the valuations to come down a bit more and then pick a target! (Of course there would also be the small matter of finding a few billion of capital to finance the purchase…)

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So it was natural that the following story: Citigroup Chief Signals Major Asset Sales caught my eye:

Citigroup Inc. Chief Executive Vikram Pandit has begun separating the wheat from the chaff in the New York financial giant’s global empire - and there looks to be a big pile of chaff.

Pandit met with stock analysts Thursday and confirmed the bank plans to shed assets to reorganize its business. Analysts from Credit Suisse who attended the meeting said the giant bank is preparing to shed hundreds of billions of dollars worth of assets to support a turnaround that could take a number of years.

So perhaps the new boss - given his somewhat unorthodox rise to the CEO suite - is going to be able to do the right thing. To unwind the complexity. To break up the firm into optimized units? Too early to say, although some didn’t seem to think this was on the table:

While large sections of Citigroup are apparently being set on the examination table, “We did not walk away with the impression that management intended to exit any major business lines in whole,” Katze said. “Smith Barney will not be for sale anytime soon, if management has its say.”

And of course with the pending arrival of the sixth paradigm, this would seem self-evident:

Katze also expects Citigroup to diagnose the need for a “massive amount of streamlining” and an upgrade of technology and systems infrastructure across the bank.

The $100bn question however is: Can an elephant learn to dance to a completely different tune?

Stay tuned.

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