Story Of A Street Smart Exchange: Business World Book Review: 6th February 2010

The focus of 'For Crying Out Loud' is on the transition of CME from an open outcry to an electronic platform during 1996-2006
By Leo Melamed

With open positions of $1.1 billion valued at $1.1 trillion, CME, known as a house that pork bellies built, did not have a single default during the financial crisis. Amazing? Yes. Leo Melamed in his semi-autobiographical book For Crying out Loud extols his belief in economist Milton Friedman’s ‘tyranny of the status quo’ that kept CME constantly innovating and improving. The degree of adaptability shown in terms of product response, alliances and fundamental business platform is quite remarkable for an organisation that is over a century old.

While the focus of the book is on the transition of CME from an open outcry to an electronic platform during 1996-2006, Melamed links the success to its inherent dynamism in responding to circumstances. He highlights the importance of John Maynard Keynes who said “when the facts change, I change”. This philosophy has been instrumental in bringing about change in the otherwise traditional institution.

CME was an exchange known for farm products and pork bellies. But today, it is a powerhouse in the financial future and options (F&O) segment. It has faced the challenges posed by its main competitor CBOT with alacrity. CME’s innovative live cattle contract was matched by CBOT’s carcass beef, which was improved by the ‘dressed beef’ contract of CME.

In the 1980s, CME replied to the launch of Nasdaq Index on CBOT with the S&P Index; and the victory of CBOT to launch Dow Jones was matched with 24-hour electronic trading in a mini S&P contract. Ironically, CBOT merged with CME in July 2007.

The author attributes the success of CME to a combination of four factors: leadership, technology, personnel and luck. While the first three are understandable, luck was manifest in US President Richard Nixon’s decision to move the dollar off gold, which, in turn, made the dollar market extremely volatile and boosted F&O trading in currencies. Stable currency environment, which was the rule under the Bretton Woods agreements, did not otherwise provide a sound basis for currency trade.

CME’s journey to become an electronic exchange through Globex was an adventure. With the shareholders against a disruption of the status quo, electronic trading started with post-traditional trading hours before gaining final acceptance. Here, the author shows human frailty as exhibited by the mind’s reluctance to change from the status quo in spite of the accompanying benefits.

Competition from LIffe in London, American Futures Exchange and Cantor Financial Futures Exchange (where US Treasuries and euro-dollar contracts were traded) provided the impetus. CME had hired Mckinsey for a roadmap, which, asked the exchange to go in for complete e-trading and demutualisation. A revived Globex, experimented with the chemicals F&O contracts on its electronic B2B platform.


The next level of innovation was in going public in 2002, and the ultimate push to convert to e-trading came when Eurex got the permission from CFTC to operate in the financial F&O segment in the US. Melamed attributes the wake-up call to three cross-currents: globalisation, capitalism and micro-dynamism. He also terms the financial crisis a grey swan as it was driven by the over-the-counter (OTC) derivatives markets, which could have been different if routed through exchanges.

The author, however, is noncommittal on whether the days of the trading pit are over. Going ahead, he sees the emergence of 2-3 mega futures exchanges and the integration of the securities and futures markets. That is the big picture waiting to emerge.

The story of CME is pertinent for India from the point of view of commodity exchanges. The revival of futures trading in commodities helped create electronic exchanges, making India a leader in e-trading. The lead was taken by the National Stock Exchange in the 1990s; it had the advantage of not having the baggage of history. Hence, it became one of its kinds in the world, where people could trade from home. While many were sceptical whether the trading community would accept this form of business, its inevitability was vindicated when the Bombay Stock Exchange too went electronic. In a way, India can take some pride in being ahead of times.


Leo MelamedAuthor Details:
Leo Melamed is an attorney and an active futures trader. He is currently chairman emeritus of CME Group, the world’s largest futures and options exchange, and CEO of consulting firm Melamed and Associates. Melamed has been an adviser to the US Commodity Futures Trading Commission. His books include Leo Melamed on the Markets, The Tenth Planet and Escape to the Futures.