The World According to Larry Mollner
With more than 30 years of futures trading on his resume, Larry Mollner ranks as one of the elder statesmen of the futures business. He spent much of his career at Dean Witter Reynolds, joining the firm in 1979 as a salesman in the commodities division. He went on to develop the firm's presence in financial futures, eventually becoming director of its futures market division. When Dean Witter sold its futures business last year, Mollner became president of Carr Futures and managed the transition. He has also served as chairman of the Futures Industry Association and in leadership positions in a number of futures exchanges and associations. Mollner left Carr in February and now says he is "studying his options.” He was interviewed by editor Joe Kolman in February.
Derivatives Strategy: How much time does open outcry have left?
Larry Mollner: There has been a lot of talk about the inevitability of electronic trading taking over for open outcry. Visionaries have long recognized the fact that the people-intensive open outcry system is costly. Moore's law says that computing capacity will double every 18 months. With the increased capacity and reduced cost for computerized trading, the two will eventually cross, and computerized trading will eventually be the surviving system. Whether that's in three years or 10 years, I don't know, but all the cards are in place for electronic trading to represent a serious challenge to the open outcry system.
DS: When are the numbers going to meet? When will the inefficiency of open outcry vs. the relative efficiency of electronic trading finally…
LM: Let me stop you there. The open outcry system is not inefficient. It is extremely efficient. Particularly in the larger traded markets—bonds, crude oil, Eurodollars, Standard & Poor's index contracts and so on—where speed of execution is essential. It is still above reproach during extremely busy times. There are efficiencies in electronic systems but there is also some slowness involved, and downtime is always a question. The speed and reliability of computer processing will eventually catch up. Just look at what we've seen take place with the Deutsche Terminborse's Bund contract challenging the London International Financial Futures Exchange's contract.
I can relate a story from a financial institution that switched its trading from the LIFFE to the DTB. During busy times, the screen trading is not as fast and efficient as open outcry, but they told me that they made the switch because they recognized that there are only certain peak periods where that speed and efficiency are of prime importance. When they weighed that with the time they trade during the month, they came to the conclusion that the cost savings and the efficiencies of the DTB's electronic system outweighed those periods when the LIFFE floor was more efficient. So they made the conscious decision to switch to screen trading. That type of decision depends on the strength of management and its control over traders.
DS: Do you think certain contracts are more vulnerable than others are?
LM: I think that the Chicago Board of Trade's big Treasury bond contract, which the majority of us trade spot month, is not as vulnerable as the Chicago Mercantile Exchange's eurodollar contract. There are all sorts of trades that go on in eurodollars—bundles and packs and the various combinations thereof. It's difficult to get accurate readings on prices if you have to go out and get bids and offers on eight different contracts and figure out what your spreads are and then calculate your execution price. So I think that's far more vulnerable to an electronic system where somebody can simply put in whatever total price or yield they want and have the system do the calculations for them.
DS: The exchanges complain a lot about competition from the OTC market but they don't seem to be able to overcome their internal squabbling to do anything about it.
LM: The exchanges openly talk about the competition from the over-the-counter market, but they need to wake up and address the real problem, which is the cost of doing business for the users of the market. Most of the major brokerage houses, investment banks and commercial banks are users and brokers as well. They recognize that exchange-traded products are cost- and labor-intensive.
Exchanges had the upper hand in interest rate products when the cost of business on an exchange was less than the OTC market, which came about because of narrower spreads and the liquidity provided by the locals. With the cost advantage gone and the ability of OTC firms to provide the financial engineering the customers need, exchanges have, in fact, been losing market share. You might say they are victims of their own devices. The more they try to keep things operating the same old way, the further they fall behind.
For example, common clearing is a prime example of something that needs to be done in the United States, but it's caught up in the political arena of the exchanges. Clearing trades is a utility. Nobody has ever asked me to clear bonds with the Merc because the Merc clears trades more efficiently, or euros at the Board of Trade Clearing Corp. Customers don't care.
DS: So what's the effect of all of this?
LM: The result is that futures commission merchants can't use their IT dollars efficiently if they are continually playing catch-up just to keep doing their futures business with all the different clearing organizations in the United States and internationally. If they spend all their IT dollars doing maintenance and such things as the Board of Trade/LIFFE Bund link, it takes away time that the IT departments could spend on such things as better order routing, processing and so on.
|"The exchanges openly
talk about the competition from the over-the-counter market, but they need to wake up and address the
cost of doing business for the users of the market.”
I came from a large brokerage firm where I had to compete for the IT dollars and bodies. Most of the internal competition was developing new products for the benefit of the firm, and I was trying to compete for time, effort and bodies just to maintain my business. When management looks down and sees that the IT dollars are being spent to maintain something that is already under heavy profit pressure, they ask themselves if it is an effort they want to be involved with.
The exchanges don't realize that's a problem. If they don't start, they're going to find one day that someone has put together an electronic order-matching system. Someday, a firm or group of firms is going to come along and say the time is right, the technology is here, so why don't we just do it? And it will be up and running in six months and the exchanges will have missed it.
The challenge is not between the Merc and the CBOT. The challenge is not who stands where in the pit and who gets the next great product. It's pretty difficult to find. The real challenge comes in modernizing a 150-year-old industry that is people-intensive and therefore highly costly.
DS: What can the exchanges do to protect themselves?
LM: The exchange leadership talks about this and recognizes it. But they're not able to do much about it. The political nature the of U.S. membership organizations means that most of the votes represent the local traders' interests. The leadership is not able to garner strength from the floor community to put the technological advances in place necessary to make this business cheaper to run. They don't necessarily do what they should to educate and inform the membership about the challenge, and the floor prefers to ignore the big picture.
DS: You don't seem to be overly optimistic about the exchange's chances.
LM: There are a lot of regular floor members I've known for years who say, "If this only lasts five more years, its OK. I'll get my five years out of it, and this isn't something I wanted my grandson to do anyway.” The leadership understands—they're just under such political pressure that it makes it difficult for them to step forward and say, "This is what we have to do.”
A consultant friend of mine once said it best: It's difficult to tell the buggy manufacturer that there is no future in the business when it merely asked for help on improving the manufacturing process.
DS: In your vision of the future, what specific technological advances will the exchanges need to develop to compete with the OTC market?
|"The challenge is not between the Merc and the Board. The real challenge is modernizing a 150-year-old industry that is people-intensive and therefore highly costly.”
LM: Obviously a single clearing process for the U.S. futures industry is important. The next step is the development of what I refer to as the common switch technology, in which each exchange can develop its own order-routing format, after-hours electronic trading system and so on, and through a common switch, brokers and traders need only one format in order to access each one of these systems.
This is not a new thought, and the exchanges have been moving in that direction. It is currently in place in the securities industry. Such a system would cut down on system duplication, consolidate resources on the trading desk where trained personnel and real estate are important, and allow those entering orders to access the market through their network rather than through the proprietary systems currently in existence—the New York Mercantile Exchange's Access, the CBOT's Project A, the Merc's GLOBEX and so on.
Following on, we need to develop straight-through processing, in which necessary information is entered only one time. This is not necessarily an exchange issue exclusively but, again, is necessary to reduce the processing costs.
DS: A lot of people believe all this new technology is a threat…
LM: History demonstrates that technology in all industries has been an improvement whenever it increases volumes and lowers unit costs. The New York Stock Exchange had a billion-share day in 1997. The same comments about access, upstairs trading, electronic order flow and so on were heard for many years, but the securities industry embraced technology rather than fighting it, and it was able to handle that kind of volume.
|"There are a lot of floor members who say, ‘Hey, if this only lasts five more years, its OK. I'll get my five years out of it, and this isn't something I wanted my grandson to do
Market makers on the floor of the Chicago Board Options Exchange can have a hand-held terminal in which they can hedge off their positions or make an outright trade through DOT. Why shouldn't a large local player trading in eurodollars or S&Ps be able to have that same hand-held technology to submit orders from one floor of the Merc to another? Or perhaps, from the Merc to the bond pit and vice versa?
All of these technological advances not only reduce unit costs, but also have the potential to increase volumes. The competitiveness of the exchange-traded futures markets gains with improvements in liquidity. The floors must stop being protective of their niches and begin to grasp the concept that volatility and liquidity are what people trade and that more can take place given some of the technological advances described herein.