Badnewsfor Open Outcry
Recent moves by three exchanges show that the end may be closer than anybody thought.
By Robert Hunter
For more than a decade, the world's three biggest futures exchanges have tried to defend their open-outcry contracts from electronic trading systems of one kind or another. Electronic after-hours trading, order-routing systems and other innovations worked for a while. But ever since last year, when volume in the Deutsche Terminborse's electronic German Bund contract exceeded that of the London International Financial Futures Exchange's open outcry Bund contract, things have been looking increasingly grim for the guys in the pits.
In the last few weeks, the news has gotten even worse. The three exchanges—the Chicago Board of Trade, LIFFE and the Chicago Mercantile Exchange—have all announced major technology initiatives they hope will preserve their businesses well into the electronic-trading future. Although they don't add up to an outright capitulation, they come pretty close—and represent some desperate thinking by exchange officials who are beginning to question their roles as financial intermediaries. "The theory of our business,” admits a top-level manager of a Chicago exchange, "had always been that if you have liquidity and you have open interest, nobody can take your business away from you. Clearly that's no longer the case.”
The MATIF set the stage on April 8, when it introduced intraday electronic trading for all of its open outcry products. The electronic system will operate from 7:00 a.m. to 10:00 p.m. Paris time, while the trading floor will operate from 8:30 a.m. to 4:30 p.m. When asked at a recent conference how long he thinks it will take for electronic trading volumes to surpass those of open outcry, MATIF chairman Gerard Pfauwadel reportedly said "about three weeks”—a dagger to the hearts of open outcry traders if there ever was one.
Following the MATIF's lead, the LIFFE plans to introduce intraday electronic trading on a system called LIFFE Connect. Options will begin trading on November 30, and futures are scheduled to begin in late 1999. "It's a difficult decision, and clearly a contentious one,” says Tony Hawes, project director for LIFFE Connect. "All of the open outcry exchanges are wrestling with electronic trading in a pretty aggressive way right now. It's really a case of ‘horses for courses'—some exchanges are better suited for electronic trading than others.”
The Chicago exchanges may not be galloping toward electronic trading as fast as LIFFE, but both are taking significant steps forward. The Chicago Board of Trade has announced a partnership with Eurex, the new European electronic exchange comprising the Deutsche Borse, the Swiss Exchange and, eventually, the MATIF. And later this year the Merc will introduce Globex2, an improved version of its electronic trading system.
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LIFFE's radical decision to embrace electronic trading comes at a peculiar time in its history. Last year was the exchange's best ever, as it leapfrogged the Merc to become the world's second-largest futures exchange. The fact that it is even considering tinkering with its trading system underscores just how much of a scare the DTB has put into it. And there is another catalyst to LIFFE's decision—it is also vying for position in post-euro Europe. Electronic trading, it believes, will go a long way toward attracting euro players who now look fondly on the Eurex's electronic capabilities.
LIFFE Connect represents a universalistic approach to electronic trading. It will offer players the ability to trade all major contracts intraday using a Windows-based PC. The system is based on an application program interface that can be connected to any automated trading system. "We've developed a new paradigm in electronic trading,” says Simon Orebi Gann, managing director of information technology at LIFFE. "The LIFFE Connect system will be able to be distributed over any network to any PC.” The exchange published its programming definition last fall, allowing third-party software vendors to create software that will be compatible to LIFFE Connect when it launches November 30. So far, says LIFFE, well over a dozen firms have begun developing compatible products.
LIFFE officials concede, however, that securing membership approval for the system may be difficult. In France, MATIF's decision to go live with intraday electronic trading raised the specter of massive layoffs of suddenly obsolete open outcry traders. The result: an ugly labor strike. LIFFE hopes it can avoid a similar fate when it puts the issue to a membership vote on May 21. "Clearly it has been a sensitive issue in the past,” says Sandy Phillips, project director for LIFFE Connect. "We and the board of directors hope to be able to present a proposal to our members that they will accept.”
|"The CBOT and Eurex are condemning themselves to operating on old technology. It is a system that will be largely irrelevant.”
Many of the exchange's members are against the proposal. Local traders, unaccustomed to electronic trading, fear that they too will become obsolete in "about three weeks.” Others worry about significant job losses among the 3,000-plus exchange employees. Indeed, rumors of 100 layoffs in March, coming on the heels of a 16 percent drop in volume in February, fueled speculation that the exchange plans to cut many more after the LIFFE Connect launch. Still other members are worried that late 1999 is too long to wait to begin trading futures on LIFFE Connect—that the exchange will get off to such a slow start that it will not be able to recover. At this point in history, they say, 18 months is an age. Rumors that LIFFE is reportedly considering introducing 24-hour electronic trading on some products as soon as next year, initially using its increasingly outmoded APT trading system, may calm fears of foot-dragging for some but could provoke widespread panic in others.
The unique character of LIFFE's membership presents an uphill battle for LIFFE Connect. The exchange's "mutual” structure allows floor traders to block certain moves that could limit their income in the future. Daniel Hodson, LIFFE's CEO, tried to mollify traders in March when he told the Financial Times "I don't think there will be a decline in the number of locals. Locals, especially those who trade short-term interest rate contracts, will continue to make a very good living on the floor.”
Despite such assurances, LIFFE has introduced LIFFE Connect in such as way as to mute the effects of angry locals by following the path of least resistance. Rather than repeat the MATIF's mistake and dive right in to a firestorm of local protest by launching futures immediately, LIFFE decided to launch equity options first, because local traders are not involved in LIFFE's option markets. Whether or not this strategy will prove successful depends largely on the May 21 vote.
"Our ultimate goal is to let the market decide the outcome,” says Orebi Gann. "We're giving people the option of trading either on the floor or on the screen, and they will choose which way they prefer.” Such a sentiment looks good on paper, but may ring hollow to local traders facing obsolescence. Some have argued that LIFFE has no choice but to "demutualize” or prepare for extinction.
The CBOT and Eurex
The Chicago Board of Trade is taking a more cautious approach to the rapidly changing world of electronic trading—cautious, but significant nonetheless. The exchange announced in March that it will link its electronic Project A after-hours trading system with Eurex in October to allow for intraday trading of the CBOT's products on the Eurex trading system and Eurex products on Project A. Initially the products will trade on a split screen, but early next year all products will be available on a single screen. In the arrangement, the CBOT will cover the trading of financial derivatives in currencies from North America and agricultural products globally, while Eurex will cover financial derivatives in all European currencies.
"The fit with Eurex is good on a lot of levels,” says Clifford Lewis, vice president for strategic planning and international relations at the CBOT. "The Eurex business plan is not competitive with what we're trying to do, so there will be synergy rather than conflict. And there will be tremendous benefits in terms of technology. The Deutsche Borse alone has spent a quarter of a billion dollars on technology.” Jorge Franke, CEO of Eurex, is equally optimistic: "This alliance adds liquidity to our market and allows our members easy and cost-efficient access to a wide range of new products.”
The CBOT is banking on the success of Project A, which, Lewis says, appeals to after-hours traders more than open outcry pits. "Since electronic trading has become a major feature at the CBOT, our open interest has almost doubled in our financial contracts. It has actually strengthened open outcry.” If the Eurex link proves successful, a mutual link with an Asian exchange will be next, though no cross-listing of products will occur.
From the CBOT's perspective, the Eurex partnership should provide a number of benefits. An electronic trading link will be in place when the euro hits next January, guaranteeing that the CBOT will have a place at the euro table. CBOT members in Europe will now have complete access to its markets, using either Project A or the open outcry pits when in session. And the CBOT will lease memberships to Eurex member firms to get them in on the action. The CBOT will provide them with "order only” screens to give them basic market access. The CBOT hopes, not coincidentally, that this will help boost liquidity.
The cozy alliance with Eurex has led some to speculate about a full-fledged merger in the future. The LIFFE, suddenly vocal in electronic trading matters, thinks that would be a mistake. Weeks after it rebuffed an embarrassing public merger proposal by the DTB—an idea unthinkable just months ago—the LIFFE said that the CBOT's alliance with Eurex will ultimately prove futile because it requires dedicated hardware, rather than an open architecture like LIFFE Connect. "The CBOT and Eurex are condemning themselves to operating on old technology,” chairman Jack Wigglesworth said in March. "It is a system that will be largely irrelevant.”
Maybe so, but the CBOT displayed its commitment to electronic trading in another way when it applied to the Commodity Futures Trading Commission in March for permission to allow dual trading on Project A. This would allow brokers to trade on their personal accounts as well as on those of their clients during after-hours sessions. Some believe the move was made to encourage pit brokers worried about encroaching technology to explore electronic trading by offering direct financial incentives—and that the CBOT may be laying the groundwork for even more aggressive forays into electronic trading in the near future.
The Merc is nosing its way into the traffic of electronic trading by revamping its Globex international electronic trading system. Globex2 will go live sometime in September. The new system, the result of a technology swap with the MATIF, will feature the MATIF's NSC order-matching system. It offers a number of bells and whistles to attract traders, including Excel functionality, real-time charting, customizable screen displays, position-tracking improvements and an expanded order book, which will provide futures commission merchants with a truer picture of market depth. The system will also accommodate more sophisticated trades, such as interest rate bundles, packs and stubs.
While these improvements are nice, the Merc is most excited about Globex2's open architecture, which, beams Merc chairman Scott Gordon, "will allow a market participant to trade from a laptop computer anywhere in the world.” Globex2's routing system will allow FCMs to link directly from the Internet, a capability that could attract individual investors interested in the exchange's Standard & Poor's 500 e-mini contract.
"If a member firm wishes to take our Internet order-routing component and do some customizing to make it available to its retail customers,” says Mario Alberico, senior vice president for Globex at the Merc, "its customers would be able to enter an e-mini order on an Internet screen. That order would go through the member firm's credit vetting and security controls and pass through our Trade Order Processing System directly to Globex2 for execution. A quick fill could be sent back to that customer within four seconds.”
Each of the Big Three believes it has positioned itself well for the imminent electronic trading explosion. While the Merc's Internet capabilities still seem a bit clunky to some, it may have captured the essence of the futures business of tomorrow. LIFFE has already begun to downplay its plans to move to a new trading facility by 2004, presumably because it believes its electronic trading system will make such a move pointless. And with true Internet functionality within grasp, it may not be long before entire exchanges occupy no more than a couple of floors in suburban office buildings.