The world was about to change, and the CME was at the forefront of the revolution. But as the electronically traded products became more and more popular, the floor community began to see a significant shift in the volume traded in the open outcry session. The noticeable change in activity sent many of the old-time members into a panic, as the dynamic nature of the new market forced them to change their trading style. No longer would they be in the pit looking for the edge that came to them naturally through the geography of the open outcry session. The edge had become as dynamic as the rest of the market.
What followed in the electronically traded products was a migration of the edge to the screen. What was at one time a geographical edge had morphed into a technological edge. Traders were no longer talking about their spot in the pit but, rather, how to make their electronic trading systems milliseconds faster. The general public does not realize the displacement that occurs every time a pit-traded product is migrated to the screen. The thousands of jobs on the floor have been replaced by thousands of jobs off the floor, but not every floor employee or trader can flourish in an office environment.
Even today, with most of the notional value of the S&P 500 futures contract traded electronically through the e-mini, traders are seen in the open outcry pit trading in what has become a secondary market to the screen. The fact that the larger contract trades in smaller increments of
10 points per tick as opposed to the e-mini, which trades in 25-point in- crements, gives those still trading on the floor a small chance to create an arbitrage opportunity between the two contracts.
Although the spread between the two contracts has narrowed consid- erably since the inception of the e-mini, there is enough customer order flow coming into the pit for a few traders to prosper. It became apparent to many members that their way of doing business was quickly coming to an end. Leo’s words prophesied the change. The market had become the great equalizer—it was, and continues to be, the finest example of economic Darwinism in our time. Only the strong—or in this case, the best—will sur- vive the changing landscape.
But as the CME was going through a metamorphosis, so was the busi- ness I was trying to run at Commerz Futures. During the infancy of the e-mini concept, the board made a very important change to the clearing- house rules. The rule change created a limited liability on the part of the collective clearing members as opposed to a “good to the last drop” policy, which was the custom. “Good to the last drop” implied that if there was a default, then the clearing members would collectively make up the balance needed in order to maintain the market and exchange. This required ev- ery large institution to create a subsidiary that would act as a buffer in the event of a major calamity. The reality is that if the CME called and asked for $100 million because Morgan was in default, my first call as the president of Commerz Futures would be to the bank’s lawyer, not the treasurer!
The limited liability allowed the FCM community two very important efficiencies: First, it created the necessary financial buffer in a way that made sense to the financial institutions facing the fiduciary responsibility of investors. Second, it allowed the firms such as Commerz Futures the luxury of repatriating the capital that was put up for the sub and bringing it back to a more efficient use by the parent institution. Because of the change in the clearing structure and the growing electronic markets in Chicago, I was called to Frankfurt to give a presentation to the bank’s board of directors.
I arrived in Frankfurt on May 1, 2001. Being in a state of sleep deprivation caused by jet lag, I didn’t notice the security forces lining the streets as the taxi took me to my hotel. I was booked at the Frankfurter House, directly across the street from the Commerzbank tower in the heart of Frankfurt. After unpacking and taking a light hour-long nap, I ventured outside to experience what I thought to be European Labor Day. But rather than a day of picnics with hot dogs and coleslaw, as we would see in the United States, May Day in European countries is often a day of demonstrations by the working class that are attended by the police. My first day in Germany was witness to a bloody riot between Turkish workers and German security forces. I stood in shock, trying in vain to understand the reason, as I watched the two groups beat each other bloody with sticks and clubs.
The following day was the presentation to board members who would be responsible for the capital needs of the subsidiary of which I was the president. The bank’s boardroom is a grand, open space with magnificent floor-to-ceiling windows showcasing the city of Frankfurt from every view. As I began my presentation, I quickly realized that the board members had short attention spans and it was imperative that I work quickly. I went over a PowerPoint that showed the rule change and the fact that capital could be repatriated to Frankfurt. After I had spoken for 15 minutes, a vote was taken. No objections were raised, and the measure was passed. One of the board members, an older gentleman from Austria, said, “Very good, Jack. You’re Armenian, right? You know what we say about Armenians in Austria? There’s nothing worse than an Armenian Jew! Oh, but this is because of your negotiating power, of course.” Confused, I didn’t know whether to tell him I wasn’t Jewish or throw my pen at his head. Back home, where I have a great number of Jewish friends, being called an Armenian Jew would usually be complimentary. But hearing it said with such disdain by this Austrian gentleman who had survived the Second World War put things into perspective. As strange as it sounds, all I can remember as I went to my hotel room that evening is thinking about my grandparents and their stories of surviving the Turkish atrocities.
The other reason I was in Germany was to spread the word about the new electronic markets in Chicago. As part owner of Eurex, the Com- merzbank community was very familiar with the concept of electronic trading. In fact, it was the Bund traders at Commerz who were partially responsible for the forced migration of liquidity from the LIFFE to Eurex for the Bund contract. But everyone seemed to be excited about trading the stock indexes electronically. It didn’t take long to realize that the S&P 500, along with the other stock indexes traded on Globex, are the most thrilling action online. A needed rule change by the German regulators allowed the retail public to open accounts without the regulatory ambiguity that had surrounded the procedure previously.
The number of new accounts began with a trickle but soon started to come in waves. Introducing brokers in Munich and Hamburg started to find huge success with traders in remote regions of the German countryside who had never been exposed to the capital markets before but found an exciting hobby in electronic trading. I met with many members of the bank’s technology department, who listened intently as I explained the upgrades to the trading systems in the CME’s matching engine.
It was the techies who really understood the true power of the elec- tronic marketplace. They grasped that automating trading strategies would allow the trader to multitask and become more efficient. The bottom line was that the introduction of electronic platforms gave the bank two very important things: It gave the bank the ability to monitor traders in a way
never before imagined, which was a necessity after the Barings debacle, and it gave the bank a much more efficient use of its capital. Simply put, electronic markets allow the institution to get the most out of its traders rather than having them concentrate on a single market.