In 1990, Nobel Laureate in Economics Merton Miller in assessing the financial landscape of that day called financial futures “the most significant innovation of the past two decades.” He was right. Not only did this event initiate the transformation of futures from their traditional usage in agriculture, it vaulted futures markets to their present position in finance as one of the most efficient risk-management tools. They are indispensable to the mechanics of efficient capital markets.
Few would argue that the modern era of futures markets began with the birth of financial futures at the International Monetary Market (IMM) of the Chicago Mercantile Exchange (CME) and its launch of currency futures on May 16, 1972 (a few months after the first issue of Futures hit newsstands). Those were seminal moments. Until then, we were trapped in our agricultural cradle and constricted by the limitations of physical delivery. Once those constraints were removed, futures markets soared. This first-mover advantage coupled with “cash settlement” and our subsequent introduction of Globex provided the momentum which ultimately brought the CME Group to today’s pinnacle of futures markets.
According to the Bank of International Settlements (BIS), 81.3% of all futures traded in 2013 were financial futures and options. The notional value of those traded equaled an astounding $1,886,283.4 billion. The success of these instruments of finance resulted from a combination of factors. First was the ending of U.S. dollar convertibility to gold on Aug. 15, 1971 by President Nixon.
By closing the gold window, President Nixon’s action led to an irreversible breakdown of the system of fixed exchange rates, initiated the era of globalization and provided the rationale for the CME, and later other futures exchanges, to prove that the traditional idea about use of futures markets in physical commodities was also applicable to instruments of finance and beyond. Tangentially, it is important to note that while it took a great deal of time for world recognition of our market’s capabilities, the Chicago community and its banks were immediately supportive.
Of particular importance were the local floor-traders themselves who had the trust and courage to believe in these new markets. Of course, we needed avenues for publicizing the values we represented. In this respect, my hat is off to the publishers and reporters at the first influential magazine originally called Commodities and later renamed Futures, which recognized the metamorphoses that was occurring.
With the advent of computer technology in the early 1980’s, business risks that exist in the marketplace could be unbundled and transferred to those most willing to assume and manage each risk component.
Consequently, financial derivatives soon evolved into a growing array of exchange-traded and over-the-counter (OTC) financial instruments with more sophisticated applications. The economic function of these instruments was to provide a safety-net based on benchmark groupings of inherent business exposures or to unbundle the risks involved into their basic components and transfer them to those most able and willing to assume and manage each component.