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Consideration of two key developments in our industry has recently unnerved
me. I admit it. I have turned into a 6 foot 7 inch, 285-pound nervous Nelly
when I think about the changes coming to the structure of this industry.
The kinda-sorta soon to be convergence of the introduction of electronic
trading at the CBOT and the probable introduction of single stock futures not
too long after that has me predicting an entirely new look for the futures
industry.
First, let me say that despite the CBOT's ability to screw up a good thing, I
think they will agree to merge with the CBOE. A merger is the easiest
solution for both exchanges to difficult problems.
A combined CBOT/CBOE will have the best shot at capturing the single stock
futures volume, which I expect will be a huge success. Actually, that
success is part of the problem I see. But I will get to that later.
I believe stock traders will embrace single stock futures. A whole new
generation of stock players are traders, not investors. Even mutual funds
have a much higher turn over rate than in the past. Traders will migrate to
the market with the most even playing field. Single stock futures, if the
futures exchanges do them right, will wear that crown. Sell on an up-tick or
down-tick. No one paying to get your brokers order flow. The true cost of
trading will be known. Spread versus cash securities or another futures
month or with the existing securities options. Traders will have greater
flexibility and choices for managing their risk. Futures will attract volume
from traders who are now in stocks.
However, the success of single stock futures will unleash market forces,
which will require firms to offer futures and stocks (cash securities)
through the same account. Some will want to be able to trade all this online
with the same interface. There are firms that already offer this and have
industry leading low rates to go with their forward looking market position.
Other firms will have to follow.
Futures firms will have to offer securities. They will have to dually
register as FCM's or IB's and broker dealers. (As I am a futures broker, I
really don't know that much about the structure or regulatory requirements of
the securities industry, so some of my conclusions may be based on
conjecture.)
Some firms will not have the resources to do both. They will perish. The
CFTC and SEC are close to an agreement on regulating single stock futures
without double regulation. But the market forces that will be unleashed by
successful single stock futures will cause firms to have to dually register
or face an uncompetitive and uncertain future. Granted, there are some firms
that are specialized in one sector and may not be affected by growth or
shrinkage in other sectors of the futures markets. They may not be affected,
entirely.
I think Congress will be slow to recognize the convergence of the futures and
securities industry and thus slow to merge the CFTC into the SEC. This will
add to the problems of firms being double regulated.
The CFTC needs to be merged into the SEC, but this will not occur, in my
opinion, until the futures exchanges have a strong foothold on stocks through
successful single stock futures contracts. Only then, after the futures
firms themselves have transformed themselves into securities firms as well
will enough players beat the political drum to sacrifice the CFTC in the name
of avoiding double regulation.
Common clearing of stocks and futures will become a big item. I would look
for the futures exchanges and their clearing affiliates to move into clearing
of securities too if they are not already.
Single stock futures have the potential to be successful enough to attract
traders from dwindling volume futures pits to the screen traded single stock
futures. (It is not for sure that single stock futures will be screen traded
and not pit traded, but I think screen traded is their best bet.) This
talent and financial muscle drain from the futures pits will certainly not
enhance the liquidity in the pits and could lead to a much earlier than
anticipated end for open outcry trading of futures in Chicago, if not the U.S.
Maybe I am wrong. Maybe I am getting ahead of myself. But that is not what
my gut or my brain tells me. They tell me we are in for a whole bunch of
change and some weaknesses in the current nature of the futures industry will
cause additional pain.
Futures firms are best run by futures people, even the futures arms of
securities wire houses. Securities have been a different animal. The
spectacular volatility of the Nasdaq and Internet stocks has introduced more
commonality in recent years. But largely securities people and futures
people are different; different risk, different regulators, different types
of investors/traders.
Market forces will encourage consolidation and mergers of futures firms and
securities firms. The firms that will dominate going forward are those
technologically advanced enough to provide their clients and their brokers
the tools to trade these markets from one screen. They will also have to
have a competitive cost structure in clearing trades.
Liquid markets will come from exchanges offering even playing fields for
traders all over the world being able to access electronically traded markets
with and with brokers offering a cost structure low enough for clients to
trade like a market maker.
Just when I thought I had positioned myself for this whole electronic trading
revolution, all this potential revolutionary change shows ups. It is enough
to make any broker nervous. :-)
Regards,
John J. Lothian
Disclosure: Futures trading involves financial risk, lots of it!
Disclosure: John J. Lothian is the President of the Electronic Trading
Division of The Price Futures Group, Inc., an Introducing Broker.
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