Tokyo, Japan
INTRODUCTION
I would like to thank the Futures Industry Association of Japan for hosting this fine reception and for inviting me to address this distinguished audience. I must say that I am a little apprehensive about their suggested topic, "the future of futures." Whenever the subject of predicting the future arises, I am reminded of the American official, around the turn of the last century, who suggested closing the US patent office because everything mankind could possibly need had already been invented. In fact, as we all know, man's inventiveness continues to flourish and to assure us of a future that is inherently unpredictable. Indeed, if the future could be predicted, what need would there be for futures markets? Nevertheless, I will venture a few general remarks on the forces of change, competition and technology that are shaping the future of futures markets and the future of the global marketplace where they play such a key role.
FORCES OF CHANGE
As we examine the forces of change, we should look first to that term, "global marketplace." It began its life as a clever catch phrase, but it is relentlessly evolving to become an immutable fact of economic life. The most obvious examples of this globalization process may be found in financial instruments trading, where multinational corporations direct capital flows from country-to-country, time zone-to-time zone, with the tap of a computer key, as they seek the best returns. The opportunities for futures in this fast-paced financial marketplace are self- evident.
But there are equally compelling examples of change from outside the financial arena. In my remarks earlier today at the Forum on Risk Management, I alluded to the new era for agriculture in which farmers in many countries are being freed from government price supports and production controls. As they make the transition to farming for the market instead of farming for the government, producers will need to protect themselves from price and production risks formerly covered by government programs. Most of this protection will come in the form of "secured revenue" type contracts. Exchange-traded and over-the-counter derivatives will be the building blocks used by many farmers and agribusiness companies in developing this type of contract. That's the good news for the futures industry. On the other hand, if the agricultural sector downsizes and embraces the integrated poultry business model, what will happen to the volume and liquidity of agricultural futures and options?
We might also look to the energy markets. In the US, for example, the dismantling of government price controls on natural gas under the Natural Gas Policy Act of 1978 gave rise to an active spot market, the entry of new marketing firms into the business and considerable price volatility. This volatility created the need for new risk management tools and gave rise to a highly successful natural gas futures market. A similar deregulatory process is now underway in the electricity generation industry. This has given rise to two new electricity futures contracts, which began trading in the spring of 1996 and have gotten off to quite a respectable start.
However, nowhere are the forces of change more evident than in the booming markets of the Asia-Pacific region. Such economic growth inevitably creates uncertainty and risk. Those who participate in this economic boom will need to protect themselves from that risk. And history has proved that futures markets are a remarkably efficient and effective way to manage risk. That is why the vibrant economies of this region are sustaining active futures markets in Japan, China, Hong Kong, Singapore, Malaysia and Korea, with exchanges being developed in Taiwan and Thailand and under consideration in other countries.
Taken alone, the Asia-Pacific economic boom and the other factors I have described, would seem to indicate a bright future for futures markets, both here and around the world. But this sunny picture also includes a few clouds on the horizon. Those clouds take the form of the twin forces of competition and technology.
FORCES OF COMPETITION
One type of competition involves the regulatory arena. I don't think anyone here would disagree, that in today's world of interlinked markets and cross-border capital flows, regulators must maintain some minimum level of compatibility among regulatory systems. The Barings and Sumitomo events taught us that lesson only too well. The question is -- what should that level be? For competitive reasons, some would suggest achieving compatibility in derivatives markets by imposing a bare minimum of regulatory protections. This lowest common denominator approach, which seeks to attract more customers by offering a "wide open" trading environment with lower costs for regulatory compliance, has aptly been described as the "race to the bottom."
I believe this course of action is ultimately self-defeating. I believe that if you set out on a race to the bottom, that is exactly where you will arrive -- and you will get there without the market and financial integrity protections a successful market demands. Lower standards and lax enforcement may lower the costs of regulatory compliance in the short run, but over the long term they will foster fraud, trade practice abuses, manipulation, financial defaults and rogue traders. A far wiser course is to adopt prudent international regulatory standards that will give hedgers and speculators alike greater confidence in the market integrity and financial security of futures trading. Such standards will also help to attract the big institutional users, such as pension and retirement funds, which are subject to strict fiduciary requirements allowing them to participate only in financially secure, well-regulated markets.
In this context, it appears to me that Prime Minister Hashimoto's "big bang" policy initiative holds the promise of meaningful change for the way Japan's financial markets are regulated. For instance, I have been told that regulators in Japan are considering enhancements to their system that would shorten the cycle for settling futures trades to trade-day plus one and allow for more open access to products by commodity pools. I would also encourage Japanese authorities to consider extending rules for segregating customer funds to include not just futures exchanges, as is currently the case, but securities exchanges as well. I believe such enhancements, and others like them, would benefit the global marketplace and improve the competitive position of Japan's derivatives markets.
Looking beyond regulatory issues, we find the more familiar arena of competition -- the normal competition for business that derivatives users, traders and exchanges face every day. This is the area most affected by the final factor I mentioned -- technology. It is also this area where my crystal ball is the most cloudy. The only statement that one can make with confidence about the technology of today is that it will be obsolete tomorrow. Nevertheless, let me just toss out a few of the questions that technology raises about the future of futures.
FORCES OF TECHNOLOGY
How will the Internet affect the marketplace? Let me give you two quick examples. As we all know, the Internet provides customers with access to futures, options, stock price quotes, banks of historical price data, and even market research -- all for the price of a phone call. And recently, some US corporations have gone public by marketing share offerings on the Internet. This mind boggling technological tool has unlimited possibilities. In my opinion, the honest individual or company that is innovative and creative enough to use the Internet to offer quality goods and services at competitive prices will move to the front of the line in the 21st century.
But what about the dishonest users of the Internet? Already, the CFTC has assigned full-time investigators to patrol cyberspace and has brought several enforcement actions against Internet violators. We have even used the Internet to place an on-line "wanted poster" of an individual who absconded with $3 million in customer funds.
Looking beyond the effect the Internet will have on futures, consider the other changes that new technologies have brought about in the futures industry. Will screen-based systems sweep the traditional open out cry exchanges aside? In the next century, will the exchanges, as we know them today, become obsolete as large institutional traders implement over-the- counter order matching systems? Or will automated order transmission systems, hand-held electronic trading cards, and a system that provides one-stop clearing and margining for futures and over-the-counter products, save the day for the open out-cry pit trading? To say the least, the future of futures promises to be exciting and challenging.