Following are the written remarks presented by Chairman Carey as part of the panel discussion.
CBOT Chairman Charles P. Carey Remarks
Business Leaders Breakfast Program
”Innovation: Behind the Buzz”
June 22, 2006
o Thank you, Len. It is a great honor to be here today and to participate in a discussion on a topic I feel is critical to maintaining a successful business—encouraging innovation within the organization.The Chicago Board of Trade has a long tradition of innovation which was hard-wired into the Exchange from its very beginnings. The CBOT’s story is a good illustration for a key point I believe about innovation: Businesses and people are at their most innovative when faced with a challenge.
o That was certainly the case in 1848, when 83 Chicago merchants worked together to try and help alleviate the chaotic market conditions of the time. You see, shortly, after harvest, when there was a lot of grain, prices sank. Then, nine to ten months after each harvest, the lack of grain drove prices to very high levels.
o In fact, one famous story illustrates the frustration cause by this volatility. In the middle of the 19th century, wheat prices dipped so low that a group of farmers dumped their wheat into the Chicago River in protest. These farmers felt if they couldn’t make a decent living off of their crops, no one was going to.
o From this strife was born the Chicago Board of Trade. The innovative thinking of the members of the Exchange drove the development of the city’s infrastructure such as the canal and harbor improvements, railroads and warehouse storage facilities and the establishment of grain grades and a grain inspection system to facilitate grain trade.
o By 1859, the CBOT sought and received from the Illinois legislature a unique charter that strengthened the organizations ability to oversee it own markets and increased its control and enforcement policies, especially as it related to grain inspection system. This charter also paved the way for the creation of the futures contracts.
o Almost immediately after our establishment, cash forward contracts came into popular use. These contracts were negotiated on an individual basis and allowed buyers and sellers of agricultural products to specify delivery of a particular commodity at a predetermined price and date. By 1865, the CBOT had developed futures contracts. Futures contracts unlike forward contracts were standardized as to quality, quantity and time and location of delivery for the commodity represented and being traded. The only variable was price—discovered through open auction trading.
o During these early years, innovation was rampant with many trading practices introduced in order to refine the risk-management benefits of our markets.
o Along with standardized contracts came a margining and clearing system designed to eliminate the problem of buyers and sellers failing to fulfill their contracts. In 1925, under the leadership of President Frank Carey—no relation— the Clearing Corporation was established, the heart of the guarantee system.
o Innovation in those early years also included product development. By 1920 CBOT markets included wheat, corn, oats, and rye. When soybeans became a commercial U.S. product, the CBOT created futures for soybeans in 1936, and soybean oil in 1950 and soybean bean meal in 1951.
o Since the CBOT’s inception, the many innovations at the Exchange has never stopped. In fact, it has expanded. Not only did the Chicago Board of Trade evolve into a successful global marketplace, it began a multi-billion dollar industry. And that is one of the best things about innovation—it’s contagious.
o Businesses have to be constantly reinventing themselves in order to keep up with the trends and forces of an ever-changing global marketplace. The CBOT’s Board of Directors and our professional management team take a proactive approach to looking for new solutions and new risk management tools to serve the needs of our customers.
o However, as I mentioned earlier, it is challenges that often are the most significant drivers for innovation. Just as the CBOT’s development of futures trading came from the problems of supply and demand of grain in the mid-1800s, many of the CBOT’s most innovative initiatives were the result of a pivotal moment when talented and motivated people saw the opportunity in a challenge and acted on it.
o This was certainly the case with the CBOT’s creation of the Chicago Board Options Exchange--the first options exchange in the U.S. to offer standardized options on listed securities. In the late 1960s, the the Exchange’s leadership set itself to the challenge of finding a market that would help diversify the CBOT’s traditional agricultural futures product line.
o It was in 1969 when the idea surfaced of applying the principles at work in the CBOT’s commodity futures markets to securities options. Securities options prices were typically obtained by word of mouth or through newspaper. The idea was that this would help remedy the stock option market’s inefficiencies
o Like most innovations, it began as simply an idea - the original concept was actually written on the back of a napkin by the CBOT Vice Chairman Ed O’Connor during a dinner meeting with CBOT Chairman Bill Mallers and President Henry Hall Wilson. However, it still took years of constant work—starting with in-depth research and finding the backing of people who had the dedication to overcome Exchange and government opposition.
o Finally, on April 26, 1973, the CBOT launched the Chicago Board Options Exchange. The CBOE’s growth was exponential and like futures contracts in 1865, the CBOT ushered in a whole new era of risk management.
o Innovation at times can be simple—pure common sense. A lot of businesses believe that in order to be innovative you need to be totally different. Yet innovation is also rearranging of the old in a new way.
o Like the creation of CBOE, the CBOT’s development of interest rate futures followed the same process. There was a challenge. An innovative idea based on the mechanics of futures. And a group of strong supporters with the courage to make the idea a reality.
o In this instance, the challenge was the explosion of U.S. government-issued debt in the 1970s, which created uncertainties in the economy. To meet this new demand for risk protection, the CBOT expanded its contract offerings into the financial arena with an interest rate futures contract based on Government National Mortgage Association mortgage-backed certificates. With the success of GNMA futures, we pushed the concept even further and a few years later based a futures contract on U.S. Treasury bonds.
o These futures contracts paved the way for the enormous growth of financial futures. Since the launch of GNMA futures in 1975, the CBOT has traded nearly 3.2 billion financial futures and options on futures contracts. And once again, this innovation in futures trading not only brought success for the CBOT, but also for the global financial community. Other exchanges across the globe took our innovative idea and added their own twist on the concept. Today if you looked at a list of the top 10 futures contracts trading--half are interest-rate based.
o Another more recent example of a CBOT innovation that started from a challenge comes from one of my own personal experiences. It occurred a couple of years ago when a futures exchange in Frankfurt called Eurex – the second largest in the world based on volume -- decided to start a U.S. exchange and list all of our products on it. In the process, our clearing corporation since 1925 (PAUSE), had become adversarial.
o Given the competitive landscape, we needed to create a new solution for clearing that would bring heightened value to our customers. Within six weeks, we put together the plan for the Common Clearing Link, a partnership with the Chicago Mercantile Exchange.
o Through the Common Clearing Link, we have helped to set the standard for the clearing of U.S. futures. Some of the benefits of this partnership have been the unsurpassed capital cost savings and lower margin requirements. Our clearing solution has delivered $1.8 billion in capital requirement reductions back to our customers.
o Ultimately, the biggest winners were our customers. However, because of our efforts, on October 7, 2004, the CBOT and CME together earned the Sun-Times sponsored Chicago Innovation Award.
o We are extremely proud of our accomplishments. Still if you want to grow your business, you can’t dwell on past achievements. The CBOT is constantly looking ahead, creating new and exciting opportunities and solutions for the risk management needs of market users. To that end, the CBOT is now concentrating its efforts in three directions – products, global expansion and strategic alliances.
o In order to keep pace with the evolution of change, the CBOT is always on the watch for changing trends in the marketplace when it comes to making decisions on new products. The CBOT also strives to offer new contracts that tap into the success of our existing products.
o Those were the two major factors in why we developed and launched Ethanol futures in 2005.
o And, we have a number of reasons to be optimistic about Ethanol futures’ growth potential. Already, many big names in the ethanol industry are looking to our contract as a pricing benchmark.
o In the area of global expansion, the CBOT is using technology as a way to reach to new customers abroad, particularly in emerging economies such as China, India, and Indonesia, countries that are seeing increased standards of living. Launching a telecom hub in Singapore has expanded our access points to 12 worldwide, providing CBOT customers globally with an efficient and cost-effective method of connecting directly to the CBOT’s markets.
o I also want to mention a significant strategic alliance the CBOT currently is working on – JADE, our joint venture with the Singapore Exchange. This new, 100 percent electronic exchange will leverage the capabilities of our cutting-edge electronic trading platform, delivering high-quality management tools on Asian-based commodities. We expect to launch a rubber contract, the new exchange’s first product, by the end of 2006.
o Recently, the CBOT has undergone tremendous organizational changes to adapt with the times. We launched a successful initial public offering last October, and I am proud to note that we reached several financial records, including revenue and net income, in 2005. As the title of today’s panel states, the CBOT did not transform from a regional grain exchange into the global leader it is today by accident. Our transformation has been the result of ongoing, and carefully considered, innovation.
o Ultimately, I believe that the innovative spirit that has been so much a part of the derivatives industry has to do with the type of people that work in the business. As Steve Forbes said, “The real source of wealth and capital in this new era is not material things…it is the human mind, the human spirit, the human imagination, and our faith in the future.”
o It also is interactions that come from programs like this one that can spark the ideas that can change an industry and the world. I appreciate this chance to share some of my thoughts on innovation with you. Thank you.
