Philip McBride Johnson: If you weren't in the grain business, who cared?

For Futures' 40th anniversary, we asked Phil Johnson to give some insight to futures industry regulations and changes.

And the adage "no good deed goes unpunished" thrives in the markets. For generations, customer funds were deemed to be safe in the hands of futures brokers but two recent (and rare) corruptions of that system have caused pundits to question the integrity of the mechanism as a whole. I favor putting customer funds with a regulated third-party custodian to eliminate the risk but, so far, the industry has pushed back. With the alternative of private swaps, at least for commercial hedgers, this is a risky strategy. 

Over the past 40 years, the futures industry has grown and shrunk simultaneously. Contract volumes have soared while industry professionals have fallen in number. Where there were once hundreds of futures commission merchants, at least two-thirds have disappeared (most quietly, and a few spectacularly). Whereas the typical nonmember per-contract commission rate in the 1970s was around $85, today the rate often is quoted in pennies. 

Speaking of nonmember commission rates, the exchanges used to set them and God help the member who tried to undercut them. Not surprisingly, the rates for outsiders were some multiple of what members paid for the same service. The official justification was that raising transaction costs for nonmembers would induce them to join the exchanges, subjecting them to the markets' self-regulatory standards and discipline. The Justice Department was not buying any of it and the practice ended quietly. 

But not until after the CBOT hired a national consulting firm, then known as the Stanford Research Institute, to make an independent assessment of the minimum-commission-rate policy. Its staff met with me many times, hoping I would point them in the direction of the "right" (i.e., desired) outcome. I did not, but it taught me volumes about the consulting business. 

One change that is worrisome involves the breadth of what constitutes "hedging," a form of market use that carries many privileges like no (or higher) position limits, lower margin requirements, etc. For decades, a hedge was a market transaction that generated profit from the same event that would cause losses in the trader's own commercial operations, and usually in roughly the same amount if fully hedged. Today, something called "macro hedging" occurs in which a variety of activities are bundled together and market positions are taken to address the "net" risk across all lines of exposure. One prominent enterprise just lost $5 billion or more using what I presume was this strategy. This is not supposed to happen. 

Meanwhile, the CFTC has gone from sole and exclusive futures regulator to sharing jurisdiction with other agencies. In 1974, much blood, sweat and tears went into the "exclusive jurisdiction" goal for this new entity, out of genuine fear that any other structure could bring forth dozens of other regulatory wannabes claiming some sort of interest in the process. Despite failed legislative attempts to undo that structure, the CFTC retained its exclusivity until the year 2000 when the Securities and Exchange Commission (SEC), with futures industry backing, was awarded co-regulator status over single-stock and narrow stock-index futures. This has emboldened other authorities, notably the Federal Energy Regulatory Commission, to venture into view as well. While there appears — ironically — to be little interest in the products where the CFTC and SEC share jurisdiction, the energy sector is prominent among futures users. Can other claimants be far behind?

Finally, despite the passage of four decades, the futures community has never hired the wordsmiths needed to overcome its "grain gambler" image. The term "speculator" has not achieved public acceptance in the way that "investor" has. Even though both commit funds voluntarily to a venture over which they have no effective control in search of profits. And both serve valuable societal purposes, one to underwrite the legitimate needs of commercial hedgers and the other to provide working capital to business enterprises. 

Forty years ago I was a fit 34 year old who felt blessed to be part of an exciting futures world in transition from soybeans to serving dozens of industries at home and abroad. It has been a good ride, alternatively fun and frustrating. Throughout, the futures community has bloomed. I can't wait to share my thought (sic)  when Futures Magazine completes its next 40 years in print.

Philip McBride Johnson profile from 2007 "Agents of Change," issue

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