Automating Futures Markets: TST Interviews Tellefsen

In this issue, TST talks to Gerald Tellefsen about automation in the futures industry. During his 22-year career as a consultant, Tellefsen has done assignments for 10 exchanges. Prior to forming Tellefsen Consulting Group Inc. in 1984, Tellefsen was senior partner in Booz-Allen Hamilton Inc.'s securities industry group.

Tellefsen: Up until 10 or 15 years ago, futures exchanges were local and specialized. There wasn't a perceived need for automation. Historically, when there has been a problem in the futures industry, it has been solved with people, not computers.

The equities market reached a crisis point (1968) much sooner than the futures market and also had a regulatory requirement to develop a National Market System. These factors spurred the earlier adoption of automation.

The options industry has been the most progressive in terms of automation because there weren't a lot of cultural hurdles to overcome. After all, the CBOE was formed only in 1972.

Tellefsen: The step that the CME has taken with Reuters is a bold initiative, but then the CME has always been a pioneer. They're not afraid to take risks.

In signing up with Reuters, the CME has chosen an organization with a strong international presence and technology base. If after-hours electronic trading works, it will force other exchanges to re-examine their strategies.

Tellefsen: Automated execution has traditionally been anathema to the futures industry, but globalization and high volumes are changing this attitude. Other than using technology, how is a futures exchange going to provide a physical marketplace -- by building another Astrodome? Automated execution may be appropriate for certain kinds of transactions -- small orders and after-hours trading. But it remains to be seen whether it can provide the kind of price discovery and liquidity that face-to-face trading can. Also, it's conceivable that certain auto-execution systems may even increase the effectiveness of open outcry.

Tellefsen: These are examples of how the trend of automated execution is starting to catch hold in the futures industry. In the case of a new market, and the different types of trading environments overseas, it may be more cost-efficient and effective to set up an electronic trading system. In addition, there is very little resistance to technology when you are starting from scratch, or when culture change is minimal.

Tellefsen: They made the mistake of starting out with a product (gold) that was already traded somewhere else and they never developed sufficient liquidity. They weren't filling a major need of the current market. Automatic execution can result in less errors and faster fills, but this is meaningless unless you have a market.

Tellefsen: Systems can be developed for small order execution and to route orders from the customer to the broker on the floor. Floor-located devices can put a great deal of sophisticated information at the trader's fingertips.

Tellefsen: It has little to no paper and no out-trades. It has intra-day trade match and clearing capability and small order execution. There will be fewer people standing in the pit but their qualifications for being there will consist of more than having the money to buy or lease a seat. In addition, there will be some form of consolidated clearing, an issue that's been talked about for the last 15 years.