Richard Sandor: Inventing markets out of thick air

Futures, Fall 2007 by Collins, Daniel P

In 1969 Richard Sandor was teaching economics in the graduate business department at the University of California at Berkeley. Even then he was forward thinking, teaching a course on futures at a time when futures, if addressed at all, would be taught in some agricultural economics course. Sandor would have expert guest lecturers address the class and one of his guest lectures was Warren Lebeck, who was a vice president of the Chicago Board of Trade (CBOT). That was the start of a relationship that would last several decades, with Sandor eventually becoming chief economist at the CBOT and creating the first futures on interest rates. Sandor would go on to create financial contracts that today compose the core volumes for the exchange.

Sandor says futures on interest rates is something that had been kicked around for some time but could not be traded until the creation of the Commodity Futures Trading Commission (CFTC), which happened in 1974- "[Interest rate futures] would have been viewed as securities," he explains. "We had been working on [Ginnie Mae futures] and the CFTC Act of 1974 gave us a way to redefine what a commodity was and it had also granted exclusive jurisdiction [by the CFTC] to retain that. The Act changed the entire complexion of the industry because you would not have had interest rate or stock index futures without it," Sandor says.

The CFTC, the creation of which Sandor calls the most important development in the futures industry, approved its first futures contract based on a financial instrument on Sept. 11, 1975. They were the CBOT's Government National Mortgage Association (Ginnie Mae) certificates. Sandor recalls that the exclusive jurisdiction of CFTC regulation was tested early on as the securities and Exchange Commission (sec) marched into the CBOT shortly before the launch of Ginnie Mae futures and threatened to bring an injunction claiming the right to regulate the new product. Exclusive jurisdiction held up and the era of interest rate futures was born.

The Chicago Mercantile Exchange (CME) followed shortly thereafter with Treasury bills, and in 1977 Sandor and the CBOT launched U.S. Treasury bonds, which would grow to be the highest volume futures contract in the world.

While the CME had already launched currency futures, Sandor says that currencies, at least structurally, had more in common with traditional futures. "Interest rates were a way to allocate capital, and currencies obviously are relationships between different countries and they were very different financially. There was a whole different set of problems that had to do with defining the regulatory environment as well as the financial instruments that would be trading."

Regulatory hassles were one problem; the other was getting banks to recognize their value. "I got thrown out of every major investment bank and commercial bank in New York and was told interest rates don't fluctuate and there is no need to hedge. 1 don't think they even thought it was viable or even worthy of note," Sandor says.

The other problem was that these new instruments were a threat to the status quo. "The last thing [these banks] wanted to do was take an opaque market and make it transparent. I mean if you are in the principal business that is not what you want to do. 1Hi, I am from Chicago. I am here to narrow your spreads and make an opaque market transparent.' You don't get exactly treated with open arms," Sandor says.

The idea, however, was not without backers from the commercial side. "We had significant support from the S&Ls at that time, they were very much in favor of it, the Federal Home Loan Mortgage Corp. was a big backer so we had a substantial group of advocates for the product that really opened the whole door to the industry."

And on the commercial side, while some saw it as a threat, those bankers with a longer view also saw its value. "The ones that were really capable and smart knew that ultimately these markets would be good for them, they would make narrower margins but on huge volumes because they were able to hedge themselves," Sandor says, adding, "The interesting thing is the early users of the interest rate market ultimately became household names in American finance. Not because they used or recognized interest rate futures but they recognized that the world was changing and this could be a very profitable way to operate. They weren't threatened by change they embraced it."

Sandor would continue to write new contracts for the CBOT adding 10-year notes and options on Treasuries in the early 1980s. He credits the leadership of then-CBOT Chairman Les Rosenthal with bringing innovations to market.

"We tried to develop as many new products because [Rosenthal] was very innovative and he was willing to lead the charge, knew what it took to make new markets, was very involved in structuring associated memberships and commodity options. If Les hadn't provided an open canvas for me I couldn't have done a lot of the tilings that I get credited for. We put as much in as we could while he was chairman."