Commodity Markets

Cattle Rancher Wants to Start
Futures Exchange on the Internet
By Aaron Lucchetti

01/05/98
The Wall Street Journal

(Copyright (c) 1998, Dow Jones & Company, Inc.)

William O'Brien wants to beef up the Internet.

Investors can already tap the mushrooming medium to watch stocks, study mutual funds and even check bank statements. But no U.S. exchange offers commodity futures directly over the World Wide Web.

Mr. O'Brien wants to change that. Last year, the 55-year-old Amarillo, Texas, cattle rancher sent in a proposal to the Commodity Futures Trading Commission to start a new Internet-based exchange for live-cattle futures and options. He criticizes the current method of floor-trading on established exchanges as too expensive, inefficient and time consuming for commodities customers who are trying to keep costs down in a competitive environment. Mr. O'Brien says that by offering farmers and other buyers and sellers a direct route to the exchange through their computers he can cut trading fees in half. "I'm absolutely convinced that we have a better way of doing business," says Mr. O'Brien, who calls his exchange FutureCom . "I've gotten e-mail that the exchanges have been around for 150 years and that what I'm doing is crazy. But I'm kind of stubborn, and I believe in this."

He'll have to. Since FutureCom 's proposal was drafted and sent to federal regulators last January, four of the largest U.S. futures exchanges have opposed the idea, saying Internet trading brings new and serious risks of manipulation and financial instability. Regulators at the CFTC delayed the application last summer to gather more information, and this week, the agency's division of trading and markets is expected to extend the comment period to get more input.

"A lot of the hard work is still ahead in thinking this through," says Michael Greenberger, the director of the CFTC's trading and markets division, adding that a decision is expected by July but could be delayed if more information needs to be gathered. "This is something that is new, and has raised a lot of technical and legal questions, as well as controversy." To be sure, Mr. O'Brien's proposal currently covers live cattle, a relatively small futures market based at the Chicago Mercantile Exchange. But Mr. O'Brien is looking into similiar contracts on corn and other commodities. In the past two months, the energy- and metals-intensive New York Mercantile Exchange and the Chicago Board of Trade have churned out multipage letters warning that Mr. O'Brien's project could damage commodities markets.

If FutureCom doesn't succeed or if large losses are incurred trading there, "the entire futures industry could receive a black eye, and irreparable damage to its, and its regulator's reputation," said Thomas R. Donovan, president of the CBOT, in a Dec. 23 letter to the CFTC.

But the exchanges are concerned about a different outcome as well, industry observers say. If FutureCom is approved by the CFTC, barriers of entry into the futures-exchange business would be greatly reduced, opening the door for other Internet challenges. "I think we'll be confronted with questions like this," besides the current proposal, says the CFTC's Mr. Greenberger.

In a 15-page letter sent to the CFTC Dec. 22, the Nymex raised doubts about whether the Internet can provide a stable trading base. "It is unclear how the Internet as it exists today could provide a networking environment which guarantees a fair playing field for traders," said R. Patrick Thompson, Nymex president.

Under Mr. O'Brien's proposal, members of FutureCom would enter orders by clicking a mouse -- much like traders enter after-hours orders on established futures exchanges. But unlike the after-hours systems, FutureCom would trade over the Internet, not a privately managed network. With participants selecting their own communications equipment, some traders may prove faster than others, throwing off market transparency, critics of the system say.

Also, critics have questioned regulators about whether a commodities-futures exchange should be run as a for-profit business by someone who trades commodities in the first place. In addition to FutureCom , Mr. O'Brien already runs an Amarillo cattle-feeding company, Texas Beef Group. "I'm sure the CFTC will look at whether Bill O'Brien can put up the wall," between the exchange and the cattle operation, says John F. Sandner, CME chairman and a cattle futures floor trader during the 1980s. "I'm sure he is an extremely honest person, but the perception alone could give people a hesitation," he says. Most of the exchange's staff and board of directors will come from Texas Beef, Mr. O'Brien says. And while Texas Beef representatives won't trade on FutureCom at first, Mr. O'Brien says he would like to be able to trade with special disclosure provisions.

Mr. O'Brien's plan for financially backing the exchange has also generated controversy. The CFTC instructed Texas Beef to raise its pledge to $8 million from $1 million to cover any trader defaults. A $1-per-trade fee has also been established as an emergency reserve fund. But the CME and other exchanges call the safeguards inadequate, criticizing the provision that makes participating traders responsible for bailing out any losses after Mr. O'Brien's promised payment. "It is unheard of in the futures industry for customer funds to be put at risk to cover the losses of (other) individual members or the exchange," said T. Eric Kilcollin, CME president in a Dec. 23 letter to the CFTC.

Aside from the exchanges, the reaction to Mr. O'Brien's plan has proven better. The National Cattlemen's Beef Association has spoken out for the proposal, as have several other ranchers who support the FutureCom provision allowing direct trading without the use of a futures broker for clearing and execution. But other traders say that even if the plan is approved, drawing volume from established markets like the CME's can be difficult because participants prefer the liquidity, or ease of trading, of one contract.

That leaves growing interest in the Internet as Mr. O'Brien's main hope. Last month, after touring Western Kansas to gauge support for Internet trading, Mr. O'Brien estimated "80% are interested in what the Internet can do for them."

But first, Mr. O'Brien must convince federal regulators at the CFTC to endorse Internet trade. Twelve months after sending his proposal and after meetings in Washington and Amarillo, the embattled cattleman says he had hoped the electronic exchange would have been approved in 1997. "I'm disappointed at the rigorous scrutiny of getting a simplified and distilled trading system approved," he says, noting he has used Internet-based trading in physical cattle operations for years. Large exchanges, "through their ability to influence the CFTC, paralyze the application," he says.

Says Paul Hitch, president of Hitch Enterprises Inc. in Guymon, Oklahoma and a supporter of the plan: "It's a mammoth undertaking to open a new exchange and to will it through the process. I certainly wouldn't want to do it."