Financial History Issue 127 (Fall 2018) | Page 27

needs of producers were met by the wide use of ‘to arrive’ contracts.” The buyer and seller in a to-arrive contract agreed to a price and quantity of a commodity for future delivery. These bespoke contracts were illiquid and carried counterparty risk. Nevertheless, commercial interests used them to lock in prices, potentially securing credit more easily. To-arrive contracts predate the mid-19th century. Though, not until the 1850s did grain elevators, railroads and a market made by commodity exchanges catalyze the transi- tion from to-arrive to futures contracts. Grain elevators and railroads enabled bulk grain to be stored and shipped. Prior to these storage and transportation tech- nologies, grain was branded according to its producer and region. Of course, bulk grain needed to be fungible. Com- modity exchanges, including those in Detroit (est. 1847); Buffalo, Cleveland and Chicago (est. 1848); and Milwaukee (est. 1849), were well positioned to service this need. Formed as commercial associations, commodity exchanges became collection points for grain, cotton and provisions, which the exchanges inspected, graded and, thus, standardized. Soon thereafter, exchanges hosted trad- ing in spot and forward markets. The Board of Trade of the City of Chicago (CBT) was the most important of these exchanges. In its first decade, the CBT was a place where members congregated to discuss business concerns. Its first board of directors represented shopkeepers as much as grain merchants. However, in 1859, the Illinois legislature granted the CBT a corporate charter that afforded the exchange the authority of an admin- istrative agency, one that executed and enforced legislative and judicial functions, including certifying grain and grain trades. On March 27, 1863, the CBT adopted a framework for trading forward contracts on the exchange. Crucially, the framework defined the terms of contract settlement, the fundamental challenge associated with a forward contract. Finding a counterparty with whom to initiate a forward contract was easy; finding the losing counterparty with whom to settle a forward contract was not. In any case, traders could not for- mally settle forward contracts by offsetting them on the exchange; though evidence of a secondary market in forward contracts suggests speculators were active in these early derivative instruments. Trading floor of the Chicago Board of Trade, 1997. In May 1865, the CBT introduced trad- ing in futures contracts. The contract specifications essentially mirrored those of common forward contracts that traded on the exchange at that time; thus, the CBT effectively converted select forward con- tracts into futures contracts. Moreover, the exchange permitted futures trading by members only, set trading times, standard- ized settlement protocols and required traders to maintain margin accounts. By the mid-1870s, the futures contract was a principal feature of North American com- modity marketing. America’s fascination with open-outcry trading in the pit had begun. Futures contracts appeared on several other commodity exchanges around the same time. For example, futures contracts derived from cotton appeared on the New York Cotton Exchange around 1870 and the New Orleans Cotton Exchange around 1882. Other examples of 19th-century exchanges that made markets in futures contracts include the Chicago Open Board of Trade, the Duluth Board of Trade, the Kansas City Board of Trade, the Mer- chant’s Exchange of St. Louis, the Milwau- kee Chamber of Commerce and the New York Produce Exchange. Early futures-trading volume was prob- ably quite high, though a paucity of data makes such a claim difficult to substan- tiate. In the 1870s, the CBT revealed its traders settled over 90% of contracts by offsetting them rather than by delivering grain as the terms of the initial contract specified. According to Thomas Hierony- mus, between 1884 and 1889, an annual average of 24 billion bushels of grain- futures traded on all US exchanges com- bined, or about eight times the annual average amount of grain marketed in those years; the comparable multiple for, say, 1966 to 1970, is four times. In any case, most late 19th-century futures exchanges lacked a clearinghouse, a defining feature of a modern futures market. A clearinghouse assumes the role of counterparty to each side of every trade: the clearinghouse buys each contract a trader sells and sells each contract a trader buys. Thus, the clearinghouse absorbs counterparty risk, assuring a robust, liq- uid futures market in which traders could efficiently offset contracts. To ensure its solvency, the clearinghouse reconciles (by marking to market) all margin accounts at the close of each day. Only as of 1925 did a complete clearinghouse facility serve the CBT. Of course, not everyone viewed futures trading as progress. In particular, many agrarians contended that futures traders manipulated—and, on balance, reduced— commodity prices. Federal and state leg- islatures and courts often existentially challenged this financial innovation. For example, the so-called Anti-Option move- ment fought to outlaw trading all manner  |  Fall 2018  |  FINANCIAL HISTORY  25