Not a week of the new millennium had passed before the futures industry was surprised to hear that two of its largest FCMs, with very different customer bases, were joining forces-The Refco Group had acquired the industry's largest discount brokerage firm, Lind-Waldock & Co. Based on the CFTC's semi-annual report of FCM finances, the customer equity of the two firms combined as of September 30, 1999 totaled $2.1 billion, making the new entity the seventh largest FCM.
Because of the differences in customer base, the firms will operate as "sister companies," according to Barry Lind, chairman and founder of Lind-Waldock, who will continue as chairman of Lind-Waldock. Joe Murphy, president of Refco, Inc. and executive vice president of Refco Group, joined with Lind in discussing the future of FCMs.
Gidel: What factors have changed the way you do businesss?
Lind: The industry is in transition from open outcry to electronic. The firms have to pay expenses on two fronts. We have the same floor staff as we did years ago and we're investing heavily in electronics. That's probably the biggest factor that is affecting us on the inside. On the outside, the NASDAQ has become the futures market of today from a retail standpoint. It's like futures used to be. The only difference is that you point and click, get your fill immediately and get your quotes for free.
Gidel: So people who like the action and the fast-moving markets are looking to NASDAQ stocks and not looking at commodities?
Lind: True. The reasons for it are: (1) the prolonged bull market; (2) they can get online to make a trade and get a fill in a couple of seconds; and (3) when they want information on where the markets are, that information is free. None of which we as an industry have right now.
Murphy: One of the reasons Refco came to an agreement with Lind-Waldock was that almost 50 percent of Lind-Waldock's orders are now taken electronically. They are not all processed electronically because open outcry still exists. But, the point of contact with the customer is exactly correct. Barry invested in the future, and this gives us a head start in moving in that direction.
Gidel: I have thought of Refco in recent years as an institutional house, even though it started out as a retail firm. Is that accurate?
Murphy: We're one of the largest institutional players out there, and there are tremendous synergies to be had with Lind. We believe in diversification and think that technology makes it even that much more compelling to continue to build our customer base. I would say we are institutional, and more focused than at least some of our competitors because we don't have a parent company that looks at us as a side effect of their overall business, and we aren't being measured from the cost-to-income ratios and other things that affect a much larger balance sheet of a holding company that owns the futures arm. We look at that as a tactical advantage.
Gidel: Does the platform make a difference on which markets your institutional customers trade? Would they be more attracted to futures if there were more connectivity?
Murphy: Hedge funds, for example, are interested in the efficient use of their capital. They're definitely interested in liquidity because they need to put that money to work. If technology can do that for them and consolidate statements globally, and things of that nature, there's no doubt they are interested because it makes their life a lot easier when they're calculating NAVs, etc. So, yes, they are interested in that, but for slightly different reasons.
Gidel: Your response to these changing factors is that the two of you have agreed to join forces. Why were you a good fit?
Lind: We have a lot of technology that Refco can draw on. Our order entry system, I think, is the best in the business. It is the only one that gives you an online valuation. Refco has the data warehouse that would be very expensive and time-consuming for us to put in. Those are just two examples of how all this works. The technology savings alone are huge.
Gidel: Is it true that doing order entry online is not cheaper than doing open outcry?
Lind: I wouldn't go so far as to say that it is more expensive. It may be more expensive right now because there are only two markets in the United States that trade online. But, if all of our business were to be online, it would be much, much cheaper.
Murphy: And remember that initially it's more expensive because you have to spend the money on implementing the technology. But once you implement the technology, that's it. The more volume and the more markets that go on that platform-the savings are exponential.
Gidel: Will the customer of the future be looking for a one-stop shop for all types of investments, or do you see that futures customers are different from equities customers?
Murphy: The lines are becoming blurred. Technology does that because of the ability to connect the customer to multiple markets at once. That's something Barry and I will be discussing down the road, but we absolutely want to avail our customers' access to as many products as possible on our platform. That's easier said than done, but we believe that's what people want. It's one-stop shopping. It's easier for the customers.
Lind: Right now it's starting to come the other way. We do all the futures business for Charles Schwab & Co.
Murphy: I would say that the market is still somewhat specialized. On the institutional side, I see a little bit more product blurring, but in general, equity firms do equity business. Refco is a broker/dealer and we can do equities and fixed income and FX. Customers that do futures with us tend to do FX with us, but, in general, it is still pretty compartmentalized.
Gidel: Where do you see opportunities as you go forward?
Lind: I think when it becomes electronic-when the customer can get a fill in a few seconds and have the trust in the electronic box and he can do that without paying a charge for information-then our business on the retail side probably could treble over a short period of time. Futures are more important than they've ever been as we become more and more a world economy. The true purchasing power of one's net worth is dependent upon our relationship to other currencies. Interest rates affect everybody. And there's no cheaper way to protect yourself than by going to the futures market. And more and more people are becoming aware of that.
Gidel: Will the growth be on the retail side in particular?
Murphy: Absolutely. The retail customer has become more sophisticated. We think that's a very large growth area, and that's evidenced by the amount of retail equity trading going on, which is exploding. I can't say there is a direct correlation, but I believe there is a correlation.
Gidel: And even a downturn of 25 to 40 percent in the stock market won't scare them away?
Lind: There has been so much money created in the stock market that I would have no fear of that at all. Let me give you an example. At the beginning of 1998, the E-mini S&P 500 was a distant third for us for our retail customer. The S&P 500 was No. 1 and T-bonds were No. 2. Today, the E-minis at Lind-Waldock trade more than the S&P and bond contracts combined, and our No. 3 contract is the E-mini Nasdaq-100. That shows the power of a moving market and electronics. At the end of 1997, about eight percent of our orders came in online. Right now, it's about 48 percent.
Gidel: Are other product lines a potential opportunity?
Murphy: We're focused on the futures industry, but we're going to be adding value with other products. However, we don't want to dilute our efforts. Barry alluded to something earlier that gives you an indication of how we're positioned. For example, Schwab is a customer of Lind and there is a reason for that. Why? Because Lind is the best at what they do. Would I rule out other products? Absolutely not. But are we running off trying to focus on other products at the expense of our core competency? No. We're not doing that because we believe that's dangerous.
Lind: The whole business is going to change so far as the products offered are going to change. I can see how my retail customer base would use strategies that right now are saved just for institutions, like getting a return on investment based on the S&P index with some type of guarantee. I can see that type of strategy coming into play in the years to come, and I don't think we're all that far from it. But I can also see us working with other Web sites where we do things jointly. Everyone will have their expertise. I can see that being the wave of the future.
Gidel: So not everyone has to develop their own "everything to everybody" site.
Murphy: That is a dangerous route to pursue because you become mediocre at everything, and not great at one particular thing. I agree with Barry that I think you'll see this evolve where one Web page will provide access to the different products. How will products change? I think the retail investor will become more sophisticated. I wouldn't be surprised to see retail investors begin to invest in what looks like an OTC-type product. There are regulatory issues, of course, but more of a securities-type investment, with a commodities link, metals link, S&P link, for example, that will look more like a structured product. We will evolve and innovate as the regulatory environment changes.
Susan Abbott Gidel is president of CGA Communications Group in Chicago, author of Stock Index Futures & Options: The Ins and Outs of Trading Any Index, Anywhere, and can be reached at firstname.lastname@example.org.