Every year, Derivatives Strategy honors individuals who have made significant and lasting contributions to the derivatives market. After consulting with current Hall of Fame members and others in the industry, we whittled several dozen names down to this year's three inductees.
The honorees: Nassim Taleb, an options trading guru; Brian Williamson, one of the founders (and the resuscitator) of Liffe; and Fred Chapey, a derivatives innovator from the corporate world.
In the following pages, senior editor Nina Mehta chronicles their achievements and struggles.

Nassim Taleb

"There are two types of traders,” says Stan Jonas, a managing director at Fimat USA. "Those who know Nassim Taleb and those who don't. If you're a trader, not having read his book is a codification of the fact that you're not serious about the business you're in.”

Among option traders, Taleb is a legend; his book, Dynamic Hedging: Managing Vanilla and Exotic Options, the Bible. Analyses and dissections of the markets abound, but when his opus came out in 1996, the doors blew open on how the markets really worked. Taleb offered a maverick, unstinting, practitioner's-eye view of option strategies and fallacies, fueled by a sophisticated understanding of the mathematics of financial engineering. The founder of Empirica Capital, a two-year-old, Connecticut-based hedge fund operator, he's a trader's trader with a contrarian, philosophical bent, who describes his options trading as a "hobby.”

Taleb was born near Beirut in Lebanon, in a Greek Orthodox community. He went to school in France and later lived in Paris, London and New York. He has an interest in language, he says, although he gravitates toward dead languages like Greek, Latin and Aramaic. At age 10, he wanted to be a classicist and a man of letters. In the 1980s, after attending university in France, he entered the Wharton MBA program at the University of Pennsylvania. He skipped as many classes as he attended, inhaling some 150 English novels in an effort to improve his language skills (he started with Trollope's Barchester chronicles).

"I hated the research coming out of academia. It did not mesh with my notion of clinical validity. It was about how the world should behave because someone said it should behave that way.”

Taleb became an options trader out of laziness. In an options theory class, he felt an immediate affinity for the product. "It was effortless for me to think about options,” he reflects. "So I told myself, ‘Hey, it's a great way to be lazy. Lazy and intuitive.'” In 1985 he began trading at Bankers Trust and quickly discovered that rare events were more frequent than people believed—and that when they happened, they cost a lot more than people expected they would. He started formulating his own way of looking at rare events. That propelled him into the jaws of mathematics. "I started studying the mathematics of distributions to understand options better,” he says, "so I'd have to work even less for a living.”

About the appeal of rare events, Taleb waxes philosophic: "Maybe because I saw war in Lebanon, maybe that made me inherently skeptical. You have to be an enduring skeptic not to rule out rare events.” But there was another, more mundane reason for his interest. The Plaza Accord in September 1985 caused currencies to flail around and a lot of traders to lose their jobs. Witnessing that was a sobering lesson in long-tail events—that so many traders had got it so very wrong. If he got it right, he'd have a leg up.

Taleb's view of tail events is a window on how he sees the markets: rare events aren't unexpected because they're not predicted well enough; they're unexpected because people rule out their nonexistence by wanting to believe they cannot happen. He concluded that distributions could be changed by understanding people's biases.

In the meantime, he traded options—first currencies, then fixed income. In the late 1980s and early 1990s, he held senior trading positions at BT, Banque Indosuez, Credit Suisse First Boston, Union Bank of Switzerland and BNP Paribas. At CSFB, where he worked for five years, he was the senior arbitrage trader for fixed-income and currency derivatives. Did his eye ever rove? "No,” he swears. "I never had the satisfaction of knowing I had the edge with other products. My edge is with financial instruments that cannot be understood linearly.”

Like father, like son

Plus, there was the larger picture to consider. Methodology was important. His father, an oncologist (and polymath with a Ph.D. in anthropology), approached medicine with a lot of rigor, and, explains Taleb fils, "I wanted to have the same rigor—clinical rigor—in the way I approached my own trading. It was much easier to do that with options than with other instruments because they're more technical.” So he began keeping tabs on what he did—notes that, 12 years down the road, would provide the core of Dynamic Hedging.

In the course of playing the markets and taking notes, Taleb realized that rigor lay mostly in having the best work, not in being more mathematical than the next person—in other words, keeping sight of how the markets really worked. Like a painter descending into the clay pits to study the rudiments of color, he decided he needed to see price formation in the option pits. So he became a market-maker for a year. In 1992, Taleb, his wife and newborn son moved from New York (where he had been the head options trader at UBS) to Chicago. He pursued his math, studied market microstructure and gained new insight into his own style of trading by comparing the reality of the pits with what he was reading about options. "I hated academia,” he says. "I hated the academic research coming out of it, yet forced myself to read every paper on derivatives. It did not mesh with my notion of clinical validity. It was too normative. It was about how the world should behave because someone said it should behave that way.”

"If you're looking for ships across a certain strip of ocean, the enemy will attack you somewhere else. That's the problem with risk management—what by definition can hurt you is what you expect the least.”

He likens the thrust of academic work in options to medicine in the Middle Ages. "The mother of Louis XIV, the head of Austria, died of breast cancer but none of the doctors ever touched her,” he says. "They would sit down, talk philosophy, theorize about doing things, but they did not at any point go touch the patient. The clinical medicine we know today came from the surgeons—they were not the doctors, they were not up there in the Sorbonne. There was a dialectic between what they were learning and their experimentation and practice. I wanted to do the same thing in finance.”

And he did. Nigel Babbage, the worldwide head of currency derivatives at BNP Paribas, sums up the argument of Dynamic Hedging as follows: traders can't attach a mathematical formula to human emotion, and what's impossible mathematically is not impossible in practice. In short, options trading is not about theory any more than being a doctor is about knowing where a platelet comes from. In the 1990s, with the pits behind him, Taleb also worked toward a Ph.D. in financial mathematics at the University of Paris, where—applying his trademark real-world approach to options theory—he wrote his dissertation on the transaction costs of forecasting volatility. He is now finishing a new book, titled Fooled by Randomness, scheduled to come out in October.

Expecing the unexpected

Over the years, Taleb has built up a reputation as a debunker of false messiahs. The rogues of risk management, in his view, are value-at-risk and faith in models. One of the basic problems relates to induction. People often assume that, because something did not happen in the past, it cannot happen in the future—an assumption that distorts models, since the family of bets that can be made based on past properties is very narrow. Another problem is that a watched pot doesn't boil. "By definition, says Taleb, "if you're looking for ships across a certain strip of ocean, the enemy will attack you somewhere else. That's the problem with risk management—what by definition can hurt you is what you expect the least, which is not the thing that people expect will hurt them.”

Taleb has made these points for some time. And disasters like the Asian meltdown and Long-Term Capital Management have come along to prove him right. But now, he says, he's done being a latter-day Paul Revere; he will use his hedge fund to make money off the mispricings of rare events.

Through all his years of study and trading, Taleb's abiding love has been literature. Not surprisingly, he has an unfinished novel in the drawer, called Memoirs of a Statue (based on the life of a second-rate terra cotta statue of a minor goddess that was stolen six centuries ago from Antioch, where his roots are), and he's a character in another novel: Le Fric (currently available only in French) by Jean-Manuel Rozan, a former boss at Indosuez.

So if he had his career to do all over again, would he go about it the same way? Yes, but he'd start a hedge fund sooner. That answer glides directly into another thought. "If I were to live in another time,” he says, "I'd live in the time of John Maynard Keynes and his intellectual snob friends—the Bloomsbury group. All those in that crowd were trying to be aesthetically involved classicists. That's pretty much what I'm trying to be. This is my green period now. I trade and I read a lot. The decade from 1987 to 1997 was the dark period—the period when I studied mathematics and options theory.”

Brian Williamson

If Brian Williamson had got his way in 1974, he'd have won the seat he ran for in Sheffield Hillsborough, England's once-great steel town, and might now be a (younger) elder statesman. And where would the London International Financial Futures Exchange be without its current chairman? Hard to say. Williamson not only helped pull Liffe back from the brink of irrelevance after Eurex, the all-electronic Frankfurt exchange, siphoned off its bellwether Bund contract, but was one of the founders of the London derivatives exchange in the first place. In 1999, when he became chairman of the exchange for the second time (after a decade away), he led the charge to overhaul Liffe as an electronic-only exchange—a radical move in those late diehard days of open outcry. In the process, he set the stage for Liffe's resurrection.

Williamson's first love was politics. In the summer of 1964, while on break from Trinity College Dublin, the 19-year-old crossed the pond to cover Robert Kennedy's New York senatorial campaign for Crossbow, a British political magazine. After graduating, he went to work for the family of Harold Macmillan, the ex-Prime Minister of England. (Supermac was the only British P.M. to be related to an American president, claims Williamson, since he tied the knot with a Cavendish and a Cavendish married a Kennedy.)

When Maurice Macmillan, the former P.M.'s son, became a cabinet minister and chief secretary to the Treasury in 1967, Williamson traipsed into government service with him, and then spent two years on Junior's private office staff. Although the Treasury job turned out to be essentially a primer on how the government wastes money, one of the large projects at the time was the Thames barrier, which, says Williamson, "stopped London from flooding.” By the time the 1979 election installed Margaret Thatcher in No. 10 Downing Street, the young politico was already trading futures on the Chicago exchanges for Gerrard & National, a government bond dealer in the money markets.

"Most financial innovation sweeps eastward from the United States. But in technology and equity derivatives, the U.S. has been singularly slow to adapt, and we will exploit that.”

Williamson had met Richard Sandor, the inventor of interest rate futures, a few years earlier. "In the late 1970s, it seemed to four or five of us that you could put together the commodity markets with the money markets and the bond market just by walking the 1,000 yards between Lombard Street and Lloyd's Avenue, instead of having to fly 1,000 miles backwards and forwards between Manhattan and Chicago,” he says. The founding of Liffe brought these markets under a single roof.

The exchange, which opened for business in October 1982, was based on the Chicago markets, but with a difference: customers and international companies could join the exchange. This made Liffe a more open market than its Stateside predecessors. John Barkshire, the first chairman, handed Williamson the reins after three years. "We decided that a chairman shouldn't be here for more than three years,” recalls the comeback kid. "You should be here for one year to get your feet under the desk, two to do what you really want to do, and three to hand it over to the next chap.” After that, apparently, the slate is wiped clean.

During his first stint as chairman (then an unpaid job), Williamson also ran GNI Ltd., which he had cofounded in 1982. In 1986 he became a director at the early incarnation of the Financial Services Authority, the U.K.'s regulatory giant, whose gargantuan territory includes the securities, futures and insurance industries. In the mid-1990s, he also chaired Nasdaq's international advisory board and was a governor-at-large at the National Association of Securities Dealers in Washington, D.C.

Cleaning house

So Williamson was a regulator when Liffe got its drubbing at the hands of Eurex. The London exchange, once the second-largest derivatives exchange in the world, had a bleak future. Its golden contract was gone and customers had deserted the exchange. Mixed feelings about what Liffe should do ran rampant, but once Williamson was back in the cat-bird seat, the plan was clear: "There was no doubt that we had to move from being caught napping to being the best electronic exchange in the world,” he says. With Hugh Freedberg, Liffe's chief executive, he overhauled the exchange, building a $100 million open trading platform that could trade not just bonds and sugar but complex three-month interest rates five years out—and slowly snuffed out the floors.

Asked about his conversion to technology, Williamson doesn't miss a beat. "I've never been converted from anything else,” he insists. "I remember signing the agreement to put electronic trading into a futures exchange. It was for after-hours.” Liffe started after-hours trading well ahead of its Chicago brethren. "But what happened,” he continues, "was that we built an electronic exchange based on open outcry, and as we all know now, you should be building a technology that is not based on open outcry. Liffe got there first, but as the world changed, it failed to adapt its technology.”

In addition, like bats using echolocation to assess their whereabouts, an exchange must take its cues from customers. If customers have decided to go electronic, and have put a lot of money into doing so, notes Williamson, the exchange can't fall behind.

Does he now mourn the passing of a floor culture at Liffe? "It's not a matter of sentiment,” he says evenly. "It's a matter of what is right at the time. When the agricultural markets were very inefficient, the Chicago markets delivered price discovery to the world. When they used that to open up the opaque world of the New York bond market and money markets, they did a great service to mankind.” He gives the floor high marks for using the liquidity and democracy of open outcry to break open the cartels on Wall Street. "However,” he argues, "time has moved on and the cartels have been broken. There is no absence of price discovery in the money and bond markets. So the open-outcry world of price discovery is superfluous.”

Chicago seems to be grasping this, but slowly. Does the Londoner think the U.S. markets will go electronic? "That or die,” he ventures.

New markets

What Liffe did is proving radical in another way as well. The exchange not only gave itself a second chance by going electronic, but by splitting into two companies—the exchange and a for-profit company in charge of Liffe Connect, the new technology—Liffe made clear that it wasn't content simply to regain the ground it lost in the late 1990s, when Eurex put the long Bund on the machine. This effectively means that Liffe Connect will not be limited to Liffe's current markets, and could potentially be offered to competitors of the exchange.

"We are trying to do to world industry what Chicago did to the financial industry in the 1980s, and that's more important to us than looking over our shoulders at the established gamut of futures exchanges.”

In the derivatives markets, it is no longer the consolidation of exchanges that's important, suggests Williamson. It's new, untapped markets. "We want to use our technology to get into the newer areas of energy and bandwidth, to look at other markets like chemicals and industrial procurement that are growing—the liquid cash markets where there are no futures or forwards yet,” he says. "We are trying to do to world industry what Chicago did to the financial industry in the 1980s, and that's more important to us than looking over our shoulders at the established gamut of futures exchanges.”

Over the past year, the exchange has managed to kick out the traces and lunge ahead. Its technology is making rapid headway, with 10 dealing rooms joining the system every month. The exchange also recently launched universal stock futures, which give investors exposure to the world equity markets. While cash exchanges talk about merging or forming alliances to broaden their reach, it's very likely, points out Williamson, that the derivatives markets will get there first. These two accomplishments, however, have faced serial roadblocks in the United States. "I know most financial innovation sweeps eastward from the United States,” he says, "but in these two areas—technology and equity derivatives—the U.S. has been singularly slow to adapt, and we will exploit that.” Williamson expects the London exchange to be among the largest derivatives exchanges in the world in the near future.

When he isn't hunkering down to plot the smartest course of action for Liffe, Williamson is often off on another course. Six years ago, he took up the Cresta Run, a tobogganing affair that once was an Olympic sport. "Basically, you go down a mile-long hill very fast on your face with your nose on the ice,” he explains. The chairman adds that he's particularly bad at the sport. With a few friends, he also jointly owns England's only hydrogen ("Don't say hot air!”) balloon, which he flies across the Alps—after his Belgian wife, a former banker at Credit Suisse First Boston, signs off on the junkets. "Those are the only two things I do that are dangerous,” he says, "apart from running a futures exchange.”

Fredrick Chapey Jr.

Not everyone wears his laurels lightly. "When I heard I was being inducted into the Derivatives Strategy Hall of Fame, I thought, ‘Am I that old?'” sighs Fredrick Chapey Jr. "Mergers add age.” At 42, Chapey, the head of derivatives marketing and structuring at Citigroup, isn't a grizzled corporate gerent with a yard-long C.V., but he has definitely shown his mettle. Over the last decade, he steered the derivatives troops at not one but two financial behemoths through complicated mergers, in the process redrawing organizational boundaries and expanding the depth and breadth of derivatives activity at his firms.

In 1996 Chapey oversaw the union of the derivatives groups at Chase Manhattan Corp. and Chemical Bank—"a merger of two slightly-better-than-average banks in which,” as he puts it, "magic happened.” Two years later, he left Chase for Citibank, just in time to integrate its derivatives business with Salomon Smith Barney's. Both mergers left the new companies' derivatives franchises better positioned and more profitable than they had been before they got hitched. And in both cases, customer satisfaction rankings—no small comment on the end result—improved.

Chapey's view of derivatives is easy to encapsulate: the business should be customer-driven. Derivatives practitioners, for their part, should be innovative and ready to link arms with counterparts in other areas of the firm. But derivatives should also spear the meat: "My view has always been to connect and permeate derivatives into any and all areas of a firm,” he says. "The derivatives business needs to capitalize on product strengths within the bank, or be a strength to help in the strategic development of businesses the bank wants to grow.” This twin-engine view helped propel Chapey's corporate alma maters up and over the broad ridge of a sometimes unforgiving business.

The eventual Hall-of-Famer cut his derivatives teeth doing corporate coverage, gradually expanding into the global marketing and structuring of derivatives, foreign exchange and risk management activities. What began as a horizontal cross-product marketing approach to these areas evolved, through reorganizations and corporate shufflings, into a vertical organization of derivatives. Through it all, Chapey unflaggingly championed the business. Even after 1994, he refused to see the derivatives industry as a dismal trade.

Flight path

Chapey grew up on Long Island, where his father ran two funeral homes. He studied finance and economics at Georgetown University, vaguely expecting to go into corporate banking. (Two of his siblings went into the family business, while the other four, like him, peeled off into the markets.)

In the early 1980s, Georgetown was a stomping ground for Chase recruiters. Chapey and three of his college roommates applied for interviews. "All four of us got acceptances to interview, three in the corporate finance area and one in an area called credit audit,” he remembers. "I got the unglamorous one. I really wasn't interested, but Chase was the first firm on the campus, so I decided I'd at least bone up on the interview process.”

"The derivatives business needs to capitalize on product strengths within the bank, or be a strength to help in the strategic development of businesses the bank wants to grow.”

In the end, that wasn't necessary. He landed the job and dug in his heels at the bank for the next 18 years.

Why the turnaround? "The interviewer talked about international travel,” remembers Chapey. "I grew up on Long Island, went to school in Washington, D.C., and went to spring break once in Florida—that was my travel. I liked the idea of a fantastic flight around the world.”

Chapey circumnavigated the globe for a few years while he analyzed the bank's far-flung credit portfolio, then landed in New York as a client executive in the firm's commodities division. Those were the early days of gold and silver leases, loans, consignments and forwards. In 1985 he wrote a swaption for a Fortune 500 company with $100 million in callable debt—at the time a large, sophisticated deal. From there he moved into the bank's high-growth swaps group, although, he now says, "I don't know if I was wooed into the group or I wooed myself into the group.” Whoever pitched the initial woo, Chapey became involved early on in structured transactions, stripping and selling off the fixed- and floating-rate legs of swaps to international banks and other investors. From then on, he lived in an over-the-counter world.

Triple-B blues

In the mid-1980s, Chase—then a top money-center bank—was in the throes of a massive swaps buildup. Like other commercial banks and investment banks, it pulled out all the stops to write plain-vanilla swaps for clients and from there show products and latch onto more high-yield business. A success-breeds-success mentality drove the industry.

By the early 1990s, Chase's credit rating had deteriorated to triple-B. Ironically, it was the bank's shallow rating that ultimately provided Chapey with his trademark approach to derivatives. Without a Good Housekeeping seal of approval from the ratings agencies, Chase was at a disadvantage competing on price. Other firms with the ratings blues retreated to the short end of the market where credit wasn't as much of an issue, but Chase took a longer view. "To be a derivatives player with that rating, we realized we had to be that much more creative, that much more customer-oriented, that much more solution-driven than our competitors,” says Chapey. The derivatives business began to focus on other areas of the firm. It worked closely with the commercial bank's syndicated loan and private placement areas, and teamed up with the project finance group, stripping out risks in difficult projects. Chapey and his colleagues also took advantage of the bank's strong emerging-markets presence, trundling off to Latin America to school corporates and governments in the use of financial and commodity derivatives as risk management tools, in the process enlarging the bank's derivatives client base.

This starfish approach to derivatives became Chapey's calling card on the merger front as well. By this time, with the markets well developed, the challenge for firms was to find ways to sustain an entrepreneurial, forward-thinking derivatives culture while at the same time integrating derivatives into the underlying cash business. "Derivatives people like to figure out how their markets are different from the cash markets,” says Chapey. "It's more important to think about the synergies and not get caught up in a siloed mentality.”

The Chase/Chemical merger made for a mighty firm. By then, Chapey was head of global derivatives and deputy head of international capital markets. "You deal with a lot of culture clashes and issues in a merger,” grimaces Chapey, "and unless you've been through it, you can't explain it to anybody—you start talking in rhymes. But at the end of that merger, important issues got addressed and change was beneficial.” The merger enabled Chase to solidify its position in the derivatives marketplace, and the bank increased business in many client segments within a year.

"You deal with a lot of culture clashes and issues in a merger, and unless you've been through it, you can't explain it to anybody—you start talking in rhymes.”

After the merger, Chase ratcheted up its interbank activity and proprietary trading business. A couple years on, Chapey was wooed to Citibank. He boarded the bank in April 1998, the month the merger with Traveler's was announced, and had his feet under the desk just as the rock-and-roll phase got underway. While strong in derivatives, foreign exchange and structured products, Citi didn't have the depth or breadth of products Salomon did. The commercial bank was also organized as a single derivatives business, while the investment bank took a more embedded approach to the cash markets. The merger of the derivatives groups consequently became one of the thorniest—and most written about—couplings in the merger. But it was probably the area that benefited the most, notes Chapey, since Citi began to shine on every front. "Now it's almost frightening the types of product strengths we have,” he says.

Much has clearly changed over the last decade. For Chapey, on the personal front, he has thrived in yet another union: with his wife, a former commodities derivatives marketer at Bankers Trust, with whom he has four daughters.

Over the same time period, as the derivatives business grew, Chapey watched a few broad trends settle over the markets. The business began to evolve more than mature, he notes, and the black-box approach to trading gave way to a more client-oriented approach—a direct result of Bankers Trust, Gibson's Greetings and other events of 1994.

Another change was that the math phase of the business ceased to be ascendant. Derivatives success has always rested on a shifting balance of sales and trading on the one hand, and corporate finance on the other. "But today the business is oriented more toward corporate finance and an understanding of related capital-market products; accounting, tax and regulatory issues; and economic capital,” observes Chapey. "It's gone from being a business of showing products and prepackaged ideas to being a trusted adviser and digging into the company in question to get the results it wants. It's no longer about calling up a company and saying, ‘Have you thought of this?'”

Luckily for a few big banks, Chapey sussed this out early on in his career.