Why Hollywood Should Embrace Movie Futures Trading

Why Hollywood Should Embrace Movie Futures Trading

Analysis: In today's arid film-funding climate, a little legalized gambling might not be such a bad thing

(ALSO READ: "What You Need to Know About Movie Futures Trading.")

The way things are going, Hollywood might just get its wish. Trading on predicted box-office performance might not happen.

But given the state of film finance over the last 18 months, the question should probably be asked:

Is a little “legalized gambling” — as the MPAA calls it — really such a bad thing?

Though two proposals for movie futures trading have passed muster with the Commodity Futures Trading Commission, an all-out ban has been tacked onto the Senate's sweeping financial reform legislation.

If it passes — and unless financiers Media Derivatives and Cantor Fitzgerald come up with an alternate plan — the film industry could be missing out on a valuable tool that would ease the risk assocated with making movies.

That, in turn, could free up the vise grip on movie funding.

“Futures markets have been used to mitigate risk in various segments of the economy for years,” Robert Swagger, CEO of Chicago-based Media Derivatives, told TheWrap. “And there are a long list of hedge funds, private equity firms and banks which have removed themselves from the film-financing sector because they have no way to offset the risk."

(See accompanying story: "Swagger to Congress: Remove the Ban.")

“Our exchange is designed to meet the very strong capital needs of the film industry right now,” added Richard Jaycobs, president of Cantor Exchange.

Led by the Motion Picture Association of America, the opposition lobby has succeeded in characterizing these exchanges as mere betting on movie box-office performance.

But the fundamental purpose of any futures exchange, the backers say, is to reduce risk, not create more of it.

In fact, futures markets date back to ancient Greece, and have, in modern times, regulated prices for everything from heating oil to bread, offering market participants tools to hedge their positions and mitigate the unknown.

Too invested in a flop, or say, bummer potato crop? Set your bid low. Not invested enough for a sure-fire hit or bumper onion yield? Set your bid high.

“I now have some idea of what my heating bill will be next year,” Jaycobs told TheWrap, noting that the now-accepted practice of futures trading on oil was a controversial subject back in the 1980s.

“Every film is a gamble, so we should get away from calling (movie futures trading) ‘gambling.'” said Schuyler Moore, a professor who also helps investors buy into movies, testifying on behalf of Cantor Fitzgerald during last week’s House subcommittee hearing on the movie-futures issue.

“I guarantee there will be an enormous flood of financing for the studios,” he said. “This is an efficient way to off-shoot risk. There is always fear of something new. All it does is create an efficient transparent market that is absolutely needed. Studios will come to appreciate it.”

Perhaps more than anything else, the opposition has successfully tied innovative new markets based on movie futures to the kinds of risky derivatives trading that created the Chernobyl on Wall Street 18 months ago.

But that's apples and oranges, the financiers say.

Jaycobs noted that the exotic financial products, such as credit default swaps, which are currently under intense examination, were tied to risky residential lending, and had nothing to do with commodities futures.

Meanwhile, Hollywood also has successfully convinced Congress — 10 more members of the House came out in opposition Wednesday — that movies are not a product like wheat or oil, and should not be subjected to futures trading.

“We’re only one step away from being the Mob anyway,” one studio executive told TheWrap last week. “Movies are perishable — they’re not the kind of product Wall Street should bet on.”

Of course, as clearly evidenced by the drop in DreamWorks Animation stock the day after 3D film “How to Train Your Dragon” got off to a disappointing start last month, movies are traded on Wall Street already.

Box office performance also has a pretty important effect on larger publicly traded media companies like Time Warner, News Corp. and the Walt Disney Company.

Perhaps more compelling than any other argument for Hollywood to at least listen to the movie-futures pitch, the film funding sector is in bad shape.

Wall Street funding for independent film financing has gone from about $2 billion in 2005-2007 to almost nil today, according to Deutsche Bank. Over that same period, indie film financing arms have been whittled from 38 to approximately 11.The foreign pre-sale market isn’t much more fruitful.

Jaycobs believes the tide of opposition can be turned by creating a better understanding of how futures markets work and what they’re intended to do.

But with Congress set to vote on broad-ranging legislation that would curb derivative products in the next few weeks, he concedes Cantor has its work cut out.

“This is not a period in our country in which financial innovation is being rewarded,” he said.

  • BobinNY

    I can't see such a futures exchange serving a useful purpose as it does for things like agricultural commodities. A farmer might “hedge” by buying corn futures, since the farmer doesn't know what the corn harvest will be worldwide and thus what prices his/her corn will fetch. Films are NOT commodities. Each film is different (unlike a bushel of corn) and whether a film is good or not is known by only a small number of people in the studio loop (unlike corn prices that one could estimate from evaluating global weather forecasts, local farm harvest estimates, industry demand, etc). Another problem is boxoffice is only one-fifth of a film's revenue, so why build a valuation on such a small slice? The futures exchange seems only to benefit the middlemen and insiders.

  • Scytherius

    Futures trading is absurd. It's like a Vegas card game except there's no impartial dealer. It's the Wild West where the cards get passed around and everyone deals from the bottom and has cards up their sleeves. This idiocy will destroy the movie industry if allowed to go forward.

  • CityHall

    I keep seeing the same easy, allegations being thrown at these exchanges (ripe for manipulation, subject to insider trading, no useful hedging mechanism) – but few if any examples of these issues thought through in practice or suggestions from critics of how to improve the exchanges. Yes, the underlying subject matter is different but when was that ever a reason not to innovate. Yes, there are clear issues with these products but not necessarily insurmountable ones.

    This ‘our answer is ‘No’ to this in any way, shape or form’ appproach is curious – film production and development comes with risk, no one could possibly argue otherwise, yet critics stubborn refusal to explore the possiblities strikes me as irresponsible – if I was a shareholder in these institutions I would question why they are not working with these exchanges to adapt them to something useable. Two companies are willing to spend millions of dollars to develop out a system of products to benefit the studios – why not harness this, get involved early in the process and shape the systems and prodducts to your needs?

    The focus on first run box office makes sense – this is the first revenue stream the film sees, and the value of many of the downstream revenues you identify flow from how the title performs at the box office. Typically dvd sales, tv revenue and others will replicate the performance at the box office. If the product tanks at the box office, those involved know their down the line value is immediately diminished as well.

  • Dave in Texas

    The potential for greed, and abuse by Wall Street sharks – I don't think so. If Hollywood needs hedges, they know how – make action films, which have a huge payoff. I could see this collapsing Hollywood – yeah that's all we need.

    Hey, how about a employment futures for the U.S. economy, so when employment goes down, the gov't makes money, and puts it into social programs.

  • CityHall

    True, one way for studios to hedge is to diversify in the product they develop and release. But it's not as simple as ‘make more action films'. Action films are not guaranteed to succeed, and in fact are expensive and need to make far more before they turn a profit. A failed action film can be a disaster for a studio.

    I have yet to hear one credible example of how Wall Street can abuse this process. Arguably, the parties best placed to do abuse the process would be the studios: somehow drive the expectation levels (and price) up for a project, and just before release short it and intentionally sabotage the films success. There are however problems even with this suggetsion: 1) This would be prohibited market manipulation. 2) The exchange could inlcude position limits or similar in the products so studios or interested parties can never make more from a film failing than by it succeeding – so ensuring the studios etc use the exchanges for genuine hedging purposes. 3) its hard to imagine how you drive the expectation levels up for the film on the exchange without doing so in the wider market and actually creating genuine interest in the product and increasing its chances of success.

    I have also read allegations that where the exchange predicts a failure, such outcome could become a self fulfilling prophecy: To me this is one of the most ridiculous suggestions levelled at the proposed exchanges for two key reasons: 1) The exchanges will not arbitrarilly price films. The exchanges will not price films in a vacuum. Instead they will do so in the same way a typical informed and experienced investor would value any security on any exchange: they take account of a variety of factors, of all the information available on the title, genre, past performance of stars, quality of marketing, trailers. Plus people seem to forget that every trade on the exchange requires a willing buyer and seller, two parties seperately valuing a film and agreeing on the price – one party alone will not be capable of convincing the market to tank a film alone. 2) Millions and millions of Americans go to the movies each week, to suggest that their movie going habits will be influenced to a greater extent by the price on the exchange than it is by the thousands of reviews in circulation, film websites/chat forums, other box office prediction services, trailers, word of mouth, stories from the set, the marketing campaign, the stars/directors involved is scaremongering and actually insulting to the work of everyone else involved in producing and marketing a picture. Box office prediction websites, box office tracking services and other value indicators have been operating for the best part of 15 years. The studios have not objected to their operation, and in fact have bought into them, use them and rely on them. It is hypocritical.