Cboe Global Markets, Inc. (CBOE) Earnings Call Transcript & Summary

a Great. All right. Let me just start it then. Good afternoon, everyone, and welcome to the 21st Annual Crédit Suisse Financial Services Forum. My name's Ari Ghosh. And I cover the U.S. exchange's share of Crédit Suisse. It's my pleasure today to introduce Cboe's management team this afternoon. With us, we have on stage, Chairman, President and CEO, Ed Tilly; CFO, Brian Schell; and we also have Debbie Koopman, Head of Investor Relations in the audience with us today. The structure of the discussion is going to be a fireside format. I'm going to hit on a few key topics and themes and then open it up to Q&A. So 2019 was a busy year for Cboe, with the company completing the final phase of its multi-year integration of BATS, executing and finishing targets and also expanding long-term opportunity sets through strategic acquisitions. 2020 has gotten off to a volatile start, with sharp active market corrections, elevated activity levels and investment in managed risk. All this is driving very strong volume for Cboe. With that, gentlemen, it's a pleasure to have you here and let's dive in.

So I think that when we headed into this year, I believe consensus expectations, which I believe -- actually think was going to be up 5% to 8%, nips around 15%, clearly a different start to the year. And given some of the volatility that's going on, we see record volumes, including in the options industry as well. So maybe let's kick things off with them, what do you see in your franchise, key products there, what are the volume trends? And then in addition to that, what makes this little different from maybe prior cycles or volatility driven events, where it might be a little more sustainable at these levels?

Well, hopefully, we don't hopefully view this market movement, not as sustainable in that. It's being driven by the coronavirus and the potential impact on the global economy. So from a humanitarian perspective, it's very concerning and very scary to us. But that is the nature of an unknown, unknown. In the past few years, the market has dealt with and I think processed pretty efficiently, known unknowns. We know certain events are coming. We know that there are certain actions you have in the world, we're not sure what that outcome would be. But the market digest those known unknowns in pretty easy fashion. This is different. So the sustainability of the sell-off or, in our case, these very, very high volumes, is uncertain at this point. That is different. Also, what is different is we see and seen for the first time, I would say, probably Tuesday of this week, a monetization of hedging has been put on over the last month or 2, and that is different as well. So it's difficult to predict the end of this current cycle or correction, but we do know, if we look out a little further on the current structure of volatility, that the market is pricing in one of those known unknowns, and that is the general election. So following the events of next week of Super Tuesday and then heading into the general, we know there's uncertainty around the presidential election, and we think the market will ultimately end up positioning in and around that eventuality. So that's what's been happening. Volumes have been pretty terrific. And not surprising, that's in our core product set. You pointed out, that's been across the derivatives industry in general. But unique for Cboe is the world turning to the U.S. benchmark, that's S&P 500 options. And for us, the derivative volatility both expressed in mixed futures and mixed options.

And then maybe a little bit about what you're seeing by client segment. So some of this volume -- the volume activity, I'm thinking, is driven by the retail segment as well. And that lets me talk about how that sort of evolved in the stickiness of the retail base over time. So maybe a little bit about starting with retail, and maybe you can touch on some of the other aspects.

So retail is a broad definition for us. But primarily, we see retail investors engaged in single stock derivatives, in a way that is only been in the last 12 to 18 months. And so it is a trend that has continued into 2020. And that is a single name interest. Not surprisingly, Tesla drew a lot of interest from the investing public. And the derivatives around managing and speculating on positions in Tesla, were on the ridge over the last 1.5 months or so. But retail is engaged. For us, in particular, we see retail show up in the proprietary product set, primarily in short-dated S&P 500 contracts. So the active retail, recognizing the benefits of a large notional value contract that settles in cash, European exercise that enjoys a blended tax rate of 60-40 treatment on any gain in a broad-based index. So we see retail show up not only in individual names, but also in the S&P 500 contracts.

And so maybe moving to some of the other customers, I actually have 2. Historically, asset managers, pension funds sort of the penetration of your core products, hasn't been all that high relative to the size of some of these operations. So I know you've done a lot in terms of education, initiatives to reach out, how is that playing? And is there anything that you can talk about in terms of create an uptick into penetration would be signed or the way they use the product.

Yes. So we pointed out the retooling of our client-facing team, that is really concentrating on the uniqueness. We really acted as generalists in the past. But now we have specialists in the insurance space. And to your point, in particular, pension space, 2 different groups to penetrate and different approaches. With insurers, we know there's S&P 500 exposure embedded in policy, and the hedging tends to be OTC. We have an exchange listed solution and a FLEX contract that allows an insurance issuer to hedge their exposure and see those FLEX options, which allows them access to OCC. So that is a different pitch than going to a pension consultant and speaking to our board on the conversion of -- or the inclusion of derivatives in exposure. This is a great moment in time for us to point at market events. And the power of derivatives, the power of hedging, the ability to change the outcome of a delta-1 exposure in the U.S. market. That's what derivatives do, and that's what we teach.

Then maybe just wrapping it up there, talked about all the good stuff, maybe hit on -- I think you've done a great job sort of with conditioning investors to think about your core products with more [ agility ] now a bundled set of solutions, using it in tandem, depending on what the markets are doing. Some concerns around despite growing it 4% to 5%, you've seen nice growth through your proprietary products, but then maybe excellent Wall event, maybe it's a little more range bound. How do you think of that? How do you address that? And where do you see the next leg of growth coming from, ex the [ world space ]?

Yes, it's -- to your point, exactly. So you've actually called out the initiative. When you mentioned that we're going directly at pensions and advisers and then I've added insurers to that, recognizing that there are different needs, and we are under-penetrated. That's exactly what we've set out to do in 2020. So we hired up midyear last year, leading up to the beginning of this year. So that's -- we're exactly at that pivotal point. Now with market and volumes like they are so far this year and in particular, over the last week, that's going to be difficult for us to distinguish, where is the 2x ADV in that proprietary product set coming from? Is it a new conduit? Is it the existing trading larger? Is it the monetization and the race for an hedge? It's going to be noisy for us now, rather than if we're in a steady state and being able to identify exactly where that growth was coming from. Volumes like this we literally are trading twice our average daily volume in the prop stack. It's going to be difficult to dispense it.

Yes. Let me shift the gears then to the tech migration. Now with the final team sort of completed right now, 4 months in. Can you talk about the either client feedbacks that you're getting? Any encouraging data points as it pertains to new client adoption, growth and cross-sell opportunities through this initiative?

Surely. So the client experience has been terrific. So we saw immediately after the migration, the market quality for us really took a step up. And that is our best advertising to the rule is the quality that our market makers are able to display and to impose to us that we intend to display to the world. The quality going up is an endorsement of their comfort with that technology and Cboe's core proprietary product set. Nothing could make us more pleased than to see that response from the equity providers. We rely on them each and every day. There is no display market in the U.S. with our dedicated liquidity. So answering their concerns and actually upgrading their experience shows up in our market quality. What we haven't spent a whole lot of time with and I'll ask Brian to touch on is the enhancements in and around the VIX settlement process. Our most crucial time in settling the VIX contract is the moment in time in the third Wednesday to settle our volatility suite. And the enhancements around that settlement, part of the rollout in October of -- on that technology was incredible, and the engagement is great, and I'll pause and let Brian...

Yes. So what we've seen -- and it's really kind of accelerated over the last couple of months. Is, while the settlement activity itself has just gone marginally higher. What we've seen is the number of participants participating in the settlement has expanded significantly. So we're seeing a broader engagement, partly around some of the real simplification, partly around the technology of what that looks like. So you're seeing a much broader engagement. And we know from experience, when they're engaged in that settlement activity that leads to additional activity as well, whether they're going to lay off into the FPX or going to be additional VIX contracts. So we see that has kind of a tag-on effect. And we're just going to, again, just kind of see that the ache is where it continues to grow. And so it's very encouraging when they see that. And again, and that's just -- we just continue to expect to see more and more shipments come in based on customer feedback.

So now being able to execute U.S. securities, derivatives and futures and European equities on 1 common core technology platform. We're in a really good spot.

And then, when I think about what we've done and what's -- and then sort of the trends that you're seeing right now, I feel like most people would probably take a little bit of a victory lap after a massive deal that has worked out, but instead you announced the acquisition of EuroCCP in December. And you've laid out yet another multiyear sort of initiative. So first question, why now? What's unique about this at this given time, given how much is going on at Cboe? And what got that elevated to the top of your priority list?

So derivatives in Europe were always a priority. And the obstacle that we faced when we bought BATS, and Mark Hemsley, who ran the European operation for BATS and Cboe until this week, now going to be Dave Howson, the driving -- the recognition of Cboe being the expert in indices and derivatives trading was to offer derivatives in Europe. We fell short on not being able to have a clearing solution for those derivatives. If Cboe were to launch computing derivative products in Europe, we would have been forced to approach a different CCV, a competitor of ours. And ask them to clear the contract that would be competing with them. And while I would think all would have accepted that challenge. I think the -- I know the economics would have been different if we can control the clearing process. We did 20% owners in EuroCCP, and the other 80% of EuroCCP became available, and we immediately executed. So why now, EuroCCP, the 80% was available. Our core technology group had successfully migrated Cboe platforms onto BATS' tech. MiFID II and the European equities operation was in a very solid state, and we decided to execute and go forward on a multiyear plan to bring the U.S. model of trading derivatives, that is continuous lit market to Europe. And as they say, it -- why not the opportunity is now. The opportunity, we think, is terrific, and we're executing.

Got it. We've also talked about how -- this moment something that just [ inward ] link that you saw and then executed on this new initiative. It was on background or something you wanted to do for a while. So given that it's something that has been part of the process and the planning, if you think about either the blueprint or from a design perspective, is -- have you done any work already, is it going to be where you kind of conservatism in what you talk about and then the layout of either the design or the way you -- way the product comes to market would be quicker?

So most importantly, we have not closed on EuroCCP. So it's subject to regulatory approval, that should happen, we're hopeful. Still in the first half of the -- later first half of the year. So think June, July. So to close on EuroCCP a clearing lift would begin officially under our watch to be able to clear derivatives. From an execution platform, Dave Howson and his team came to Europe and have actually been gearing up and hiring up now. So that they can take all we've learned from the U.S. derivatives market, customize it for -- all we've learned in U.S. derivatives market, customized it for Europe. So that work has already begun. But coming together for clearing and execution we'll have to rely on, obviously, us closing the EuroCCP.

Right. And then the derivatives side of it, that's sort of a longer-term one. A little more complicated, but also has a larger potential opportunity there as well.

Correct.

So in terms of products, can you talk about just the division that you have, and then also the work that you -- that you are going to be doing either with index providers, or something like that from a licensing standpoint, to create that proprietary sort of ecosystem in Europe like you have here?

Yes. So it's two-pronged approach. And if you recognize the incumbent exchanges in Europe, when they moved into derivatives, they were competing with an embedded OTC market. So the exchanges model -- market model is competing against what they need to compete against and that was OTC. So the blocks are very friendly. There's not an incentive to competitive requote. And markets are indicative. In the U.S., it's a complete opposite. We built a derivatives model by incenting liquidity providers to quote from the open to the close. And the reward is being able to participate and interact with flow, as it occurs or as it is intended to cross bid/ask. That model is what we're importing. So it's not just the index construction. We'll get in that in a second. But it's really the core of the market model. So we are taking the U.S. model, importing it, continuous quotes, incentive to quote and the ability to interact once you've deployed that capital into the marketplace. So on index construction, we'll start with futures and options on individual country exposure, which you can gain today, but you need to fund through separate and independent CCPs, depending on what region your exposure is in. You would have different index construction rules. You'd have different index fee rules, different cap rules, different capital requirement rules and it's very, very difficult for a U.S. investor to look at Europe and see a market. And so the U.S. investor, who wants individual country exposure tends not to engage in the same frequency they dare to do in the U.S. Relative size of the economy, if you look at broad Europe is roughly the size of the U.S. But the turnover and the notional trade in derivatives is a fraction, a small fraction of the difference. We're not going after the embedded index businesses or derivatives in Europe, that's fine, that's the incumbent, that's the stocks of the world or tech. That's fine. We are going to bring to the marketplace, look-alike index products that are easy to access from the U.S. in a constantly lit market. That's the goal.

Okay. Maybe before we move on to the next topic. One comment on maybe the broader sort of economic market. Your thoughts on that. Some of your competitors have talked about how they've seen slowing consumer trends from Europe. So how do you -- I just want to get your thoughts on what you see there in terms of demand. And then the indie, is then that -- if things slow down in Europe, given the sort of the risk that you have while you develop your business, how do you hedge that? How do you think about that?