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

All right. Good morning, everybody. We'll go ahead and get started. I'm Patrick O'Shaughnessy. I'm capital markets technology analyst here at Raymond James. We are pleased to welcome Cboe this morning. From Cboe, we have Chairman and CEO, Ed Tilly; and we have Chief Operating Officer, Chris Isaacson. Format of this is, we'll just do a Q&A. And then we'll open up to audience questions at the end.

And to kick us off, it probably makes sense to talk about current events a little bit. When Cboe sees a spike in trading volumes like you did last week. Can you maybe just kind of characterize some of the trading that you saw? And then talk about how you actually work to turn that spike into something sustainable going forward?

Sure. I think we get a little added lift this year and going forward, the election was really the uncertainty that the market was preparing for a long in advance. We had listed -- to be very public, we had demand for off run strikes. So we have been listing that -- the general election strikes in the S&P 500 for months now, and that -- open interest has grown steadily. There was a big spike in implied volatility out in the fall that was really the uncertainty that the market was preparing for. One of those known unknowns on the horizons. So hopefully, we get through all of the fears on coronavirus and all of the uncertainty around what that means for the global economy, and we get back to planning and investors aligning for what they know is coming at them. So -- but this is different. The uncertainty last week, and one of those unknown unknowns, those are the ones that are most disruptive to an organized market. Yet, over the last week, we've seen a very orderly sell-off. I know that sounds strange if you look at 100-point school moves. But for our market makers, our traders, there's been liquidity. There's operational efficiency Chris can get into. But we see an orderly reevaluating of the short-term uncertain market. So a little bit different. So how do we convert this? Obviously or coincidentally, we are driving from here to our own conference in Southwest Florida this afternoon, a risk management conference. We'll have practitioners talking to other practitioners. I'm sure the theme will be heightened volatility, how to trade this market, how to position for the eventuality of this ending and then back to the economics of the day with Super Tuesday upon us. And preparing for and getting aligned with the known risks of the marketplace. So we use this as a teaching opportunity. The difference here and what we've observed the last week. Early in the week, we saw a lot of monetization of hedging. That is that orderly if you positioned yourself for a repricing of a market that was not my opinion on the market, perhaps a long more run. And we're positioning in the eventuality of some correction, did not think it would be this. But we had investors well-positioned for a correction. And so for the first time some real serious monetization of hedging. So hopefully, we found an opportunity to reprice, but we'll see what happens in the next coming days. I think overnight, probably the most volatile overnight sessions, I can recall, looking at both our futures and S&P 500 futures overnight, incredible range. So perhaps we're looking for a new point. But operationally, I think it's important to take a look at as well.

Maybe to sum in, we saw record volumes there across many of our markets last week as well as the amount of messaging that's occurring through our systems. Post-migration in October, where we completed our migration of our largest Cboe Options Exchange. Last week, we processed almost 18 billion orders on Friday and almost 12 million contracts, 47 million contracts in all of options, clearly, the OCC, which was another record after setting a record earlier in the week at 40 million contracts. So kind of unprecedented volumes, unprecedented messaging. And thankfully, across the spectrum of the market, while it, obviously, were violent moves last week. It was very orderly from an operational perspective. And frankly, the market is set up now to be able to move very quickly, but in an orderly way.

Great. And Ed, you touched on your conference that you're heading down to after this. Are your sales and client education efforts more geared towards getting existing customers to trade more? Or are they about bringing more customers in your ecosystem? And to the extent that you are finding new traders, new people that are going to interact in your exchange. Where are you finding these investors?

Yes. I think the existing traders trading more. You can't really encourage them to trade more. It's really trading differently. And it's looking at any risk in the marketplace, which contracts or which combination of contracts, given your perspective of risk, would have the greatest payout. And again, we won't set up your risk. But if you can describe what you see in the uncertainty, it's trading different. It's trading smarter. It's being armed with all the tools that we have in this unique product set to be able to take advantage of -- in this instance, perhaps repositioning in the market, but hedging for sure. So I think existing is the easiest to convert across the product set. And as for new, I don't know if we call them new, but we have identified, obviously, an under penetration. We've been very public on this over the last couple of calls. We're underpenetrated in the insurance sector, for example. Insurance policies have S&P 500 exposure. The hedges tend to have been OTC and with the ability to customize flagship options listed and cleared at OCC. It's really an education and awareness program rather than a conversion. So that will be a big focus for us in the remainder 2020. And then pensions, it's really the communication with providing white paper and education for those consultants that are advising pension funds. So it's more precision. It's really not a conversion. The awareness of derivatives and the power of derivatives. The ability to turn does one exposure and shape a payout scheme and curve, that's really what our education process is all about.

Got it. So tying this conversation into an area of focus for Cboe. On your last earnings presentation, you talked about Cboe Information Services as optimizing the customer experience throughout the trading process. Can you help us understand what that phrase means? And then how your recent acquisitions have played into that?

Yes. It's actually perfect timing. So we've been very vocal that we're interested in touching our customers from their -- the idea of a trade until whether it's a hedge speculation, any positioning. So the ideal trade through post-trade and I'd derive data. We're able to do that pre-trade, our access into Cboe has been huge. So we've made strategic investments as far back as 2015 with LiveVol, 2017 with Silexx and then most recently, what you're referring to is FT Options and Hanweck. Where we're now with the ability to touch customers at trade. And no better environment than last week to be able to have the power of FT Options, which is really a cross-asset look at the portfolio, powered by Hanweck's analytics. So that now we're involved in being able to hold a customers' interest at the time of trade. So that entire life cycle from idea through post, that's really what we are after. And it's always having armed those traders and the decisions that they're making the most informed so that we can take existing traders, allow them to optimize their positioning and hedging. And then for us to derive data at the end of the trade, being able to circle back in that endless loop. Anything to add?

Yes. I think, I mean, just last week is a great example of why these acquisitions make so much sense. If you talk about Hanweck, Hanweck offers risk analytics, giving customers the ability to view what their margin calls are going to be, what they should expect, what their risk offsets are going to be. A major focus for us strategically is capital efficiency, and customers need to know how much capital is going to be charged by the clearing firm they're using. Hanweck is the leader in that area. We are working with Hanweck and the OCC in order to drive further capital efficiencies where we can, so that -- especially in markets like this, where they want to deploy the maximum amount of capital possible because what happens is if you deploy that capital, liquidity has improved during times of great stress. So the thesis could not have been born out more clearly, as it has in the last couple of weeks and why these make sense. We need to touch our customer pre, post and at-trade.

So taking a step back, it seems as though Cboe is maybe a bit at a transition point. Your multiyear conversion with that is complete. Your integration is complete at this point. You've just announced the acquisition of EuroCCP. Does it seem like that way internally, like you guys are kind of turning the page to a next chapter for Cboe?

I think we're probably in a little further along than all of you who are watching. I mean you don't purchase EuroCCP over the weekend, right? This was a multiyear strategy when we completed the acquisition, that's where the European equity business has identified an incredible opportunity to get into derivatives, and we lacked the ability to control a CCP. So when the other 80% of EuroCCP came up and was available to us. We immediately executed. So it was really running in tandem to the efforts to integrate and migrate the system. Never stop looking for global expansion in what our core business. We are moving into derivatives in a new geography. That is core to our beliefs. It's what we're very good at. We're not going to have to hire up people and say, "Gosh, wonder how to trade a derivative?" This is taking the U.S. model that we think we're very good at and importing that to Pan-European trade. So we're a natural fit. So it really wasn't this switch off an integration, switch on an expansion. It was really a direction we're really looking forward to going.

Got it. That's helpful. And then digging into EuroCCP a bit. What is it about the European index and single-name futures and options business that you find compelling? And if you can almost justify some of the modest earnings dilution that you've spoken to?

So quite simply, roughly, if you look Pan-European economy versus the U.S. economy, roughly the same. The U.S. is still slightly larger. But in notional turnover, fraction of the size on the turnover. And we believe a great deal of that is due to market structure and the lack of transparency in the derivatives market. If you think about it, it's an historical issue. The derivative exchanges in Europe were built to compete with OTC trading. Well, how do you do that? You build out crossing mechanism and indicative quote. And the crossing mechanism, which are exchanges, allows those trades to be sent to a CCP. The U.S. market when Cboe started a derivatives exchange in '73, it was to incept liquidity providers, to provide liquidity transparent with an accessible from the open bell to the closing bell. From there, our best advertisement is the quote on the screen. We like that. U.S. investors or global investors looking for exposure into Europe are quite frustrated by the model. Doesn't make it a long model. It makes it a model that's not prone to turnover as frequently as the U.S. model. When you can't see a market and you're uncertain as to the point of execution, you tend to look away. If you know you can point, click, move on, that's an accessible market. U.S. investors, global investors are used to that when they look at the U.S. and frustrated when they look at Europe. We're simply taking the U.S. model in indices first in Pan-European country-specific exposure and opening of that access. That's the plan. We have global liquidity providers interesting -- interested in posting that liquidity from open to close. And we have demand looking for European exposure that we plan to satisfy.

In addition to European derivatives, I mean, owning up EuroCCP, it's a strategic asset for us. There aren't many CCPs around the world that are there to be purchased. Post-Brexit, it's the only Pan-European CPP, and it is the entrée for European derivatives as well as facilitating our further growth of European equities. So it's a great strategic asset for us. And as Ed said, a turnover of derivatives in Europe is a fraction, say, 1/7 to 1/10 of what is in the U.S. And you see what happened to volumes last week in the U.S., where you have great on-screen liquidity. Volume can just explode during times of volatility, not as much in the OTC market.

So I think Chris' point is a great -- we're not looking to carve out the existing share in European derivatives, rather, really growing the size of the buy, and that's what we'll be after.

Got you. And do you think about EuroCCP as a potential entry point for Cboe to push further into European derivatives? Obviously, I think there's higher barriers to entry may be in financial futures or some other aspects. But could it be a launching pad in other areas? Or do you think this is what it is? It's going to be index features and options and that’s kind of what we're comfortable with right now?

No. I think you nailed the Phase 1. I mean there's always, from my perspective, not the guy needing to build out, both the clearing capacity as well as training capacity. I can scope creep with the best of them. But Chris and the discipline of the team, Dave Howson in Europe is -- we're starting with indices, futures and options. We'll get into single name. And then we can get into derived contracts, as a result, think volatility contracts. But it really must be orderly. Let's -- we're going to get there. We're going to get there with measure and do what we do well, and that is really the indices' country-wide exposure.

That's both our delivery of capabilities. Also, we want to focus liquidity because we're trying to build what is an on-screen liquidity like similar to the U.S. and so focusing on a few contracts. The start is the right path.

Got you. So you intend to pay for EuroCCP with cash on hand as you did with your small acquisitions of Hanweck and FT Options. Your debt-to-EBITDA has been hovering just north of 1x in the past few quarters. So obviously, you're not totally levered. What is your appetite for further M&A? Certainly, you have the dry powder. You've got a conference last week, you said you'd be open to the concept of a larger deal. So what is your appetite for that? And realistically, what are the options? Because certainly, governments and regulatory authorities have made larger deals in the exchange world, in particular, very challenging to get executed.

To be clear and clarify, I've said since our IPO in 2010, that we're open to larger scale M&A. So the story didn't change last week. And not meaning to correct you, but it is nothing different than the position Cboe has taken all along. If there is an opportunity for us to expand in our core, in a scale business, matching buyers and sellers, touching customers pre-, at- and post-trade, we're interested in taking a look. So that has not changed. That is exactly where we find ourselves. So while the transactions of late have been cashed to your point. If there is an opportunity, and we need to lever up, we'll do it. That is not something that we need to do. If you look at M&A in the exchange space, a lot of M&A is driven from a lack of organic growth. We are a believer, first and foremost, in our organic growth story. That is what we're building out. These last few acquisitions are conferred as unique product sets in U.S. Equities, European Equities, now European derivatives, and of course, a volatility franchise. That's first and foremost. But we must always keep our eyes open for other opportunities. So to your point, you've nailed it. Deals -- international cross-border deals are difficult. We've said it all along, especially when you're dealing with national treasures and not so difficult if you're not. So we'll keep eyes open. And if there's something that makes sense, we will be able to execute because the balance sheet has flexibility.

Got you. And then speaking of organic growth. Certainly, I think your volatility products, SPX gets a lot of attention, but you also are trading in U.S. Equities, European Equities, foreign exchange, multiple-listed U.S. options. Where do you see as the growth opportunities in those products and maybe U.S. options might be the one that comes to the forefront just because those volumes have been incredibly robust, I believe.

I think the entire industry over the last 2 years have seen from what was flatline in multi-list U.S. options for a number of years, really an increased interest in single-name derivatives trading. We do a well. We'll take at least our product share of that business. We will partner with customers, with introducing brokers, online brokers in education. So great opportunity for us, a nice capture for us. When you do have a multiyear run in the market, correlation of dispersion come into play and the pivot away from index trading into single name, you get paid or rewarded for picking winners. In market selloffs like we've seen over the last week, correlations go very high and people tend to go back into macro hedging. So we do recognize the difference in ebb and flow. So when correlation changes, we're there in single-name and couldn't be more pleased with the expansion. I think the greatest example over the last month or so would be Tesla, where there are a few -- couple of million contracts a day traded at a single-name. That's remarkable growth, remarkable. So we're there. Again, it's a shared medal at that point. But watching have high-growth is a great business to be in. U.S. Equities, a little different. We are fighting a market structure issues there. With more and more transactions being traded off-exchange. And fortunately, Cboe now being able to participate in market close more and more our volume being traded at the close. So while we were able now to compete at the close with Cboe's. There is a great deal of shift off-exchange in times of low volatility, and that's more of a challenge for us from a competitive perspective than, I would say, in the U.S. option.

I guess I might mention also with free commissions coming at least in equities, you see kind of, I'd say, the base of order flow from retail brokers has gone up. And I don't -- we don't expect that to recede, so there's some natural tailwind there from retail brokers. I'd also mention in U.S. Equities, the Cboe Market Close, as Ed mentioned, we're going to launch that this Friday. Very excited about that after a couple of years of working with the SEC on that approval to be able to compete in that part of the market that is 7-plus percent of the market every day and growing, especially when in times of more tranquility. So very excited about that and bringing out new order types like retail priority. We've seen great growth in retail priority on our EDGX market, one of our 4 markets. And we also have some institutional order types to compete with what -- some of that flow that's gone off-exchange. Also mentioning U.S. Equities, for instance, when volatility goes very high, the off-exchange percentage of market share goes down. So it had been hovering for basically almost all of January. It's about 40%. On Friday, it was at 33%. So in times of volatility, people come back to the lit markets, and we benefit from that.

Got it. So...

And FX, maybe we should talk about...

Yes. The FX.

FX, we set a record just last week on Friday, 75 billion, so 75 yards. Our previous record was 68. It's -- and then clearly, what's driving that was, obviously, volatility from last week. But we also have an offering called full amount, which does what it says. It's a full amount trading at large sizes, reduces market impact for traders. And that continues to grow very, very nicely. We're starting to trade nondeliverable forwards on our SEF, on a very regular basis, on the tune of $100 million or so every single day, and we have plans for both on- and off-SEF. So there's just a lot of growth opportunities in our FX market that are very organic and we're very close to our customers as we've used data to better understand their trading needs. And so we think we're well positioned as volatility is now back in the market after a 20-year low in FX volatility. Clearly, it's back. We have data to help support our customers.

Got it. And you mentioned, how the SEC approved your market on close, real request or real filing. They've been busy. They have also been introducing proposals on the SIP, that's consolidated basically. What's your reaction, your initial reaction to their proposal? And what are your areas that you agree with them? What are your areas of potential concern?

I think for the most part, if we think in the background, honestly, the SEC is doing no harm. We're probably in the favor, that's a pretty broad statement. So if you look at the majority of the issues by conflict of interest of enhancing the performance of SIPs, where exchanges -- most of the primary exchanges have been supportive of or having variations of dual filings to do just that. So the SEC's release captured much of the direction that we all have intended to go. I think when we tend to pivot away from the SEC is when the SEC, without authority, gets into price setting. So while that's not explicit in the release, that would be where Cboe would start taking the other side about the SEC's proposal. Also, and when I say, do no harm, the debate around competing in multiple SIPs in different geographies for latency purposes. We're not sure how that helps the customer at the end of the day, and we think that may add complexity and cost to the system. So there'll be some debate around there. I think conceptually, if you can kind of nag your head. But at the end of the day, is a customer better off? I'm not sure as if more burdensome for those that are routing orders probably. So I think a lot of detail, and it won't just be the exchanges that have been voicing concern around making SIP more complex than it needs to be. So if you take a step back, the majority of the release, we like changes to governance, we like enhancements with growth, we're finally providing book debt. So a lot of it is heading on from our perspective, early days. And that will be a long day.

Yes. And as Ed said, we -- I mean, frankly, previously that's we've been an advocate for SIP performance, SIP improvements for many, many years, asking advisers from the industry to come on to the SIP operating committee. So a lot of good changes have been effective there from an operational resiliency and speed perspective. As Ed said, I think we're very supportive of the governance changes or talking about those content, additional content and then delivery of those. In fact, if you look at our market structure principles we put out in January, talks about a distributed SIP, so putting SIP in all the major data centers. We think that makes a lot of sense, but that's further complicated potentially with competing SIPs. I think where our biggest hard run comes is, and frankly, we disagree, is just the SEC is going to be in the price-setting business. We've been pretty clear with our transaction fee pilot ahead of response that we think that's not the place.

I think we have a couple of minutes for audience questions if anybody has one. All right. Still early. I'll keep going. So I think more broadly on the whole market data topic, what is Cboe's ability to grow your market data and your access capacity fees given some of the constraints currently placed upon you by the SEC? And do you expect that to change anytime soon?

You answer.

I think the answer is the growth in market data and access and capacity fees or really about unit growth. It's about new products and new users or users using more accounts. So Brian made on his earnings call, percentage, a large majority of the percentage of growth in our proprietary data or market and access fees has come from new unit growth. As we've migrated each platform, people have demanded more capacity on the platform. During these times, we need even more capacity. So that's driving unit growth. And then from a market data perspective, our Cboe One product is very competitively priced. And so we don't need to increase price in order to grow that revenue. It's about distribution. It's distributing to new users that a product that is incredibly compelling, that they're paying more for a very similar product today. So -- and then as we migrate each platform and bring on new products, we're thinking of new products all the time and also mentioned with Hanweck and FT and bring that -- filling the gaps we have in information solutions. That's a small from a small base, but a nice growing segment of the market with risk analytics.

And when you have events like your upcoming conference and you're educating people about different products that you have in different trading strategies. Is there also the education about, "Hey, here is the content that we have that can help inform your decisions?"

Oh, sure.

Absolutely.

We'll feature -- we've always -- in 2015, LiveVol has been part of RMC. No better visual of the volatility surface that process the class in LiveVol. And now with FT and Hanweck, they will be featured for sure at our Cboe Investor Day in the few days.

Great. Well, I think we will wrap it up there. But we'll have a breakout session downstairs.

Great. Thanks.