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

Fireside chat. So we're very excited to have both the CEO and CFO of Cboe Global Markets with us today. I'm Brian Bedell, the broker asset manager and exchange analyst at Deutsche Bank. And maybe just to do a little introduction. Ed Tilly is with us as the Chairman, President and CEO of Cboe. Starting with Cboe on the trading floor, actually way back in 1987 and rising through the ranks to become CEO in 2013, developing the VIX franchise and spearheading numerous strategic partnerships, including the acquisition of Bats. And I know even if this the opening we're having a trading for close. So we'll talk more about that in the presentation. But speaking of Bats, CFO, Brian Schell, came to Cboe with the Bats acquisition, and have been CFO of Bats since he joined them in 2011 after more than 20 years of experience in financial services, including a 16-year tenure at H&R Block. Anyway, thank you both for being with us today. And so I'll start out with some questions of my own and leave some time for questions for the participants.

Just some quick instructions on that. You can ask a question via the web portal. Or you can e-mail me at [email protected], whichever is easier for you. So again, welcome Ed and Brian. Maybe the best way to start is just to give us a quick overview on how you're handling operations in the current work-from-home environment? And what you're hearing from your user base across your product set, and how you see work from home impacting trading of your products?

Sure. Well, thanks, first of all, it's great to be with you virtually, and great to be sharing ours observation on the market place. And yes it's a great place to start, I'll say operationally, I couldn't be more pleased with the way Cboe as an entire organization has executed in this environment from closing the trading floor over a weekend and being able to open up 100% electronically was a big thing for C1. And then our work-from-home started before it was a bad day in various cities and across the globe actually. We took those precautionary steps very, very early and really had made a pretty amazing transition to work-from-home. Our productivity is up, our interaction with our customers is exactly where I'd like it to be. It's different, but it is certainly getting us the feedback and the interaction and thoughts from the street that we've always relied on to be able to share with you our views on the broader trading environment. And I think what I'm -- most encouraged is while there's still uncertainty with how this event around the world will end, the adjustments, at least in the industry, and I'll speak and observe our peers in global exchange operations, exchanges have worked and the transparency, the access, the regulation has all been in place. And I think some certainty in the most uncertain times that, I hope are behind us, I couldn't be more pleased with execution from all of us in the most uncertain of time. So that's my early observation. Much to be done, much more ahead of us, but in a really, really good spot and really hitting on everything we think we need to.

Yes. That's a great introduction. Maybe just moving to the trading floor. So you did just announce yesterday that you do plan to open the floor on G&A, as, I think, you said there is 50% capacity. So can you talk about that process? And then just from closing the trading floor, what you think the overall impact on volumes has been from the closures? Obviously, that impacts the SPX options complex more, but to what -- what to extend -- to what extent do you think that had an impact on the whole volatility ecosystem into VIX options and even VIX futures?

Yes. Great question. I don't -- I think macro market events are really the biggest driver in both the volumes we enjoyed in the first quarter. And then just like events in the past, when there's been a major correction, a major move in the market, the reset, the reevaluation and repricing of risk going forward is always been part of the cycle. So the reset before we engage. So I think that's the biggest driver from operationally and specifically to the trading floor and then to the ecosystem. Certainly, we know that there are trade strategies, the most complex. And then strategies that are the most risky. And I can define those really easy for you. But those have been the one that have been impacted most by the limited access to the deepest pool of liquidity, and that is in the S&P 500. And the complex trades are kind of easy for you to imagine. It's what we referenced on our earnings call. I think 6 legs and more in the SPX. We saw the reduction of those by 50%. That's meaningful in those complex trades. And in the highest risk trades, which we didn't spend a whole lot of time with -- on the earnings call, think of those as directional in nature. And you've got this now $3,000 underlying the S&P 500 and directional plays, I need to buy 500 these, I need to buy 1,000 of those. We're affected really efficiently and with great price transparency and discovery and open outcry. And very difficult to do on a screen because someone has to come in between the liquidity provider and the user, that's a broker. And the risk should not be put on a broker, we don't believe in trying to find that liquidity in an open outcry, it's a pretty simple process. Customers on the phone with their broker, brokers standing next to the deepest pool liquidity in the market. And on the fly, RFQs are responded to and trades are consummated. So it's a really easy process, and we can't wait to get back to floor trading. So the utility of the floor and that deep pool of liquidity is intact, the link between the buyers and sellers and sellers and buyers are in place. And as to your 50%, yes, we're going to reopen the pool, we basically divided our trading floor in -- into basically 2 floors, right? Hence the one will be the SPX, the other will be VIX and multi-list options. We've gone through extensive research, we've consulted with disease specialists and infectious disease specialists and come to what we think is best-in-class sort for a safety protocol. And in the SPX, the most difficult to accomplish social distancing, we've done it. We redesigned the SPX pit to allow for social distancing, which does limit the amount of market makers and brokers that are allowed into the new complex. But most importantly, there's no group, whether it's a broker or a market maker who's excluded. So some trading firms and prop shops might have had 5 or 6 market makers in the old SPX pit. They won't have 5 or 6, they might have 3. And that's the reduction, and that's what we do to ensure our best scenario for health, but we think we'll be able to accommodate liquidity and maintain the healthiest environment for traders. I will say we've added some technology and some solutions for communications. So we're allowing wireless headsets, cell phones, were allowing a broker's favorite chat and messaging. We're on a solution today, but we could BlueJeans, Zoom, pick your favorite multi person messaging we're allowing that on the floor. So we think we've closed a lot of the gap and really looking forward to the relaunch and reopen on June 8.

You have technology scientific part of this. And then you mentioned also on the first quarter earnings call about developing some new complex order trading functionality that could replicate some of the operations on the floor, the procedures on the floor. And now that you'll have traders coming back maybe you don't use that as much, but to the extent that you have developed it, and it's been -- it is starting to be used by the traders. Maybe can you comment on whether you think that could be additive to your overall capabilities if you run that along -- parallel with the floor being opened? Or do you not need it?

Well, a need is the interesting word because returning to the floor in that moment in time in the need is back burner, but if we look at the evolution of the market model this is leaps and bounds being able to do offer our customers the best of the liquidity in face-to-face negotiation and the distribution that's allowed and new methods of communication that they got they're not new to the world since they're around in teams. But in the use case for trading comparing those 2 is, I think, perhaps not needed on the ace, but will be needed over time. And I think the enhancements that Cboe and the way we will define that interaction, I'm offering the best of both is what the future will look like for our customers. So we're committed to making sure we don't find ourselves not able to offer our customers all access in all the utilities that we do. And we even think we're coming up with some new unused methods for price discovery and then ultimately, the supply of the liquidity to the users we're looking for it. So exciting times in well beyond defining what that looks like and the practical application really what we'll be getting it out now in the months ahead. But exiting times from our prospective and it's -- as a human there is nothing more sad then watching this. But as an operator who needs to offer some certainty in the world, as far as finance and price discovery. We find ourselves in a very, very good place and making leaps and bounds on technological advances.

Yes. Yes. No definitely. That's important. Then maybe just zooming in a little bit on the VIX side you're obviously, so good at explaining this on earnings calls in terms of the dynamic. It is complex to understand sometimes in terms of how trade or what to trade are traders particularly looking for? Or what types of environments are conducive to heavy VIX future usage. But maybe if you can talk about, and obviously we've gone through the volatilities serge, we're passed that now. And people are now putting on the risk physicians as much. But what do you think it will take for some of those VIX futures volumes to come back to normal levels in terms of either shape of -- conditions into VIX index or trading behaviors?

Well, you nailed it. It's macro, and if we look back over time, this is not new VIX is a curve, which spikes in the first month it's not a normal situation that's exactly what we saw on this move. We tend to go flat when the market has no opinion, meaning they cannot currently speak through the end of the effect that's underway. We have seen that in the past and when there is -- and this is really important when you can see through the event, and that doesn't mean that then event is over. It means that there is a state and moment in time where we think the risk in the marketplace is changed, and that will show up in the VIX term structure. And right now it's very flat and very uncertain. So we look out front month compared to 6 months out in the VIX term structure, it's the same, which means the market is saying, this isn't going away I don't have any more certainty in 6 months when I do today. That is a really difficult trading environment, in particular for VIX futures with a flat term structure. How -- when there is some certainty in the world, the how this is going to end, maybe as a vaccine. Pick your favorite scenario for this to be behind us, you'll see that show up in the term structure and the VIX futures will begin to trade as they do in a more normal circumstance. Again, not dissimilar to past event.

Right. Right. Yes, we've seen it's, we've seen this movie before, so to speak. Maybe switching gears to growth initiative. Can you talk about some of you recent acquisitions and you're long-term game plans in these areas. So maybe just for starters, how are Hanweck and FT options enhancing you're analytics capabilities? And are you starting to see any revenue synergies with increased customer usage of those products?

Good way to -- a good place to start. Two profitable businesses when we bought them. So Hanweck and FT, great installed base. In the proprietary trading end of the world, these were household names, and with best-in-class portfolio evaluation and management, FT, top of class. So putting these together with our pre and post-trade information services offerings already so that was dialect in LiveVol. We think we have a pretty terrific suite in turnkey solution for proprietary traders and large institutional traders with the offerings that Hanweck and FT bring to the table. So a good stuff, we're in integration right now. And I would look for the benefit of the revenue synergy in 2021. But as I say, profitable companies when we bought them with great installs. So we like where we're starting and the integration underway and looking for a 2021 bigger bang on revs.

Okay. Great. And then maybe while we're on the topic of acquisitions. The recent acquisition of MATCHNow, the Canadian dark pool. I guess how long have you've been looking at the Canadian market? How do you plan to increase the market share in that market of this venue? Maybe just your outlook on the Canadian equities landscape overall.

Sure. It's a great question. I think -- the how long goes to, I think, the M&A rewind play answer that we've had since we were public in 2010. Businesses that fit into Cboe's core that allow us to expand on what we believe we're best at. And in this case, this is trading equities in the seventh largest equity market in the world, in a jurisdiction that's easy to manage, right? Same time zone as New York, easy to access, when we're doing that again, from Chicago and New York. The team in Canada will report to a North American equities group now that we're expanding across the border. So easy for us to see the integration. Market is big enough that it's interesting. What it does lack, to your point, is we're only 7% share of the Canadian equities market. That's not the scale we like to operate on. So we believe that this will be the starting point for our expansion into Canada, and we'll take the benefits of what we've learned in first growing the U.S. business, where our customers are very, very similar to the customers and overlapping a great deal in Canada. But really, the expansion that we've -- how we've learned to do it in Europe, in multiple jurisdictions. So we've got a lot of case study behind us, and we're going to take the best of what we've learned in multiple jurisdictions, bring that to Canada, the alternative space, that'll be our starting point for what we think we'll be able to grow in Canada.

Okay. And that's a good segue maybe to your other global acquisition initiative, and that's EuroCCP. Maybe just if you can talk about the long-term game plan for that? What type of products do you plan to develop within? I think you've mentioned in the last 2 earnings calls that within the futures side of that. I guess what gives you confidence that you'll see reasonably good demands from these? And what type of structural trading differences exist in the European trading arena that seems to be keeping activity much lower relative to, say, what's going on in the U.S. platforms.

Yes. Great question, and it is exactly -- it's the -- the answer rolls up into the multiple part question that you asked in that because of the difference is where our confidence come. And the confidence comes from listening to customers who say, "Gosh, for a callout market, Europe, I guess, work pretty good. I can call a bank, I can call a source and get a price and a trade can go up". But that is different than the U.S. market where the users in the U.S. or those that are accessing the U.S. market are used to seeing liquidity on the screen that's easily accessible and/or employing brokers who have multiple access points, we'll use again, the S&P 500 liquidity, and so that the price discovery is much more transparent and open and access is much easier. That is the demand we want to answer for those that need European exposure. So take U.S. investments who want a clean exposure. They're not used to that nontransparent market and prefer the transparency of the U.S. market. So we will offer a broad-based indices across Europe that allow for trading in the style that is more the U.S. way. So we are answering demand from customers. We have liquidity providers who are looking forward to our model, who want trade with customers and not be subject to a dial up call and whose top of the list of a dial up, they want to fight and they want to compete by the best quoted market. That's what we're building, and that's what we'll employ in Europe.

And this is maybe just a reminder of the time frame. I know this is more of a long-term endeavor. You don't close it until later in the year. And I think you've described it as a multiyear initiative. Maybe if you could just flesh that a little bit in terms of the timing?

Well, actually, we're still looking forward to closing and every indication we get, Brian can give you a little bit more color on the steps that we've accomplished even in this work-from-home environment. But we still expect to close in the next month or 2. And then the build-out on our platform is really going to be independent, meaning we can build out the functionality for the match engine in Europe, and we'll lean on all of the lessons learned here in the U.S. That's on Bats technology. And then EuroCCP in order to clear those trades, will start its build in being able to clear derivative transactions in Europe at EuroCCP. But the timing, I think, Brian, it's important to note what we've accomplished since we last spoke with the community, being able to affect what's the -- obviously, the critical point that is to get approval. Yes. So just -- and Brian, let me add just a couple of things to that. One is that as we thought about the key milestones for this deal to close, obviously, there's the regulatory approvals from the various bodies that will need to happen as well as the -- getting a line of credit in place. So that facility has been raised, it's committed. So that's a -- so those are basally the last steps to make this happen. And like I said, the liquidity line of credit is essentially in place, pending regulatory approval, as like I said, is the last step for those items. And just remember that this is a business we know well, meaning we were already a 20% owner. So it's not completely brand-new that we might -- all of a sudden, we have to realize is like who is this group, we don't understand our technology. So it's a group we know well already. So make the future integration and -- -- a little bit more seamless.

Yes. Okay. That makes sense. I do have a couple of questions here from the audience. And they're both around market structure, maybe and just divide them up into 2 different parts, which -- one is more on the regulation on U.S. cash equities market structure and one is more about competition. So maybe just starting with the regulatory side. How are you seeing the environment? Obviously, the SEC has been quite vocal on market data, especially with the new governance proposal. So maybe if you can start off with that on the market data side. How you see that faring in terms of the SIP versus proprietary market data and U.S. cash equities? And then I don't know if you want to touch on just the general, I guess, the access fee pilot that's hanging out there that might happen at some point?

Yes. And let me start with -- and I rarely get to do this. So I want to make sure I do this on this call. The SEC through this entire event through the entire pandemic for us going and needing and requiring to go electronic has been incredibly helpful. They've understood all of the things that we're trying to deliver to the marketplace, they've trusted us, they've trusted our guidance. And we've been able to make decisions and they've made decisions overnight in some cases so that we're up and running the next day. And the accommodations that they've put into the marketplace for us to answer customer needs has been off the charts cooperative. And I -- we wouldn't be here in this market with this transparency, if not for their cooperation. So I want to put that in a column because it's really, I think, the model and opportunity for the future, is the importance of these markets has never been more clear and the need for us to be partners with our regulators. This has been just amazing. Now here's the other side. The other side is overreaching and outside the balance of what we believe are -- is what the SEC is allowed to do or it changed for the sake of change, where maybe a squeak is what would be better. So in general, we are in favor of governance changes, for the governance for the SIP. No question about it. We made proposals, we've all along said representation around the table is important and hearing the street and their concerns on the SIP very, very important. So we're not opposed to that. There are some changes in the proposal that we'll push back on and fight. But in general, governance changes in the SIP, we've been supportive. And that's not to say we're taking all these changes without a debate, but the debate is exactly what's needed, and we've been behind much of it. Market data in general and the infrastructure proposal, we think is a -- are a lot of moving parts without clarity on the benefits for end users. So think about competing processors and the complexity and what that adds to the marketplace. And for what benefit? We don't see it, and we think it becomes more complex and wouldn't let us to keep things as simple as possible, but by making improvements. And in some of these instances, we just don't think that will be SEC's doing, and we're going to be vocal. At the end of the day, those are our regulators, our door is open because the SEC allows us to open our doors. But we still need to be an advocate for the end user and the customer, and we'll find ourselves at odds at times with the SEC over structural issues, and we'll push them on it. And we'll challenge them, the debate will continue. But at the end of the day, our doors are open, and we will adapt to whatever the street and the world thinks is best on structure. It just shouldn't handed to us without a deep debate as these last couple of proposals have been from the SEC.

Yes. It sounds like we'll have to stay tuned. And so it was a long -- sort of a long movie, so to speak. Maybe then just on the other part of that question, which is the competition. You guys have obviously been on offense, really most of your history is in the U.S. Cash equities business. And most recently, with the market on close, maybe you can talk about how that's progressing? And then on, I guess, what would be the defensive side, just your view of the members exchange when they -- when you think they may be coming into the market and what initially, obviously, we'll have to see, but what your thoughts are about responding to that?

Sure. MEMX will come into the marketplace, and they will gain share that is without a doubt. It's a very deep-pocketed consortium with order flow and liquidity. They will gain share. The extent of their success, however, I think will be curbed by their inability to offer anything new and novel. This isn't turning the market model upside down and saying, this is the way buyers and sellers should meet. This is a whole new approach, and we've answered this demand that all of the other exchanges with your multiple medallions have never been able to do. That's just not what's happened. So the extent at which the SEC allows for the internalization model to continue in a lit market will guide, I think, the success that MEMX has. They will be subject to best execution numbers, just like those firms are subject to that review in the current situation and justifying moving flow just because you're an owner of exchange, really does, I think, beg at the SEC level, the level of conflict of interest that's in the marketplace today and then what's furthered in the marketplace as a result of MEMX. So again, they will gain share, but I think there's nothing new and nothing novel there, low-cost provider. Boy, if you look at and some of the founding members are paying on the street for their flow today, you're not getting lower cost because they're getting paid net that. And so as I say, there's nothing really new and nothing really exciting there from my perspective. So we'll see the level of their success.

Okay. And then maybe just on the market on close in terms of progress there? If we're quoting Europe?

Yes. So market close in Europe -- Cboe closing cross in Europe, had some early traction and not surprisingly, things got a bit sidetrack over the last couple of months. And then the delays that our competitors put in our way in the U.S. market by their multiple appeals to the SEC, that process got bogged down for multiyear. So again, our timing was great when we launched, filed and was approved. And the practicality of it is in the most unknown trading environment, we're just not going to give people's attention to pivot and look at Cboe's market close. So I think good things to come, still optimistic. We are the low-cost provider on that effort, and we'll be rewarded for that. It will just take a little bit more time than we had modeled. But gosh, it's installed, we're ready. And it's now just a matter of customer testing and some early movers. So I don't mind where we are given everything that's happened over the past couple of months.

Okay. Okay. Yes, that's fair. I do have a couple of financial questions here for Brian. That's come in. Brian, can you just talk about the expense guide of the $418 million to $427 million. Is there more downside to that forecast given the prolonged nature of the quarantine? And as the lower volumes that we've seen in some of -- on the VIX complex and especially in the futures. Maybe just start with that 1 and then just one other financial question after that.

Yes, sure. No problem. And that's a good question to our friend in kind of 2 parts. I think there are 2 things that would drive that number, which has the potential to lower it below the bottom end of the range that we have, but we feel good about where we are today. The reasons that, that might take -- we would have an operating expense number lower is, one, if volumes were continuing to really low, they're below our expectations, and they're below the thresholds and the targets that our Board and the compensation committee set for us from an incentive compensation standpoint, obviously, that number would go down. So there is certainly, like we saw in -- going from 2018 to 2019, where we did not hit the targets that we wanted to hit and to achieve, you saw lower incentive comp payout. So there's certainly -- some of that could occur. The other is independent of volumes, more of "the physical economy, the quarantine, the social distancing" and how that takes place? And is there a reopening of physical conference or different types of conferences. So there's a fair amount of travel, meals, marketing spend, sponsorships for the traditional conferences that we obviously did not incur those expenses in the first half. We don't expect a lot over the summer, nor did we see -- expected much in the second quarter. We do have baked in that we would essentially use some of that expense in the kind of the certain in the third, somewhat in the fourth. But I said, if that comes -- shuts down per se, that could bring the number down a little bit, but that's a relatively smaller number of the overall expense base.

Right. Okay. That's fair. And then I just did get a question on just maybe reiterating the guidance that you had on the second quarter call between the categorization of revenue between the access fees and transaction fees for the second quarter. And I guess if that could come into the third quarter depending on the -- I guess, the state of the 4 really, but maybe if you could just go through that again real quick.

So Ed will give me -- I'm sure I'll hold 30 minutes on the earnings call to explain the variances between those 2 categories. So what you'll see is the -- and again, it's -- now that we're introducing the floor on June 8, or opening back up, the fees that we saw go away in April and May are likely to come back in June, and we hope for the duration. So we reinitiated those nontransaction fees and -- so that's one element that we had to remove, like I said, for 2 of those months in the second quarter. You have the full impact, full quarterly impact of the Hanweck and FT. And Ed has already talked about the benefit of that margin risk and portfolio analytics capabilities they bring, but we get the full run rate for the quarter there. So that's on the positive side. Like I said, and then we'll continue to try and highlight the organic growth that we're seeing in the proprietary market data and the access capacity fees. What's unit growth and pricing growth? So you're going to see a mix. And then, of course, you have the complicating factor of the technology conversion from a year ago that moved some of the nontransaction fees into transaction pricing. So we'll try to lay that all out. Bottom line, given the floor closure, we'd expect to see that low to mid-single-digit non transaction revenue growth for the second quarter year-over-year. Just because of all the mixes and the changes to -- we'll have to lay it out. But just know that, I think, what we've tried to do both for our shareholders and to our market participants is that we've tried to make that revenue neutral regardless of the temporary foreclosure versus opening back up. So again, we're not trying to take more than we should or anything like that. We're trying to keep that neutral to their own P&Ls to facilitate them to be able to trade that they need to. So that -- like I said -- but we're also not -- we're also trying to price that appropriately as well for providing that service.

Right. No that's -- it's good to walk through that again. That's definitely helpful. I think we are out of time. Ed and Brian, do you have any other closing remarks you'd like to say?

No, it's been great. I really appreciate this, Brian. It's nice to be able to have the dialogue even in this environment. And we really appreciate it. And our commitment for our shareholders hasn't changed. It's a new environment, but we're eager to execute, and we will do that. So thank you for putting this together, and thanks for including us.

And thank you for joining. We really appreciate all the great color on everything. So yes, very much appreciate it from our end as well. Okay. With that, we'll stop, and we'll talk to you soon.

Great. Thanks, Brian.

Thanks, Brian.

Yes. Bye bye.