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

Good morning, everyone, and welcome to the Cboe Global Markets European Strategy Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the call over to Debbie Koopman, Vice President of Investor Relations, for opening introductions. Please go ahead.

Thank you. Good morning and thank you for joining us today to discuss our recently announced European derivatives launch plans and strategy. On the call today, Ed Tilly, our Chairman, President and CEO, will give a brief introduction and then hand it over to David Howson, President of our European operations, to provide an update on our planned strategic initiatives in Europe as it relates to the launch of Cboe Europe Derivatives. Then Brian Schell, our Executive Vice President and CFO, will provide some brief comments on the projected short-term EPS impact of this initiative. Following their comments, we will open the call to Q&A. Also joining us for Q&A will be Ade Cordell, President of Cboe NL, our Amsterdam-based exchange. In addition, I would like to point out that this presentation will include the use of slides. We will be showing the slides and providing commentary on each. However, we will not be advancing the slides, so you will need to advance the slides, which are available either through the webcast or through the IR website. Again, a downloadable copy of the slide presentation is available on the Investor Relations portion of our website. During our remarks, we will make some forward-looking statements, which represent our current judgment on what the future may hold. And while we believe these judgments are reasonable, these forward-looking statements are not guarantees of future performance and involve certain assumptions, risks and uncertainties. Actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. Please refer to our filings with the SEC and the slide presentation for a full discussion of the factors that may affect any forward-looking statement. Also, note that references made to the planned European derivatives buildout are subject to regulatory approval. All plan dates and time lines are subject to change without notice. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise after the conference call. Today's speakers are joining from different locations, so I'd ask that you please be patient if there are any technical difficulties. Now I'd like to turn the call over to Ed Tilly.

Thank you, Debbie. Good morning. I'd like to thank you for joining us today, especially ahead of the holiday weekend here in the U.S. Yesterday, we announced the completion of our acquisition of EuroCCP, the leading pan-European clearinghouse, and our plans to launch Cboe Europe Derivatives in the first half of next year. Despite the challenges related to COVID-19 over the past few months, we were able to close the EuroCCP transaction on time, and we are exceptionally proud of the teams at both organizations for making this happen. I am delighted to welcome the EuroCCP team to Cboe Global Markets. The completion of this acquisition marks a significant milestone for our European business. Full ownership of a leading equities clearing house not only enhances our current European equities business but also provides opportunities to diversify our business into trading and clearing derivatives, which Dave Howson, President of European operations, will explain in a moment. Both Cboe and EuroCCP are highly valued by market participants for their track records in providing exceptional client service and successful market innovation. We believe the complementary nature of our businesses will amplify those qualities going forward in equities and other asset classes. The acquisition of EuroCCP helps enable Cboe to execute our long-term strategy to bring pan-European derivatives trading to Europe to unlock the considerable potential we see for this market and to fuel its growth. Cboe is known for successful derivatives product innovation and for developing vibrant derivatives markets. We couldn't be more excited to bring this expertise to the European marketplace. I'll now turn it over to Dave to walk us through our European business strategy and how we plan to leverage our derivatives expertise to grow our business in Europe.

Thanks, Ed, and thanks to everyone who has joined the call today. This deal marks the beginning of the next chapter, Cboe Europe, and together with EuroCCP, we couldn't be more excited to further deliver on our pan-European mission with the planned launch of Cboe Europe Derivatives. I'm pleased to have Ade Cordell on the call today as well. Ade joined Cboe Europe early this year and is overseeing our expansion into European derivatives. He has been appointed President of Cboe NL, our Netherlands-based exchange, which will serve as the home to Cboe Europe Derivatives. Turning to Slide 6. Our European Equities business remains strong, and we continue to be Europe's largest truly pan-European equities exchange. Over the last decade, we've built a track record of delivering innovative products and services based on customer needs. These now include a suite of trading and reporting services, listings, market data and indices. We support a single European market that brings investors together in a robust market free from national legacy. And we believe efficient pan-European market infrastructure helps grow capital markets in Europe. From the beginning, we have been focused on improving market structure and transparency. We plan to leverage our successful equities blueprint to create a derivatives market designed to simplify cross-border, pan-European equities -- derivatives trading. Turning to Slide 7. It is this existing vibrant, pan-European equities business and ecosystem that will help enable us to create high-quality derivatives products in a cost-efficient manner. Our solid equities trading business creates robust market data, which is used to calculate our suite of pan-European indices. These indices are highly correlated and comparable -- with comparable benchmarks and will serve as the foundation for a successful European derivatives business. Turning now to Slide 8. The acquisition of EuroCCP completes the missing piece of the puzzle by providing us with a clearing solution for our derivatives platform. We're happy to welcome EuroCCP to the Cboe family. While EuroCCP will become part of Cboe's overall European group, it will remain operationally managed by EuroCCP and its strong leadership team led by Cécile Nagel. For EuroCCP customers, it's business is as usual. EuroCCP will continue to support an open-access model, offering choice and competition in the clearing space, something that Cboe has long championed in Europe. As mentioned, we expect EuroCCP to enable us to grow our European business as well as further diversify our revenue stream by enabling us to launch Cboe Europe Derivatives. Additionally, as an in-EU clearing house, we see EuroCCP as a strategic asset in light of the political and regulatory uncertainty surrounding Brexit and the future framework of European capital markets. On Slide 9, this slide outlines where we believe there is a great opportunity for Cboe to help grow the derivatives market in Europe. The first thing to highlight here is the size of the European economy versus the U.S. economy. When you think about the U.S. economy, which is effectively a $21 trillion market, and overlay that with the equity option market in the U.S., which are denoted by the green and blue bars, you see an obvious upward trend. The European economy is approximately $19 trillion, similar in size to the U.S. economy, but the equity options markets in Europe and the U.S. show striking differences. When you look at 2009, you can see that Europe and U.S. are on par. But in the years since, the U.S. has grown rapidly and Europe has stagnated and, in some respects, started to trend downwards. Moving to Slide 10. We ask the question why do these 2 markets look so different. We believe that the lack of transparency and competition, particularly in the index products, and the current market structure have hindered the growth of the European derivatives market and created suboptimal experience for customers. The current market structure is dominated by a prearranged block trading model with limited on-screen liquidity. We believe this structure encourages OTC, or off-screen trading and lacks the technological and market structure design to support a lit market. Additionally, the market is fragmented and siloed, which creates inefficiencies for participants. In order to trade the key index products outlined on this slide, participants currently need to connect to 3 different venues with 3 different clearing houses, 3 different pricing structures and 3 different market models. On top of that, the contract design and specifications and index methodologies used to create these products are inconsistent across the markets, which creates additional inefficiencies. Our research shows that market participants are frustrated by the opaque market structure, low levels of liquidity and inefficient design of the market. We believe we have a better solution. Turning to Slide 11. We can see -- we see client demand for a vibrant on-exchange market model similar to Cboe's U.S. derivatives market that addresses inefficiencies in the European market. We believe a transparent, lit, quote-driven market will attract a diverse range of market participants, including retail and institutional investors. Addressing transparency and market structure issues will help participants better see opportunities and fuel market growth. We plan to leverage our derivatives market expertise to promote transparency and deep on-screen liquidity over block and prearranged OTC transactions, which is currently status quo in Europe. Moving now to Slide 12. We plan to launch our venue in the first half of next year, subject to technical and stakeholder readiness and regulatory approval from the Dutch AFM and DNB, and will offer trading in futures and options based on 6 Cboe Europe indices. These indices are managed under the same consistent, transparent rules used for Cboe indices and valued using Cboe's own market data. This is the first phase in creating a one-stop shop for pan-European derivatives trading. We plan to add futures and options on additional European benchmarks at a later date based on customer demand. Essentially, we have listened to the needs of market participants and designed our market from a pan-European point of view, leveraging our global derivatives expertise, European equities footprint and world-class technology to build a more efficient derivatives market. Moving on to Slide 13. Our pan-European model will offer efficiencies not available in today's fragmented market and enable market participants to access a modern derivatives market through a single access point, creating efficiencies in trading and clearing. On the product design front, we expect to offer uniform contracts to create efficiencies for customers. Our goal is to encourage deep pools of liquidity through homogenous products all constructed the same way. We've developed rightsized index contracts with appropriately calibrated tick sizes for index futures and options contracts. Advancing to Slide 14. We have had requests from both U.S. and European market participants to bring a new derivatives market to Europe. Our aim is to attract new sources of algo flow from clients looking to transact European options on a deeper, more liquid order book. We have commitments from trading and clearing members to be there on day 1. To summarize, our mission is to create a modern and vibrant pan-European derivatives market designed to grow and bring competition into the derivatives markets in Europe and truly unlock the potential of this market. We are not simply trying to take market share from existing exchanges. Rather, our aim is to grow the overall derivatives trading pie in Europe. We believe a robust, transparent pan-European market infrastructure, coupled with smart, holistic product design, will help provide efficiencies for customers while fueling growth of capital markets in Europe. Moving to Slide 15. You will see our planned launch time line. As previously mentioned, we plan to launch the new venue in the first half of next year. We have been making very good progress on the technology and operations development and expect to have the platform ready for testing in the fourth quarter of this year. We are excited to launch this new venture, and we look forward to building a better derivatives market in Europe. With that, I will turn it over to Brian for an update on the projected short-term EPS impact from this investment.

Thanks, Dave. I'll be brief here as we wrap up the call. We are reaffirming that we expect the acquisition of EuroCCP and our investment to build out pan-European derivatives trading and clearing to reduce earnings per share by about $0.08 to $0.10 in 2020 and 2021. However, we now expect the impact to be at the higher end of the range, primarily reflecting slightly higher than originally projected facility fees associated with EuroCCP's new EUR 1.5 billion backup line of credit. We were very pleased with the bank participation and our ability to execute on this line of credit without delay despite the shifting market conditions in the midst of this pandemic. We're excited about the opportunity we see to grow the pan-European market for derivatives trading and view this as a great investment in a long-term growth of our business.

Thanks, Brian. At this point, we would be happy to take questions germane to EuroCCP and the pan-European derivatives build-out. [Operator Instructions] At this time, I'll turn it over to the operator for instructions on submitting questions. Thank you.

[Operator Instructions] The first question comes from Ken Worthington of JPMorgan.

Can you give us a more robust history of the equity options business in Europe? You think there's an opportunity here? Can you describe maybe what others have tried in the past to develop a more robust options business and address some of the issues that you look to be addressing in your offering and maybe why those didn't succeed?

This is David Howson. So I'll start off and hand over to Ade. He has a great history in the equity derivatives market in Europe. Many of the preceding initiatives that you saw come into play in Europe were predominantly focused on copycat market structures and product sets as well as being driven predominantly by just looking to introduce cost reductions. The real differentiator here is the unique market structure that we're going to be bringing to Europe, which will really induce new flow and unlock latent demand that we see coming from international systematic and quantitative funds around the globe.

I think adding to that, Dave, it's probably worth highlighting some things that happened in the past. And so from a European perspective, a lot of the exchanges, as I'm sure you understand, have grown up as being national champions. And so they typically concentrated on their own domestic products. With that, just thinking about the way market participants trade today, which is largely cross-border, pan-European in nature in Europe today, it's actually very difficult to do it in the index options space. And so when we're looking at what other exchanges have done in the past, actually they largely haven't addressed this, which is why when you look back at the -- I think it's a slide that Dave was walking through earlier where you see the differences between the U.S. and Europe, in the index options space, there really hasn't been much competition amongst the exchanges. And so I think we're somewhat uniquely placed to be able to launch futures and options based on our own indices to actually address this given that we have a pan-European exchange and we are truly pan-European in nature.

The next question is from Kyle Voigt of KBW.

Maybe just a question on -- I think the plans originally or when it was talked about originally were to kind of focus on these country-specific benchmarks, which obviously 5 of the 6 initial that you're rolling out are, but also you're rolling out a similar or look-alike contract to that STOXX 50. Can you just talk about the inbound client demand that you have been getting for those country-specific index derivatives versus the kind of inbound demand you've been getting for a pan-European benchmark and derivatives trading solution that's different than the one that exists today? And then I guess do you have a view on whether there's more opportunity in that country-specific bucket versus that broad Europe benchmark bucket?

Okay. So on that, and so let's talk about the country specific first. From a domestic standpoint, one of the things that participants have told us is there used to be a lot more trading in the domestic or national indices, particularly from an index option standpoint. What they've noticed is that volumes have trended down over time; and secondly, new types of participants have come in who typically are largely technology driven, so be it quant fund, systematic funds who typically want an order book traded product. These funds have typically struggled to execute business on a venue which is largely driven by block trades, and that's even more persistent in the country benchmarks than it is in the pan-European benchmarks. And so when we're attempting to address this, market participants also told us, we appreciate that the pan-European product is also -- certainly, from a European perspective, looks liquid on the surface, and it is. But ultimately, for us to calibrate our algos and just look at the pattern with trading throughout the day, it's actually very difficult for us to do that because there's still a significant amount of block trading that happens in that particular product. And not only that, it'll allow the business [ imprint ] at the end of the day. Can you actually deliver something to the market which one offers all of those products in one silo, firstly? And so we would like to trade the country benchmarks. We have capital to deploy in those countries but also make sure it's an order book-driven model similar to what you are today in the United States. So your Cboe platform in the U.S., where we trade day in, day out, can you replicate that in Europe and actually have all of these products trading in that venue? And that's ultimately which -- what we're going to deliver.

The next question is from Chris Harris of Wells Fargo.

So I guess with this initiative, you can have a better mousetrap. But if there's no liquidity, it seems to me that nobody is really going to use it. But I guess how do you guys plan on building liquidity at this new venture? I'm just a little bit confused by that.

Great. Thanks very much for the question. There's a variety of stakeholders that are key to teething a critical mass liquidity for any volume, and this -- at any venue, and this is no different. We've got great conversations going with all stakeholders covering the market-making community, sell-side community as well as the indirect clients, those end funds. And what we have is a great confluence of factors that bring together the critical mass liquidity from providing a market structure which is interesting both to the market-making side of the community as well as the sell-side part of the community as well as the index and macro hedge fund community. So with a market structure in place, it creates an environment where a liquid market can be seeded. But on top of that, there will also be the need for additional incentive schemes to help seed that marketplace, and these are factors which have been included in our plans and are subject to keen discussions that we are having with customers both bilaterally and through the working groups which we are initiating over the summer period. I'll hand on to Ade for potentially some more detail.

Yes. So I guess a key differentiator between what we're doing and perhaps some of the initiatives you may well have seen elsewhere would be this. Think about what we've outlined. The key thing here is actually where there's latent demand. And so you've got a frustrated group of investors, group of funds that actually want to deploy their capital in Europe, and they're effectively saying, we can't do that today given the current market structure. Now this, in some respect, is actually the best problem to have if you're in our position. So you've got the demand side where participants actually got business to transact. Now the question that they pose to us is, will you be able to get market makers and liquidity providers to make 2-way prices on your venue? And the answer to that is, yes. And so we've spoken to all the key market-making firms that are active on other venues, that are experts in index options, that are able to make 2-way prices throughout the trading day across expiries, across strikes, and effectively described exactly what we're planning to bring to market in first half of next year. And they've effectively told us, if you can do this, if you can bring this to the market and you have this latent demand, we will be there. And so the feedback from market makers and liquidity drivers has actually been outstanding. And so that's why we feel confident that we can launch this venue, over time it will grow, volumes will pick up and you'll get a variety of market participants coalescing around it. The key thing here is the latent demand. If there wasn't this latent demand, it will make it that much more difficult for us to do. But it's there. And so we need to make sure that we get the other side of the coin, which are the liquidity providers, to make these 2-way prices.