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

Hope you guys are enjoying the music as much as we are. The FILS team testing loves this kind of music. So I hope you're having a bit of a dance like we are. So coming up next, for those who've just joined, is the topic of how to unlock the full potential of indexation in fixed income markets and how the buy side can optimize credit derivatives indexation with corporate bond index features whilst overcoming liquidity concerns. Joining us now is one of our advisers, Christoph Hock, Global Head of Trading at Union Investments; and David Litchfield, Director of Derivatives Sales at Cboe. David, over to you.

Good morning, good afternoon, and good evening. My name's David Litchfield, and I sit in the cross-asset derivatives team in Cboe EMEA It's my pleasure to be sitting alongside, albeit virtually, Christoph Hock, the Global Head of Trading at Union Investments. And before we start, for those not familiar with the newest index kid on the block, I'll briefly run through the mechanics of the futures. There are 2 currently, dollar high yield and dollar investment grade, and they're cash settled against an index. That index comprises cash bonds, so it has both the rates and credit components embedded in there. The dollar high-yield index uses the holdings of HYG ETF as its base; and the ETF tracks the Markit iBoxx dollar liquid high-yield index. And the investment-grade index uses the holdings of the LQD ETF as its base; and that ETF tracks the iBoxx dollar liquid investment-grade index. And because of this construct, the futures and ETFs are over 99.9% correlated, and this is very important for their liquidity. Market participants can lean on the liquidity of the ETFs. I don't want to bore you with any more specifics. Please contact me separately for more information about the index instruction and its dynamics. However, for now, just know that the futures are cash settled against the NAV of an index comprising cash bonds.

Christoph, I wonder if you could set the scene with indexation and beta instruments in general. What are the changes you've seen in the last couple of years with the advent of portfolio trading, and where do you see beta trading evolving over the next few years?

It's a very important component. And good morning and good afternoon also to the audience here from Frankfurt. It's a very important component already as of now. But going forward, derivatives in general and also portfolio trading, I think, will become more and more important on our side. So you mentioned, David, beta instruments. How did they evolve over the last couple of years? I think there were a number of trends we have seen. On the one hand, ETFs, they have become more and more popular also in the fixed income space. Portfolio trading, that's something which we saw years ago, predominantly in the equities space. This is also one of the execution styles, execution ways in these days, in the fixed income area. And then there's the trading of derivatives, i.e., listed futures, OTC derivatives, where we've seen, not only in the market in general, but also here at Union Investments on our side, a significant exponential growth over the last couple of years. Starting maybe with how we see ETFs. So that's a kind of sub-asset class where we have very little to none activity at all as Union Investment. So we define ourselves as an active manager, and selection on our side is key to generate our performance for our end investors within the investment process. So that's why, regardless whether it's to step into certain positions or to reduce positions, while ETF is an instrument, we make literally no use at all of. What's much more important on our side is when setting up and launching new funds, for instance, to create on day 1, the relevant exposure is some that we step in either via derivatives or we make use of portfolio trades. Portfolio trades, I mentioned it before. We know it as a pretty efficient instrument from the equities space. So I'm not running fixed income only, but also you mentioned it briefly in the introduction, trading in all asset classes. So we are set up as a multi-asset trading desk. And that's why my fixed income traders, someday, when having discussions with the equity guys, and they know pretty well how to make use of the instrument of portfolio trading. It's something, I think, we here at Union also pioneered here on the continent, so it's already a couple of years ago, we started to trade highly manual, the first portfolio trades here. But now with the platform providers having highly efficient electronic offerings in this area, we are much more at an automized level as we know it from the equities space. So portfolio trading, clearly, is a discipline as a way of execution when you want to set up exposure across your entire fund in line items of partially 100-plus when you have redemptions and you want to reduce your exposure. Third instrument on -- so the ETFs portfolio trading third instrument is derivatives and that's an area where we've been highly active in the past but where we see a decent growth over the last couple of years, especially in the rates and in the credit space. It was in the past predominantly in instruments where we made use of OTC derivatives. So for instance, when looking at the credit area, you have total return swaps, you can trade. And that's in the U.S., IG and high yield, same for the European instruments. Disadvantage from our perspective in total returns from swaps is the missing liquidity. So differently to CDSs. You can trade clips of 25 million, 50 million, maybe 75 million. But there's a missing, so to say, liquidity from market makers and some also in terms of titles of spreads. It's by far not comparable to what you see in the credit derivative in the CDS area. When looking at CDSs, it's a highly liquid instrument. So that's also an instrument which was functioning in a very efficient way during the peak of the COVID crisis, second half of March to beginning of April. But in general, when looking at OTC derivatives, we see a trend towards trading these instruments in form of listed instruments on exchange. So for instance, going into the FX area, we are currently replacing a number of forward positions we have with highly liquid and FX futures. And therefore, we were also one of the drivers, having pushed in the credit area, a product -- a listed product where we can efficiently replicate, build and also hedge our exposure. So that's -- we highly appreciate your offering. And we've been in the past already very active in the U.S. high-yield future, and I'm sure that's what we will continue to do so once this product further grows.

Excellent. Thank you very much. And I think looking at CDX or the CDS indices as the very liquid go-to instruments in the space, it's interesting that you're making -- or you have a directional shift towards the exchange-traded contract. What are these balances you have in your mind? And what are those drivers that are forcing you or encouraging you to use an exchange-traded contract as opposed to CDS, given the liquidity that is available in that incumbent instrument?

I think it's a good question, David. And I think we already made a first step given the fact that the key products in the CDS space, for instance, from a European perspective, the main and the crossover, they are not typically traded bilateral anymore as it was in the past. But due to the trading and tiering obligation, these products are, in the meantime, centrally cleared now. So that's, from our perspective, an important step in the evolution of the derivatives market, having the shift from bilaterally traded products into the centrally cleared space driven by, as I've said, driven by regulation. However, we still experience that in a number of our funds. So we, as Union, for instance, we have 1,300 funds-plus in the number of funds, and we were not allowed to make use of OTC derivatives. So that's in the kind of chain of evolution, first that we made, shifting from bilaterally traded into centrally cleared products. But now, obviously, from our perspective, the next step is to have a highly competitive, highly liquid offering also in the listed area. And that's where we welcome your -- definitely welcome your product, David.

Lovely. So yes, the -- one of the feedbacks we do get from a number of managers is that the centrally cleared nature is very important for the young, uncleared margin rules and the regulation that's coming in. Obviously, CDS indices are now pretty much centrally cleared, as you say. So I think the element of trading on exchange allows an interesting price discovery mechanism, such that it's not just an RFQ market around a number of brokers, you have those brokers and market makers participating in the order book, as well as other institutions looking to trade at the same time, some long, some short, fast money and real money as well. So in terms of price discovery, how do you view that given that these futures are certainly not in a mature market? How do you view that price discovery process holistically on exchange versus, say, how you might look to price up a CDX high yield?

In terms of price discovery, we see the listed future in the way it's constructed by Cboe. We see it more superior compared to the mechanisms you have in the CDS space. So also when looking, for instance, at the main, when looking at a crossover, you also have kind of basis trading in these products. I mean you have, on the one hand, the index itself. And on the other hand, you have the single-name CDSs comprising this index. And there's not really a perfect, so to say, arbitrage mechanism. So you can't compare the CDS area, for instance, with an S&P or with a Nasdaq future where you have highly liquid underlying. Where you have, on the other hand, highly liquid futures, you have a perfect arbitrage mechanism. Given the fact that there's a lack of liquidity in the single-name CDSs, you don't have this perfect arbitrage mechanism. So in the CDS area there, there is a kind of price discovery, but given the lack of liquidity in the single-name area, it's not so easy to figure out. When looking at your index -- your credit future, you have a highly liquid ETF as an underlying. And so yes, that's a value -- fair value calculation of this ETF. And then based on the huge basket of this ETF, you have composite prices, allowing you to calculate the fair value for the ETF and therefore, for the futures. So I think in terms of pricing, mechanism price discovery, it's a bit easier in the index futures space rather than in the CDS space, where you have more of the problem of lack of liquidity in individual components.

That's an interesting thing you say. I have not really thought about that before because, obviously, most people would say that those indices, so CDX and credit derivatives, are very liquid and the kind of go-to product. So the price discovery mechanism, I haven't really thought about in terms of -- and actually being easier perhaps, in the futures. And to that point, obviously, they are still a relatively new product, and therefore, liquidity and in terms of what's available on the order book and open interest is growing, but it's far from fully mature. So how have you found your trading experience thus far in the current liquidity environment, notwithstanding our growth ambitions for the product?

So I think we are one of the active players in your high-yield product in the U.S. as of now. Order book liquidity is already there. And my level of expectation is that this will significantly grow over the next couple of months. What's still missing is some of the kind of block trading possibility. I think that's where we have to chase our broker firms, being active in this product and going forward, that they also, given the high liquidity in the underlying itself, that they also will offer liquid futures markets. So from our perspective, it's a product where we will see decent growth going forward. We've had a similar situation, to share an example, in the equity world, where we were one of the pioneers when it came to trading of MSCI World Futures. There, there was also very little activity in the order book itself. But then in discussions with the key broker firms making markets in this product, given the underlying -- the liquidity in the underlying itself, we developed together with them also the facility of making markets in blocks. And roll is also an important point for us. So that -- so it's, on the one hand, order book liquidity, which is important, block trading is important, but also you need to have tightly priced markets when it comes to the roll, and then you have a perfect product.

Yes. The roll is something that we've worked extremely hard on in terms of tightening up, making sure that it's not a question you can get into the products and then come roll time or come close out. It's a tricky proposition. So we work very hard on the roll, and we're very proud of our roll markets. But what other developments would you like from us in terms of this market and other markets? What would you like to see from Cboe and the market at large?

So when discussing the roll, David, it's essential from our perspective at the moment, you have, for good reason, monthly futures. But given the fact that cost of trading is a key component for us when having monthly rolls, it's by far a more expensive exercise rather than when looking at the mature listed futures. We have these days in equities and in fixed income rather than when having quarterly futures. So I think from a buy-side perspective, this has to be one of the goals to trade for a highly liquid quarterly product. And then when looking at expanding the product range, you started in the U.S. with a high-yield product, then you developed the IG product for the U.S. We definitely expect that you come with a European product somewhere in the coming month. And I've heard from you that this is already in the pipeline. And yes, then as a next step, we definitely have to discuss also about options on your product offering.

Lovely. Yes. We've certainly -- obviously, options run through our veins thick and fast. So we're certainly keen to look at the options market on it. And again, the client demand that we've had is significant for that. So I'm sure that will be a matter of time. In terms of those quarterly and monthlies, we launched the monthly simply for liquidity purposes. The fixed income indices rebalance every month, and therefore, it was easier to get the product off the ground. But again, in conversation with clients, I fully anticipate that the liquidity will gravitate towards the quarterly futures as and when the product grows. So I think that will be a natural evolution soon rather than later as the product does grow. And then launching a new product in certainly a corner of the market where liquidity is paramount. The design on the drawing board was key, but sometimes it can be left on the drawing board. And it's great to hear that you have started to experience the product and are happy with your experience of the product. We'd love others to join and grow this market to the size that I'm sure it can be. We struggled a little bit with that chicken-egg argument. But I hope you're happy with what you're doing and you're a proof that you can do size in this market and use the product. So we look forward to working with our sell-side partners to grow the product in that block space as well. So I think it's just left for me to say, thank you very much indeed, Christoph, your time today. It's been a pleasure speaking to you, and look forward to carrying on our relationship.

Yes. And we love to see innovation. We'll have to see competition across in the product area. So thanks also from our side for the offering of these credit futures.

You're welcome.

Thank you, David. Thank you, Christoph. I'm going to have to excuse Christoph, who unfortunately had to log off immediately for an important meeting. But I do have David who has a few more minutes available, and I can see some questions. So David, if you can just join me on screen again. If you don't mind, I can see the Cboe background, but I can't really see you. There you are.

I'm coming back.

Yes. So actually, there, we've got some questions. Up to you which one you want to start with. Are you happy to just read them or I can do that for you, whatever is easier?

Yes, I can read them out. The first one is about API for trading on buy-side assistance. So I can follow up with whoever asked this one separately. These futures look and smell like equity futures, and by that, I mean, they trade on incumbent exchanges. So we've not set up a brand-new exchange for this. This isn't new architecture that needs to be connected to. They trade on the Cboe Futures Exchange in Chicago, the CFE. And that's the same exchange that the VIX futures trade on. Of course, they've been around for a fair while. So they use the same exchange mechanisms and the same clearing mechanism. So it's all incumbents. There's nothing new that needs to be set up other than connecting to the CFE, if not already done so. And then down here as well, the trash bucket question, I think, is perhaps one more for Christoph in terms of the UCITS concentration. But that is certainly something that we get fed back to us from clients, especially if they are allowed to use OTC products, having the ability to free up some of that budget to utilize elsewhere if they can use a listed product as an alternative. And then very quickly, there's another one that's coming about, margin. So they are margin by the OCC. This is the same clearinghouse as VIX futures. And the margin requirement is currently around about 4% for the high yields and a shade under 3% for the investment-grade. And they did get raised in March during the March volatility, but they were raised from roughly those kind of levels to about 5%, just a little bit over 5%, certainly nowhere north of that. So in terms of the margin models that are emerging now, we don't expect there to be significant policies in there. And then finally, there's one here about the open interest. Currently, it is sub-100 million, but it is growing thick and fast. So the high yield's actually reached about 100 million yesterday, but your Bloomberg channels will be 1 day delayed, and the investment-grade is growing. As I say, these aren't in their maturity yet, but we are growing the products. And the liquidity is there, and I'm more than happy to talk through those dynamics off-line to save time.

Great. Well, thank you, David. Yes. As you said, people can still use the app to set up meetings with you or chat with you privately. So I'm sure you'll be happy and around for the rest of the day to kind of take any questions from our audience. Thank you so much, David. And Christoph, as I said, unfortunately had to go and log off. Unfortunately, I can't force him to be on stage like I would do normally at a physical event. But thank you so much. David.