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

I'm Mike Carrier. I cover the brokers, asset managers and exchanges at BofA, and hope you're all doing well. Next up, we have Cboe Global Markets. And with us today, we have Ed Tilly, Interim President and CEO; and Brian Schell, Chief Financial Officer and Treasurer. Ed and Brian, thanks for being with us today.

It's great to be here, Mike. Thank you.

Thanks. [Operator Instructions]

So maybe just to kick it off. If we take a look at the proprietary products and kind of step back, if I look at the past decade, Cboe has done a really good job. And if you look at the growth over time, it's been pretty consistent. You had years where it was extremely healthy. But obviously, more recently, it's been a little bit more muted and under pressure. I'm just curious, like, what do you think has changed, whether it's the user base? Or has it been mostly the environment, I mean, that has created kind of the current impact? And what could turn that around?

I think you recognize, I think, the biggest change, the macro trading environment. If you look, historically unrecognizable. This is extremely prolonged uncertainty of the marketplace with 2 huge factors that really had no clarity as to when they were going to end. And we know what those are, the pandemic, and while there's really good signs that there's progress being made, there's still -- you can see, if you look at the VIX term structure, the longer-dated futures contracts still show that indifference surrounding the pandemic. And from the month, we saw greatly impacted with the election, not surprising that it happens in every cycle. But in this month, even more so. And we don't have total clarity there as far as what the market is telling us in the first couple of months. So that flat volatility surface is one of the greatest indifference from an institutional perspective. And we see that in the proprietary product, both the mix between SPX, VIX futures and options. And then just overall, engagement. Institutions have not participated, into a great extent, in this incredible move up in the market. Now that said, over the last couple of weeks, we've seen an engagement in VIX options and a reengagement in SPX options. So while the VIX futures still remain a bit -- trading the slowest or the least quick to return to trading, we've seen a lot of VIX options, a lot of SPX trade of late. So what we've told you all is playing out in the market, that institutions have been sidelined. We'll utility in the product set when they have in mind where the market will go over the next months, and then obviously, a longer cycle than that. So as I said, in the recent weeks, we've seen some return on the institutional trader.

All Right. Good color. And then maybe just on that -- in terms of that backdrop, you guys have been more active on the strategic front. So when I look at the M&A activity, whether it was EuroCCP, BIDS, MATCHNow and others. So what's been driving kind of the pickup in M&A activity for Cboe?

Well, let's look at the 2 categories. So -- and I think you've started to do that. If we look at what we've done in Information Solutions group, and that is the extension that you saw really mid-year with FT options Hanweck and Trade Alert. That is really rounding out that Information Solutions feud that was really started with LiveVol and then we added Silexx. And now really, for the more sophisticated trader offering pre-, at and post trade services, we don't let that integration play out, but we think we're in a really, really good spot offering a unique in combination or really picking along that those choice of offerings, all of our users can find much help in their pre-, post and at trade services by Information Solutions group. So really a good spot there. And if you look at M&A in the next category, that's either a global expansion or asset class expansion, that's where you'll see EuroCCP, BIDS and MATCHNow. And I don't think we're ever really going to be done looking at global expansion or asset class diversification. So a lot of the build in Europe, which was facilitated by buying EuroCCP, allows us to move into pan-European options using the technology on the base that we've built in Cboe's equity chain across Europe. And then in MATCHNow, part of our North American equities division, really our core business, very similar customer base and really comfortable with rules and regulations in Canada. And geography really, an easy move for us to operate out of North American equities. And then most recently, an announcement that we plan on closing our transaction with BIDS, a great partnership that we've enjoyed in large and scaled trading in Europe. And recognizing the great services that BIDS is offered in the U.S. that locked trading, not disintermediating by -- or the buy side and the sell side. We love the model and we think there's room for growth there. And immediately, what we called out that will continue to strengthen the U.S. -- bid presence in the U.S. and Europe with us already, and then we move into Canada. So everything really falling into place on M&A has been a very busy year, we recognize that. But in a pretty good spot right now.

Okay. Great. That's good color. And maybe just spending a little bit of time on EuroCCP and sort of 2 questions. First is, can you just provide some context on like what's missing in that market? I mean, like what's Cboe trying to provide? And how do you see that opportunity over time? And then separately, maybe for Brian, is just when you look at the revenue contribution in 3Q, it appeared to come in probably better than expectations. And so is that like a good run rate all else equal? Or was there anything unusual there?

So let me start, Brian, and then I think you can jump in. And we think that the European derivatives model has served benchmark European companies' final. This is not a share play for Cboe. So what we saw was an inefficiency and market model and an inefficiency in clearing. You need to clear pan-European risk in 3 different clearing houses today. We don't think that's optimal and EuroCCP will offer the same country-specific exposure and one clearing house, completely efficient, really easy to get to, easy access, we're about that. Market model. We think that the market has served the European investor, okay, but we know there's pent-up demand for continuous quoting in markets that are easily -- much more easily accessible, similar to the U.S. market model. So we're really just lifting up what we've learned in the U.S. and building out that capacity in -- more broadly across Europe so that the markets will represent and work very similar to a global user as what they're used to seeing in the U.S. market. It's that simple. It's a heavy lift, but the concept is pretty simple, and that's what we're on track to deliver mid-year next year. Brian, second part of the question?

Yes. So I would say, Mike, good question. Thanks. That the -- it did come in a little stronger but I would say that the transaction volume through there was probably what we've seen historically. I think the one thing that was nuanced that we probably could have done -- provide a little bit more clarity to the investors and looking at those results is there was a little bit of a catch-up from something called our settlement efficiency fund that, once you put in a project or where you improve the settlement process, you recognize some -- maybe some pent-up revenues that you were accruing, for example. So when we made the acquisition and we put in place a line of credit to enhance their overall liquidity and settlement profile of EuroCCP, that released, I would say, a couple of million more revenues that was a little chunkier in the third quarter. So bottom line, if you look from a run rate perspective, it was probably a little bit more by a couple of million dollars in that quarter, which would normally be more spread out over the entire year. So if you're kind of looking to normalize that, that was probably the, I'll call it, a little bit more unique to the third quarter. But otherwise, much in line with what we expected from volume across the other revenue categories.

Okay. Great. Maybe just shifting over to U.S. equity. So that's an area where volumes have been very strong. You guys have multiple initiatives in place to kind of improve your positioning despite still fairly active like competition in that market. So how has the retail priority initiative work versus expectations, particularly just given the strength that we're seeing in the retail part of the market?

Well, I think the retail party, in general, has been terrific. I mean, what Cboe is trying to do in U.S. equities is just not offer the same thing. And we're looking at what can we bring to the marketplace as this new, unique, while serving our customers a little differently or better. And customer priority is one of those things. We continue to grow customer -- priority continues to grow the share that we're trading on Ajax. There are now -- it's about 23-or-so percent of our average volume in Ajax. That's a big deal. So that means that there was demand, and the customers are finding utility in that priority. And we will continue to look for things that differentiate us from our competitors. And then I think more broadly, Brian, some comments on U.S. equity trading from you would be great.

Yes. So I would say that what we've seen is, as you look at the entire perspective and where we've looked at it, it's not just been the retail prior to where we've done. This has been a -- as everybody knows, it's a highly competitive environment, a highly competitive market. So retail priority is one element as to what we're doing. We've continued to look at pricing, continued to balance that market share. We've implemented midpoint discretionary works. So there's a lot of things that we're doing to compete within the exchange environment of continuous trading. We're also then looking to how do we motivate flow that was going off exchange back into the exchange landscape. So you're seeing a very holistic approach and innovation that we're just going to continue to not rest on what's there, but continue to listen to the customers that are trading, how can we improve their experience and implement something that we think they'll find greater utilization in versus, hey, it's a commercial contract. I'm just going to try and get more revenue. So we think that's the best way to build kind of that long-term value for our shareholders by listening to customers and introducing vehicles that really enable them to have a better trading experience.

Okay, great. Brian, you mentioned just looking at like pricing and market share. And I think you guys have done a good job over time in balancing the 2 to make sure you're maximizing sort of the revenue opportunity. But given some of the competition, it mimics coming into the market. Pricing seems like it's moved the pie a little bit more than people have expected. But has anything shifted on how strategically you guys look at those 2 and how to try to maximize like the revenue opportunity in that market?

That's a good follow up. Thank you. So we look at it. It's a long-term -- we look at it from a very long term, right? I mean the idea is we're charged with deliver long-term shareholder value. And one of those things that we think is important, part of that is the long-term value of what the North American Equities business is. And here, we're obviously just focusing on U.S. equities. And balancing that revenue growth and its total revenue growth over the long term, even if there might be a couple of, call it, shorter-term bumps. And as we continue to titrate the pricing to try and get that Goldilocks point of balancing, a really strong market share against an appropriate capture, to really how do we help make the net revenue growth over the long-term more effective because we want a very strong share to help continue to, obviously, generate the SIP revenues. It's important to continue to have a lot of value around our proprietary market data, continue to have a lot of value of people wanting access and capacity to our markets. So that movement is a little bit of art sometimes. We want to make sure when we put incentives in place it's -- it's incentive behavior that we want. And again, it's not just because you have new entrants coming into the market. We have new exchanges that came online. Like I said, I mentioned earlier, it is we want to attract from the existing exchanges, not just the new and competing against them. But it's also trying to, again, pull in some of that flow. It's like, how do we attract that flow that's going off-exchange on-exchange and make that attractive. So like I said, we're trying to provide a real holistic offering, continue to leverage our data analytics framework, providing customers with a sense of here's the value on trading with either this type of order or on this exchange and what they can expect from the TCA analysis and how their orders are really trading and their overall cost.

Yes. It makes sense. And then maybe one more on the U.S. Equities business. You guys have had a partnership with bids. Now you're moving in with the acquisition. What do you see going on in that part of the market that makes you think that like having that within Cboe makes more sense kind of going forward?

It's not just in the U.S. market. So while bids began in the U.S. in very successful block trading platform, we like the model without disintermediating buy side and sell side, as I pointed out a bit earlier. But we had great success in Europe and our partnership with BIDS, like, in large and scale and bringing the block fitting mechanics to the European market for us. And then as I said, the opportunity to do so in Canada just continues to make sense. So BIDS in and of itself is an expandable platform. Block trading is a universal need, we think, from our customers who had exposure in different geographies. And we think there's an opportunity to expand. In the U.S. market, obviously, just off-exchange trading in general continues to grow. So our first foray into being able to compete off-exchange in this regard and block trading makes real sense for us, recognize the potential of BIDS outside of U.S. as well. So a perfect combination for us. The business that Tim Mahoney built with his team, we love it. We've gotten along incredibly well in Europe. The teams work closely together. We love the partnership and like the direction the teams move the company.

Okay. If we shift over to the options part of the business, like the multi-listed, that's also another area where volumes have been pretty active this year. There is a level of competition. But how are you guys continuing to try to differentiate in that space as there is still a pretty good level of competition, but you guys have kind of held your own?

Yes. It's not dissimilar to equities, super competitive. What can we bring to the market that either is being underserved by our customers or what can we do slightly differently and we continue to stay at the forefront of that. Many times, with Cboe, that's in contract construction and bringing new analysts in new exposures to the marketplace in different ways or more efficient ways. So we'll continue to press that. We've relaunched our XSP which is a mini version of the S&P 500 with a make-or-take pricing scheme just recently. So that is recognizing a need, we believe, that has not been filled for retail and exposure to the S&P 500 in a much more capital-efficient way than currently, spiders' offer. There are simple things that I think we need to continue to do. More broadly, the opportunity for retail is recognizing that the new retail investor has not been satisfied with either the products we offer or our competitors and/or the platform and the manner in which they're accessing our markets and we need to change. We need to catch up. So we see great opportunity to bring along, being in front of the move, a new retail into equity chain to teach derivatives and more complex strategies how to lower exposure, lower risk in a the portfolio while still being able to have either the same economic exposure, but in a much more efficient way. So incredible opportunity to offer education and new products to what we've seen is a very exciting engagement in new retail users.

Okay. And then just shifting over to the proprietary products. You guys have been active in launching additional index products over the past several quarters. Where are you seeing some of the more interesting demand when you have some of these product launches that you're kind of excited about?

Yes. I think it's important to note that as successful new products are years in the making. So if we look at iBoxx, completely new. A great uptick; month in, month out, we're seeing engagement and growth; normal rotation in the market, and we've seen a number of changes in investors' outlook just in this year and having a complete suite that gives you global U.S. dollar predominated exposure, having that complete set of products, very important for us and bringing our customers along. And that awareness and that education is very, very important. Of course, you referenced relaunches, I talked a little bit about XSP, great -- we see great potential there. But just mini contracted, mini exposure on the short-dated side. We know that's capturing the imagination of the new investor and actually, you'll see us focus, meaning this was a great launch. Over just the last couple of months, it's been just an incredible uptake in first, more sophisticated traders who are not trading the big VIX futures contract. And now a small and steady adoption of retail, who's finding the notional value of the new contract much more digestible and hitting a more traditional active retail account. So much work to do, but there'll be more on that front for sure.

Great. Great. Great. And then just shifting to European equities. You mentioned, when we talked about BIDS, that there's some opportunity there. And in European equities, you guys have generally done well, even through Brexit. But just when you look at your market share today and you look at sort of the growth opportunity going forward, is there more from like a market share opportunity? Or is it more growing with the market, just given that you've been as successful as you have?