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

Good morning. We are live. I'm Patrick O'Shaughnessy. Welcome to the Raymond James Institutional Investors Conference. Up next, we have Cboe Global Markets. Presenting on their behalf, we have Chairman, President and CEO, Ed Tilly. We have Brian Schell, CFO and Treasurer; and Chris Isaacson, Chief Operating Officer. Chris is having some audio difficulties, I think. So hopefully, we can work those out. Format for this is just going to be a fireside chat. There is functionality for you guys to submit questions online. And where appropriate, I will try to work them into the conversation. So please do feel free to take advantage of that functionality. And with that, I will get going. So good morning, guys.

Patrick. How are you? Good morning. Good to be here.

I'm doing well.

Good morning.

We'd be doing better if we were in Orlando, but we're going to make this work, and then we'll plan on Orlando next year.

I will look forward to that for sure.

So I'll start with the topic that I know you guys addressed at a competitor's conference last week, but I'm guessing not everybody listening to this event heard the company's response. So I'll risk a bit of redundancy. Cboe recently filed an 8-K disclosing the change in the executive compensation in the case of involuntary termination due to a change of control. So suspicious minds are going to look at that and think, hey, Cboe is contemplating a sale. How do you respond to those suspicious minds?

Well, look, as you know, we certainly wouldn't comment on any speculation, but just to affirm that, that's a requirement that we need every time or if we change some of those procedures that we did. I think what really we should focus on is the guidance we've given to you for our growth and the expense spent in anticipation of that growth. And then some of the guidance we've called out for the first time on revenue and opportunities. So we are prepared as we always are for the operation of the business and the growth of the business, and that's what the management team has been concentrating.

All right. Fair enough. And I will get to that growth outlook. But before I do, so assuming that Cboe is inclined to remain a buyer rather than a seller for the foreseeable future. Do you expect that there's -- there are many more large-scale-driven acquisitions in the company's future? Or should we expect more along the lines of the smaller tuck-in deals that you completed in 2020?

Yes. We're always on the lookout for opportunity. We've capped a balance sheet that's flexible, that allows us to look at larger scale M&A if that fits the profile for us, but nothing that we need to do. But just like to be in the position as we have for years to be ready if there is an opportunity that we think fits our path, our trajectory and in the best interest for our shareholders. As for the tuck-ins, if we look at them through the various categories, our Information Solutions group, I think it's in a really good spot. So that's the FG Handwerk and Trade Alert acquisitions of last year. We're in the integration process. So I think that's really on track for the pre- and post-trade services that we were looking to pull together in that group. And then as far as the expansion that we've looked at in either asset class or geography, our big investment that we're looking to launch in kind of midyear on time is European derivatives. So not -- no need for expansion in European derivatives and beyond what we've done with EuroCCP and our internal build-out. In Canada, as you know, with MATCHNow and most recently in BIDS. So we do like your work. We like those tuck-ins. We're always on the lookout for something that furthers geography or asset class. So while nothing to announce today, we're certainly mindful of the opportunity and really like the buy versus build examination that we do on a regular basis.

All right. Makes sense. So getting to your growth outlook that you guys provided during your fourth quarter earnings call, so long-term revenue growth outlook, 4% to 6%. How do you see that breaking down between transactional and nontransactional growth?

Brian, why don't you take this one?

Yes, I'll take this. And Patrick, I would suggest some people look at this. And as we think people I'm sure are obviously trying to model it is that with the pipeline and the really good visibility we have to the nontransaction revenue growth, we gave that -- call it, that organic forecast of the 6% to 8%. And when you say, well -- and that's a longer-term perspective over time as well, as we look at that 4% to 6% -- excuse me, that 4% to 6% over that longer term. And you kind of back into -- we have some pretty good visibility, really good visibility of that nontransaction piece. And generally, if we assume that the take plans, both the equity and the opera are going to be relatively flat, there's probably even some downward pressure. But when you have the new entrants coming in, you have some consolidation. They're probably pretty muted for growth, if any. And so that really more mathematically, you get to kind of the lower end of that range for the transaction side of it. Again, over a period of time, which, again, we feel very confident around, you saw the initiatives that we're launching. And so over that medium-term, we feel pretty good about the lower end of that 4% to 6% range is where the transaction growth we'll be able to kind of support those numbers.

Got it. That's helpful. And kind of talking about transaction revenue a little bit more. I think I ask some version of this question every year, Ed. But a large part of the growth basis for your proprietary contracts is expanding your user base who trades them. Can you walk us through the primary use cases for these contracts? And why you think there's still upside to grow each of these user bases?

Yes. So on the proprietary products, I think, Patrick, we've spent years and years talking about the institutional use cases in various macro market environments and well last year was a perfect example of 2 completely different environments. And ultimately, how we view the engagement from an institutional perspective. So these are the ultimate hedging vehicles for the U.S. market. And I believe also potentially the ultimate vehicles for enhancing returns in a relatively volatile environment. So just about any macro environment, these contracts -- when we say these contrast, SPX futures and options outperform one another or given your expectation of risk in the foreseeable future should be the go-to hedging vehicle for any portfolio. So use case, again, quick reminder, implied volatility relatively low. That is really an opportunity that we've seen year-over-year in premium cash. So shorter-dated options, a continual cycle of just selling that at or something out of the money option, whether it's cultural puts, that has been an incredible enhancement to a portfolio for years and years. Heightened volatility, when we see realized volatility coming in as we did at the beginning of last year. And even in a couple of months over the past 6, the outperformance of having a long position, the S&P 500 options, that daily move in the S&P 500 really allows the holder of those options to monetize positions by just a simple gamma trick. So depending on your perception these contracts really come into play and should be part of a rotation, and that's what we've seen. Our customers really perform the best when they're rotating these contracts based on the perception of risk for the macro market. Also I'd point out, super important in a market like we see today, we have been on a bull run. Hedging a portfolio of the S&P 500 with VIX options is not a strike-specific hedge. You've heard us use that term before. If we see the S&P 500 moving up 50 points here, 20 points here, another 50 points, the constant exposure to a 10% out of the money put, for example, requires a lot of rolling that strike specific hedging. In VIX options, we really don't have that. A 10% move, a 20% move involved is really in and around those 10%, 20% out of the money calls, which tend not to move much. So it follows roughly [ 24, 25 ]. Those dollar rules at [ 24, 25 ] act much the same way as they could follows at [ 18, 17 ]. So we really -- it's a hyper efficient way to gain hedging exposure when we're on a bull run.

Got it. No, that's helpful. They're somewhat unique complicated contracts. And I think to frame it that way, I think, is a useful exercise. So I appreciate that. How are you thinking about pricing trends throughout your transaction businesses, both in your proprietary and your nonproprietary products?

Let me turn it over to my colleagues.

Yes, Patrick, this is Chris Isaacson. Sorry, I had a little technical glitch to start there. But I think pricing is very steady in most of our businesses and either steady to trending upward. Obviously, in our competitive -- more competitive businesses, there is some capture pressure depending on the competitive dynamics. But the pricing in -- especially our products, of course, has been steady. Nontransactional revenues of pricing there is very, very steady. And in fact, all of our businesses, the one business where, I think, has been noticed as this is from pressure has been U.S. equities. However, we were due for a repricing of U.S. equities last fall. We made that decision. And looking at market share capture to optimize net revenue, we did that. And we also changed pricing to end the year. And we feel very, very comfortable with where our pricing is at and our competitive positioning, especially in those competitive markets for the future. And we've benefited also quite handsomely in those markets, especially U.S. equities, multi-list options, where the volume because of the retail investing boom has really been -- the market volume has been very, very high. So we've captured our fair share of that. So the pricing dynamics are different by every market we're in. Clearly, there's more pricing latitude for our products than in our nonproducts, but we're optimizing net revenue, and we'll continue to do so. Brian, anything to add there?

Yes. No, Chris, I would just say that in the growth that we have experienced in the past has primarily been through volume -- through subscribers or units. Sorry, there was no video there for a second. So that the growth has been primarily through units and not pricing and as well as, Patrick, when you talked about we kicked off the chat with kind of our longer-range growth, the majority of that growth we also see has primarily been driven by units and/or new subscriber growth versus just a pure pricing play?

Patrick, I usually help these guys with technology, and I'm just not next to them. So they're very frustrated this morning with not having my know-how. It's been...

We'll muddle our way through it. So touching on something that you mentioned earlier. Cboe's big internal investment right now is building out that European derivatives franchise. As I'm kind of thinking about it, the challenge here is twofold. First, you have to get industry buy in to think of brand-new indices as buyable alternatives to the current benchmarks. And then you have to build up liquidity in those brand-new indices. So how are you -- how confident are you in the success of that initiative given that what seems to be a challenge?

Yes, we're very confident on the liquidity front fees. We have gone to attack the global liquidity providers who recognize what we're trying to build in Europe. And quite simply, it's taking the U.S. model for publishing quotes from the opening bell to the closing bell and sending liquidity providers to be there. The global market navigators who are in our markets each and every day and something that is able to show up in our new indices in Europe right from day 1. So we're very confident in the progress we've made with them -- with that group. And that nearly allows us then to point at a screen and say, look, we're not trying to replace a benchmark. If you're an European investor and you're in your home country, your benchmark is the country's -- a national treasure benchmark, that's terrific. That's not the market that we're looking to take share. Rather, there's a world out there looking for country-specific exposure in Europe. We're not benchmarked in those European indices and would love the access to point and click transparent markets that they're used to in the U.S. to have the same experience in Europe. So think of a U.S. investor, an Asian investor, who just wants country-specific exposure and/or pan-European exposure frustrated by the current dial-up method of finding liquidity. We're just bringing that transparent marketplace to Europe. So it's not a share gain. The existing benchmarks, I'm sure, are serving a purpose for those investors that we serve today, but there's a big world out there that is not benchmarked to the national treasure. And then really importantly, Patrick, and it's part of the story that we should probably spend more time on. It's EuroCCP being able to clear pan-European risk and country-specific risks in one CCP is different than the market today. So if you had to pick your favorite countries in exposure, Patrick, you'll need 3 CCPs to clear that exposure today, whereas the Cboe version will be just EuroCCP hyperefficient and you'll be able to clear all that risk on CCP.

Very interesting. And at the same time, the absolute dollars that you're investing in the European derivatives build-out, it's really not that big. Obviously, it did create a -- there was some perception with your fourth quarter earnings call, your expense guide was maybe a little bit bigger than what people are expecting. But in absolute dollars, it's not a huge investment. So how are you thinking about the ultimate ROI of that initiative?

Right. So I would say that with most organic initiatives, and we look at this as kind of part of best practices how did we deploy capital over the prior year. And then sometimes you need a 2-, 3-, 4-, 5-year look as far as what does this look like. And when does this start yielding the higher ROI that we're all challenged with that as a team for the betterment of our shareholders. And with most organic initiatives, we would expect to see high double-digit, and in many cases, triple-digit over the long run as far as what that ROI is. Because like you said, that base, when you really aggregate it over time and you look at what that investment is, it's relatively small. So if your revenues are generating anything like your other businesses and what you've started that contribution to your bottom line is significant. So we don't view this any differently than starting up any of our other kind of core assets as far as kind of that mid-double-digit ROI in the medium, and then hopefully, triple-digit in the longer-term.

Patrick, to speak to the return profile, we're just -- we're extremely excited about this. The likelihood of success, obviously, is, we think, high based on customer demand across the ecosystem. Ed mentioned market makers, order flow providers, vendors. We obviously own the clearing house. And it's about growing that pie. European equity derivatives is 1/7 the size of the U.S., roughly the same GDP. And so speaking to the return of profile, given the relatively limited amount of investment, if we grow that pie, even, say, another $0.01 or $0.02, it's extremely high-return for us.

Got it. That makes sense. Switching gears a little bit, maybe more of a current events type question. You guys obviously have a lot of exposure to the retail investor through your equity options through your U.S. equities, even some of your proprietary contracts these days. How do you work to achieve the right balance between wanting retail investor engagement in the markets, but also discouraging irresponsible and risky trade behavior? It seems like right now, maybe the market is airing on the side of, hey, let's let everything go, we'll deal with the consequences later. But I think for you guys building out your franchise, you want to make sure that you have sustainable growth with these retail ambassadors.

Well, it's a terrific question, and there has been great debate. But one word really rings from the launch of Cboe at [ 73 ] and that's education. We recognized that the investor that's here day in, day out, year in, year out is the educated one. So we've actually made adjustments to our options institute, which historically has been focused at institutional traders, bringing the institutions along from basic overwrite strategies through using your words, our more complex products on the volatility suite, pivoting and now including education for retail investors. We need to tell the story. We need to bring to the new retail investor the power of changing the risk profile of just being trading Delta One being either long or short, it just doesn't have to be that binary outcome and teaching the advantages of limiting risk and hedging. It's really what we're all about and always have been about. Enhancing return, taking a long position in overriding calls, taking a long position and protecting those with puts, entering a position in stock by just selling puts. There's so many basics here to teach. That's really what we're all about on retail. We're also big fans of suitability. You've heard us use that term for years and years. And primarily, it's been around leverage products. Are they for everyone? We don't think so. Are they suitable for investors who do their homework and understand what they're trading? Absolutely. They're incredibly powerful tools. So think education and suitability, and I think we can bring along this retail investor base for years and years.

Got it. That makes sense. How has options clearing infrastructure held up with the massive increase in option volumes? Obviously, equities infrastructure has been the headlines, options has not. So do I infer from that, that everything has actually been pretty smooth sailing on the options infrastructure side of things.

Yes. Before we get to clearing, I'll ask Chris to weigh in. Really, I think it's of note, when you look at things have been -- asking the questions about the infrastructure and how resilient the infrastructure is, I think it's super important that the outages we've heard about over the last months, those are not exchanges. Exchanges have been incredibly resilient and uptime through the incredible levels of volatility all through last year. And then even in the runoffs and the compressed volatility in some classes over the last months. So I really want to make that distinction that the marketplace, the exchanges, our competitors and Cboe's many exchanges have proved to be able to handle the influx on single lane and then broad market volatility. It's super important. That's our commitment to the investing public. It's our commitment and our partnership with the SEC to have that backup and that delinquency day in, day out. Now specifically to your question, I'll turn it over to Chris on clearing more broadly.

Yes, given the events in January, the clearing infrastructures, I guess, has become more in the news because of settlement cycles and whatnot. But in short, Patrick, the plumbing has worked. The clearing infrastructure, both in equities and options has worked extremely well. Now we do have T plus 2 settlement in equities, and there's good and healthy discussion about shortening that settlement cycle. The DTCC came out with a paper last week supporting T plus 1, which we would support as well, and over time, shortening settlement cycles as much as possible without doing away with the efficiencies you get from netting. So in terms of fee, the infrastructure worked extremely well from exchanges down to the clearing infrastructure. The outages that did happen were really some of nonexchanges. It was further out closer to the customer. But given the volumes we saw overall worked really well. It doesn't mean there's not room for improvement on some of the structure, or as Ed said, education, suitability, some -- maybe market access controls, things like that. But overall [indiscernible].

Got you. Another current events type of question has been industry conversation around payment for order flow. I think most of that conversation has been so far about U.S. equities. And there's the view that payment for order flow keeps a lot of the retail liquidity off the exchanges. Do you think it's healthy for markets to have -- for the U.S. equity markets, in particular, to have so much order flow traded off-exchange?

I think it's important for us not to confuse the debate, payment for order flow in and of itself is not a bad thing. Customers enjoying free transactions, for example, I think it's a good thing. I think the debate, what's traded on and off and price formation is a great one. I mean, Chris, we internally have been echoing Ken Griffin's words on exchanges are a competitive disadvantage in this rule. And rather our encouragement and hopefulness with the new Chairman of the SEC is to begin that date on how to make exchanges more competitive with off-exchange rate. And then at equal footing really let the best platform, secured platform and the customer experience really carried the day. But Chris, I don't want to get too aired on, but I think this is much better debate. A couple of thoughts that you have on PFOF, and then maybe a word or 2 on a couple of easy moves at the SEC to make the entire environment more competitive.

Yes. I mean, regarding PFOF, it's all about transparency. And actually, with the new transparency regime of Rule 606, we have a lot of transparency now at the PFOF. And so there's good questions being asked about, as Ed said, there's nothing deleterious about PFOF. It's just we need transparency around it, where there is an unequal playing field and Ken Griffin in testimony said this, was that the off-exchange you can trade and you trade at sub-penny prices, and on exchange, you really cannot. You can't quote and trade at those prices and rank at those prices. And that in equity has caused more volume to go off-exchange. And that's he called tick-sized reform, something in our market structure principles for years, even Bats and now Cboe that we have actively been advocating for is a leveling of the playing field around tick sizes is an elegant way in which to level the playing field. So there's other things to be talked about there, but I think that's one of the biggest things that could help level the playing field.

And then a reminder, Patrick, I think you brought up options in the same data. I think it's important to note the SEC has recognized the importance and the difference between a quote-driven market and an order-driven market. In the options markets, as you know, we rely on quotes from the opening bell to the closing bell and incentive market makers should be there over hundreds of thousands of strikes. It's a lot different than being there in 1,000 or so names. And the SEC requiring those trades that may have found liquidity off-exchange, but forcing that liquidity, that paired order onto an exchange for further price discovery and exposure very, very important to the derivatives market. And we are hopeful that the SEC continues to see the value-add in having the entire options classes lid off from open to close. And that's a big, big difference in structure and one that we are very much in support of getting.

Got it. No, that's all really helpful. So kind of spoke about exchanges versus off-exchange and equities. But in terms of on exchange competition, you mentioned earlier, you made some pricing tweaks, and there have been some new exchanges that rolled out. You recently acquired BIDS. What's your kind of current evaluation of the competitive landscape for on-exchange trading in U.S. equities?

Go ahead, Chris.

Yes, I think -- Patrick, I think the biggest story is the growth of the retail investor and that retail investor, primarily trading off-exchange with the market of a retail flow. The nonmarket retail flow, we are taking advantage of. We're getting a lot of benefit from because they are coming to the EDGX exchange, and they're getting better execution quality. But this -- we're seeing month-over-month highs in off-exchange trading. And so that's really the competitive landscape. There have been other exchanges that have launched. That really hasn't driven our pricing decisions. We're looking at what is the overall accessible pie for us, and that -- more and more of that has come -- gone off-exchange. And therefore, these changes around tick sizes, some experimentation about how to potentially bring some of that retail flow back to exchanges to -- for our exchange to improve execution quality. We're definitely open to that. Regarding BIDS, BIDS is not a retail play, BIDS is a block trading network. But it does compete in that almost 50% of the market, now that is off-exchange, an incredible asset that we're very excited about owning now. You know about our partnership in Europe since 2016, the Cboe LIS success there. We're excited about bringing BIDS to Canada. We announced that just a couple of weeks ago as part of our integration of MATCHNow. But this does give us a foothold into that off-exchange portion from the market in the U.S. equities market that we have really not had a footing and all.

Got it. So Brian, earlier, you're kind of talking about kind of your outlook for market data revenue, consolidated tape revenue. How does the SEC's tape proposals that they made last year? How did -- if at all, how does that impact your expectations for nonproprietary market data revenue?

I think we'll -- Chris, I'll tag team this one. I'll tell you could hold another hour as we could debate all the different nuances of, call it, the multiple proposals because in many ways they are linked. And if you look at holistically, it could go any number of ways, and I could make compelling arguments that does that pool remain? Does it get broken up into different mini pools? But in the aggregate, it's the same base with different fee structures? Does that more than aggregate to different proprietary market data pools because the information flow is different, the depth is different, and therefore, the prices are different. So if you think about the old -- the metaphor of the water balloon and where does that go, and it's going to find a place where the value is being driven, whether that's a consolidated plant or that's individual exchange or off-exchange data feeds, we think the value is still there. Investors still have an increasing need and demand for data and for that analytics to be able to facilitate the trading environment. So it would be hard for us to speculate one way or the other direction given the very early stages of the debate and what it looks like. And where I would say many participants are still scratching their heads thinking what exactly does that mean with some of those proposals, and how would that work. Chris, I know we've talked a lot about this internally as well.

Yes. I'd just say, long term, we think there's a place for both the consolidated feeds and the proprietary feeds. And that there's -- we are all -- we have been consistently for improving the content of the consolidated feeds and the delivery. It's been part of our market structure principles, but there's going to be value in the consolidated feeds. And even as we -- we talked about retail fair amount during this chat. There's millions of more people that may only have delayed data today that are as they become more educated and more empowered in their trading they're going to want real-time data. And they're going to want that either a consolidated feed or maybe some enhanced data through proprietary feeds. So we were overall neutral to positive on this. We think that the -- yes, that we should improve the content and delivery, and our -- the issues we've had with both the governments and infrastructure proposals. You can read our comment letters and challenges on those.

Got you. And then in any case, I think it's going to take years to play out, it would seem. Ed, earlier, you mentioned the Information Solutions business. How do we think about the strategy underlying that? It's a recurring revenue play, I think, but it also is an effort to, I think, generate incremental trade in volume. So kind of like the double whammy play?

Again, it's just a great way, I like that. I might use that again, Patrick, for all day actually while we're listening. I love that double whammy. That's exactly right. So there's a revenue stream that is recurring from the suite of products and information solutions, but most importantly to us really is the opportunity for our customers to maintain their positions, their trading, their intention in any market environment. And we have missed the at trade portion of that and really were able to pick that up with FG Handwerk and Trade Alert that at any moment of the trading cycle pre- and/or post-trade, our customers are armed with information that they stay in the market, maintain the position in the direction that they intend, super important for us, do not stop. We will give you the information that you need to continue. And from a former trader's perspective, that was really, really important to have that information in any market environment that I stay in the market and maintain my strategies, pivot my strategies, but information is key in the Information Solutions, that is their goal. But yes, Brian smiles when he recognizes the double whammy approach for sure.

Got it. And maybe last one for me, I think, as we're coming towards the end of our time. Cryptocurrency is certainly on a lot of people's minds these days, and there's S1 floating out there. How do you see those opportunity in crypto?

Well, you'll notice today, we -- it should be noticed in the register that we filed with [indiscernible] another structured product that allows exposure. We tried this before, a few years back, SEC did not approve. We're back at it. We're committed. So wonderful partner here with [indiscernible]. We're looking forward to the SEC taking a fresh look at crypto for the masses, and we think that structured products are the way in. So part of that ecosystem that we were missing when we launched it first was the futures contract a few years back was the engagement with retail. So we're committed to get there. We understand the SEC's perspective. We will be extremely patient with them. All the information that were comfortable about this is the latest rule of filing. We stand ready to work with them, so we can bring more contracts that meet the needs of investors in the marketplace. And then we think the timing is right.

All right. Well, terrific. I think we can wrap it up on that note. But thank you guys for joining me this morning, and have a great rest of your day in meetings.

Good to be with you. Thank you so much.

Thanks, Patrick.

Take care.

Thanks, Patrick.