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

All right. It looks like we're back on. Hello again, everyone, and welcome back to the UBS Financial Services Conference. For everyone, I'm Alex Kramm, senior research analyst at UBS, covering the U.S. exchanges, the rating agencies, information services and commercial real estate brokers. I know that's a mouthful. But next up here, we're going to the exchange part of my coverage, and delighted to have Cboe with us today, and in particular, Brian Schell and Chris Isaacson, who hopefully will spend the next 45 minutes with me to give us an update about what's happening at Cboe and why we should be excited about the direction of the company is taking. Just a quick housekeeping update here. There is a question-and-answer ability on this webcast. So if you do have any questions, please use that functionality and I'll try to work in any questions into the conversation, and we'll go from there.

So again, Brian, Chris, thank you very much for coming again. And why don't we just get going here. There is no formal presentation. So I like to usually, at these events, start off very big picture. Forget the environment as we see it currently. Forget COVID over the last few years -- or less, sorry, last year and change. When we look out over the medium or longer term, what gets you excited about Cboe's position in the industry? And why do you think there's still some structural growth ahead?

Yes. Thanks, Alex. First, thanks for having us, and good afternoon, everyone, or good day, everyone. I think we're most excited medium to long term just about the leading global securities and derivatives trading network that we're building. And we've hit on this in the last few earnings calls for sure. And we feel like this plan is coming together the most recent part of that plan was the acquisition of Chi-X Asia that we completed July 1. But we -- this leading securities and derivatives trading network we're building, we're seeing increased trading in index and options and futures. We think that will continue. Our non-transaction revenue growth is -- continues to grow at outsized rates and we look forward to more of that. We are launching our Cboe European Derivatives market that will launch September 6, something that we've been planning for the last 18 months, kind of really started when we purchased EuroCCP about a year ago as the clearing entity that we'll use to clear those derivatives. We're excited about our BIDS trading expansion. We purchased BIDS, closed that transaction at the beginning of the year and are now taking BIDS to Canada and then Australia, we've already did in the U.S. and Europe and very successful there. And then we're expanding access for all of Cboe's markets, products and services through initiatives like 24/5 trading for SPX and Options futures that will come this fall, full-fledged in November. In addition, we're doing migrations of recent acquisitions, both in Canada and in APAC, like I mentioned at the start. So a lot on our plate. It all feeds into building this leading securities and derivatives trading network. So that's what we're most excited about in the long term.

Great. And I'm sure we'll unpack a lot of these in more detail. But again, I guess, zooming out just for a moment, I mean, I know you're doing a lot of different new initiatives and new markets. But at the end of the day, for a lot of people, it still comes down to your core legacy proprietary products. And for us, and I've asked probably on -- in this forum, but also on some of your earnings calls in the past, it is always very difficult for us to see how and if the underlying business or user base is still growing. So I know your peers have more insights and they like to talk about this. But what can you talk about to confirm to us that you still see that growth -- structural growth, I guess, happening in your SPX complex and your VIX complex and those user bases attached to it?

Yes, it's a great question. We have some visibility into our users, but not controlling the clearing in the U.S. We have some limited visibility, but I will speak to a couple of things we have noted this year for sure. So 2020, our products, there were some muted volumes given the unique impact of COVID and whatnot. But we said all along that institutional traders, institutional investors would come back. And in fact, that's what we're seeing, with very steady and growing SPX volumes. We've also seen a 50% growth in SPX volumes from retail firms since January of this year. We think that's 2 things. One is just greater adoption of our products by retail traders. Others could be some that are transitioning from other potentially retail brokerages onto retail brokerages that have better access to our products. We've been pretty clear all along the way that we still have some room to work with retail -- the new retail brokerage firms so that they get access to our products, and we're excited to see what's happened in the first half this year. I'd also say we -- not necessarily customer segment, but greater access with 24/5. We've seen year-over-year growth of 100% between 2019 and 2020 and continued growth in '21 about the amount of index options trading that's occurring outside of U.S. hours. So global trading hours, and that continues. That's why we're doing 24/5, and that will allow us to access users outside the U.S. time zones or even some that they may want to trade in this time zone. So those are just a few things we're focused on. Institutions are back. Say that we've seen some blocks that have occurred with VIX options, not as many with SPX options. We -- in general, things have tilted more towards short-dated and smaller contract size, but the overall volumes have been very steady and growing. I'd also mentioned another thing, so what the composition of our index options trading has changed a bit since pre-COVID in that it's -- we think -- frankly, we think it's quite healthy, the base of users and contract sizes, we view as a steady and growing base.

All right. No, that's helpful. If the -- I don't know if I'm asking the same question again, but my last question was obviously a little bit more on the structural side. But in terms of -- and some of those things that you asked -- answered where we're focused a little bit on the near term. But it is a little bit difficult to assess why volumes are doing what they're doing on the proprietary side or on every side. But like things are looking pretty healthy, like you pointed out, both on the index options side and the futures side. So anything else that you would point to on the maybe from a macro perspective that we should be thinking about, what's been helpful? And then anything that we should be watching out for? Something that, I guess, would worry you that changes maybe what looks like a favorable trading environment. So maybe the question geared more at the macro versus what's happening on the user side, anything you would add there?

Yes. On the macro side, I mean we've entered a somewhat more normal trading environment. Although more recently, the markets been a bit skittish with Delta variant concerns, concerns about inflation. So you see, say, the VIX term structure at the outer months are steeper than it has been in months past. So it is a good trading environment. Really, 2020 was quite an aberration from a -- just look at strictly how there are so many unknowns, that people were having a hard time modeling. And now we're -- even with variance coming of COVID and they're still uncertainty there, but there's more known and people are trading as they normally have. And so in many ways, we feel like 2021 is just a return to the growth path for our top products that they've been on with layered on top some very nice retail growth.

Yes. Since you just mentioned the retail, I know you mentioned a couple of times now, but I know retail is a big focus. But yes, can you talk about any sort of other verticals that you're looking to expand into a little bit more? Any other customer types that you see more or less with? Again, some of this came already out earlier, but in particular, as it relates to your proprietary products, maybe anything that you haven't touched on, on the customer side and what particular initiatives can help?

Yes, I'll mention a couple of customer types we're focused on. One is asset managers, growing our penetration of asset managers, and that's really a sales effort to educate them on how they can use -- better use our products. And the second is the insurance space, we have dedicated sales folks that are -- which is really a combination of sales effort plus the right product. So we have a flex product that allows insurance providers to be very precise in hedging their risk and underwriting their risk. And we have an extremely high share of flex options that are traded every day. And now we're focused on further penetrating that insurance space. That's just 2 examples of the different customer segments that we're focused on. I mean the utility of our [ seamless ] products, our product is very durable, it's stood the test of time. Really, frankly, returned to the mean as far as the use of our products and are quite excited about the future.

Yes. Thanks for that. And I know we want to talk about some other things, not just volumes, but obviously, volumes still account for 60% or so of your revenue base. So just a couple more here. I guess, first off, equity options, the business, we haven't -- I guess we haven't been as focused on over the last [ 2 ] years. But when you actually look at it, it's probably making the most money it has in the last 10 years. So can you talk about the strength you've seen in that business? But then also, give us an update on the competitive environment. And if you go back 10 years ago, the unit economics were like 3x of what they are today. And I think since then, volumes have actually increased 2.5x last I checked. So it's going in the right direction, again, from a volume perspective. But clearly, there's always the risk that things get a little bit more competitive. So give us an update, what's happening on the equity option side, which is kind of like your legacy, and how you can sustain that business in this environment?

Brian, you want to take it?

Yes, I'll jump in on that. Thanks, Alex. The -- I would say from a -- there are more exchanges, but I don't think it's become more exchange medallions, but I think has become any more or less competitive. I think it's always been competitive. I think you've seen a little bit more pressure on capture, but I think it's been settling in at this level for the last several years. But you're right, we have seen a significantly higher level of volume, say, 30 million to 35 million contracts, and that's been that way for a while, as you mentioned, maybe the last 18 months. I think we like our competitive positioning here. I think where we're sitting with respect to market share, where we're looking at net capture. Again, we look at the aggregate kind of net transaction revenue as we look at kind of as we compete for share. And is that right overall, and we continue to innovate and provide the right services there at the multi-list. But essentially, I think the bulk of that with that single name volume -- and the other side effect of this is what we're seeing is that we're seeing a really strong interest, being derived by this, is the real-time market data as well as the access to these exchanges. So they're continuing to grow. I mean you're seeing the volume on the transaction side, you're seeing the non-transaction side of that also benefit from not just those elevated volumes, which appear to be sustainable for quite some time with probably a bit of a retail influence, no doubt. But again, you're seeing the market data and the access both on a real-time market data as well as on an enhanced basis.

And just to poke a little bit more, you say it looks like it's sustainable. I mean I guess, why are you saying -- why do you view it as sustainable? And why do you think does this surprising volume explosion that clearly has, by the way, been more sustained than what you've seen on the equity side, for example, on the cash equity side. So again, volume is always hard to determine where they're coming from but any insights will be appreciated as it has become a bigger portion of your revenue base again.

Yes, I would say that, obviously, it's not a crystal ball prediction, but it's not as high as it has been. But honestly, I think many of us in the industry thought it was going to come back down somewhat, thinking there was a spike, it will come back down, maybe a little lesser volatility environment. But I think the stickiness here, as you've seen more and more retail adoption, they're realizing the effectiveness of these tools from an overall portfolio management, either they're looking for premium harvesting or they're looking for continuous hedging opportunities on those single name as they're starting to utilize these contracts as an overall part of their portfolio strategy. And this plays in perfectly, and Chris and I we talked about this in respect to education is a big part of this as well, which, with our Options Institute, is a key part of how we plan on growing and sustaining that and working with the various retail platforms and institutional clients, at obviously a significant higher level as far as that education goes, but that very much plays into a sweet spot of seeing the sustaining levels. Again, I think we'd all thought it was maybe not go back down to the 15 million, 18 million contracts per day, but seeing this level that's sustaining between the 30 million, 35 million, it just feels pretty sticky, Alex.

Yes. Hopefully, it will be. Good for everyone involved, I think.

Alex, [ I'll mention ] this as well, but obviously, the frictional cost, commissions have gone down for retail customers quite substantially both in equities and in options. But the other thing is the kind of the post-trade costs have gone down dramatically also. The OCC has reduced their fees 2 or 3x, and so the cost of clearing is nearing 0. And so at this time, we have structural change and a new user base that's adopting options for the first time because education is better and access is better, we also have costs coming down throughout the life cycle.

Yes, that's probably not something we've thought about as much. So thanks. Last one on the -- I guess, somewhat last one on the volume side, and this is an open question. But anything else you would point out on some of the other businesses we're not maybe paying attention to as much? I mean equities in Europe, for example, FX. And I know you've done a few acquisitions that we'll talk about in a minute. But when you think about the, I guess, some of the legacy Bats businesses, any interesting things you would point out that you're -- either you're excited about or that you're seeing the macro one way or another that people should be aware of?

Yes, Alex. We -- I want to start in Europe, I think, is what you mentioned first, but it's where we were going to start anyway. I think that we are very excited about what we're seeing in Europe in our equities franchise there. You obviously had Brexit that occurred at the beginning of the year. So we had 2/3 of our volume transferred to the Amsterdam Exchange where we opened up that's provided a nice tailwind on nontransaction fees. But our market share is up, our capture is up. We are not trading Swiss securities again as of February. The business is very strong. EuroCCP is performing well as we prepare for derivatives. We're just well positioned. We've navigated over the last 2 or 3 years MiFID II, and now Brexit. Dave Howson and the team have done a great job in doing all that. So we are the place where customers come when they want to get their trades done and also entertain new ideas of better ways to execute trades. A perfect example of that is Cboe LIS, which is -- finished June the #2 block venue in Europe, and we're knocking on the door of #1 on a daily basis. We're very excited about our success there. So that just provides an amazing base for us to then launch into European derivatives. So that's probably it on Europe. On FX, we're really excited. That's the -- we're excited about FX because it is a great organic growth story at growing market share year-over-year, specifically in FX, nondeliverable forwards. That's been a multiyear effort to build up a customer base. And now we're starting to get to an inflection point, where we're seeing hundreds of millions being traded every day, and we have a critical mass of participants and it's starting to be a consistently strong volumes. And then in futures, just say the rebound of VIX futures in 2021 is encouraging to us, it's what we anticipated. But also, I'd call out here iBoxx futures, our fixed income futures that off of the low base are growing. I think we've had 6 record -- 5 or 6 record months this year alone. So those are some things I call out from our other markets.

That's helpful. And yes, I remember when you launched, I think you launched the iBoxx at -- when you were right at this conference a few years ago, if I remember correctly. Good to finally see something coming through there. Now since you mentioned earlier, you just closed the Chi-X acquisition. Can you talk about earlier initiatives there and maybe remind everyone in this forum how concentrated is the business today? How easily can you expand to other countries? What major regions are not penetrated yet? Maybe even China, is that an opportunity down the line? I mean you're one of the few exchange operators, Western exchange operators that actually has a beachhead in that region now. So what are the ambitions and what are you doing near term and obviously longer term?

Yes. So we're excited about Chi-X Asia because it really puts us in that region for the first time. We've had a handful of people there to sell our products and services before, but never at this scale. So the business we purchased with Chi-X Asia was a combination of Chi-X Australia, where we have now about -- I think a full-fledged exchange that has about 20% market share of the equities market, goes a little less than 20%, but competes head-to-head with the ASX. But better, faster, stronger is our goal, being very disruptive to our roots. Also, Chi-X Japan, which is about 2.5% to 3% market share. That is a PTS, not an exchange, and primarily trading in the dark, but there is a [ lifting ] as well. So that's -- those are the kind of the part of the assets we bought. What we're excited about is bringing BIDS to Australia as soon as possible and then Japan. And then on the back of that, we would also do platform migration of Australia then Japan to Cboe's world-class trading technology that runs all of our equities, options and futures markets around the world. To that end, I'd just say a couple of things on Chi-X Asia. We're excited about the assets that we bought as part of that. But what really got us over the top was the ability to sell our existing tradable products, SPX, VIX and others, and data into a region that is largely untapped for us. So quite excited about that. The extent to which we're going to expand into other countries using this asset, I'd say that's further out, still needs a lot more analysis. And then access to China, I'd say that's -- again, that's further out for us. But we're excited about what's right in front of us.

Yes. So I guess, just to sum it up, the other regions because Asia is -- APAC is a big region, right? It is just too diverse and not that easily -- like there's more near-term opportunities to grow what you have and cross-sell in that region?

Yes. I will say that the sale of data, especially, and our products, now we will have -- we have a Singapore office, we have a Hong Kong office, we -- and those will persist. We will be selling our existing products in a much more intentional way into all the major countries in that region because the utility of our tradable products and data is pretty ubiquitous across countries. So that is one area that we are focused on in the near term as well.

Great. And finally, moving away from the volume side for a second. So nontransaction fees have shown some very good trends over the last few years. I think last I checked, they were 43% of total revenue. And I think when we focus on the proprietary pieces in that, it's 28% of the revenues is recurring. Some of that has come from M&A. So I guess, can you talk about how much of that is coming by design? How much of it is a focus, I guess this is for you, Brian, to become less volume sensitive? Or if it's just that's how it played out? I mean for some of the other exchanges, quite frankly, the recurring revenues became bigger because the transaction revenues weren't growing anymore. So again, is it by design? Is it just happening? Or what's the strategy here on the more recurring side?

Yes. I would say it's not necessarily the strategy that it's got to be x percent of our revenue base or it's got to be more or less. We view it very much a part of our overall ecosystem of having that, I'll call it, that transaction or revenue that we think about in traditional equities exchanges or -- and then we obviously have then had the derivatives element. And then sitting in between those and both derived from them as well as feeding them with the market data and the access as we kind of think about a flywheel per se. And they're all really a very important part to the growth of the other components. We think that the growth of the transactional markets, both the equities, we call it, the spot markets and the derivatives markets very much reflect the growth of the transaction side and vice versa. As people want increasing access to those markets, it's going to show up there. As people want increasing real-time data, it's going to show up there. As people want more and more enhanced data, it's going to show up there. As they want -- again, can see those proprietary data feeds, again, it shows up there. So I would say it's by design. That's by design for the growth, not certainly by design that it's now at 35% or 20% or whatever, it's very much part of the overall growth. We do think it's going to grow faster than the other transaction revenue just because of the things we have in place, the pipeline Chris talked about, the incremental geographies, the incremental sales effort that we have, the incremental markets, the incremental products. So that collaboration across those, I'll call it, those transaction venues is very much part, is supporting that growth. But again, we do love it because it is growing faster. It is obviously a more stable source. And what, again, is supporting more and more of that growth beyond the incremental output that we're seeing from it is we're seeing clients requesting more data. We're seeing clients requesting more analytic tools. So we're seeing that client demand pulling that forward such that, hey, this is what we want. And again, we see really positive momentum of that going forward.