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

I think we're good. All right. Well, thanks, everybody. It's my pleasure to welcome Ed Tilly, Chairman and CEO of Cboe; and Brian Schell, the company's Treasurer and CFO. I was going to make a tie reference and then I realized not a lot of people will probably get it anymore. So we don't say that. So I'll just give a brief introduction instead. But over the course of 2022, Cboe continued to build out its global derivatives and securities network with record growth in the SPX complex, significantly market share gains in European equities and accelerating growth in data and access solutions. With markets remaining quite volatile, so we look forward to getting an update on the business, obviously, hearing how Cboe is positioned for growth in the future. So thank you both for being here. It's great to see you. Always a pleasure to have you.

Great to be with you. Thank you.

Why don't we start with sort of like the big top of the year, which has been SPX. SPX volumes have seen enormous success. Last time I checked, I think up over something like 60% or so year-to-date. A lot of it could be attributed to the introduction of 2-day and daily, Tuesday and Thursday expiration contracts early in the year. So I was hoping we could start with talking about just the durability of the SPX volumes as you look out into 2023 and how the introduction of these contracts sort of reshaping the client activity in the ecosystem.

Sure. Good place to start. It has been pretty amazing. And I think when you start with sustainability, I think it's important to note that the growth in SPX to your point has come really in the very super short-dated exposures and not at the expense of the third Friday. So third Friday is still an institutional favorite exposure. But the growth in and around short-dated has been a continuation of a trend that we saw over the last few years. So adding Tuesday, Thursday really allowed for the growth of super short-dated low premium exposure, but added a component in a user group who is very interested in defined outcome investing. What we mean is very limited risk exposure and therefore, limited upside or reward. But the certainty around defining that outcome is -- plays well in a market like we see today with very, very huge daily movement. But over a period of time like maybe 30 or 60 days, not a whole lot of movement in the U.S. market if we look back in larger time chunks. But what that favors is being the precision around the daily exposure. And the certainty that at the end of the day, the nature of a cash-settled contract as opposed to a physically settled contract, you have certainty and you settle in cash. There's no continued risk. There's no continued exposure to the market, that nothing lasts overnight. You're able to look at the market fresh again the next day, and either reload a similar strategy or completely reverse that strategy given the movement more broadly in the U.S. market. So we think that is sustainable in that those defined outcomes don't really lend themselves to completely blowing out opinion because they are limited in their risk. And then the follow-up question is usually, Alex, I know you're going to ask me what happens in that if we return to a lower volatility environment. We actually see the opportunity for the user group to say roughly the same as it had a more sophisticated than pure retail, adopting their strategies and going back to what was very commonplace in a low volatility regime, and that is a regular premium harvesting. And we think that the growth around strategies with defined outcome around premium harvesting should work well with daily exposures as any vol regime or any change in the trading environment.

Yes. You mentioned that in terms of the customer groups, the core of your institutional customer base still using the third Fridays. How are you thinking about expansion of the Tuesdays and Thursdays to that customer base, right? Because retail or sort of retail plus maybe has been more active in something like this. But as you think about expanding the customer base further, what does that look like?

Great question. And to be clear, the growth in these dealers are coming from retail platforms tend to be much more sophisticated than just pure retail. This is probably when we use like these term propel, which is retail tending professionals, but maybe not capitalized as you would think of a prop shop, but the strategies are more sophisticated and the notional coverage of the SPX very large notionally sized contract. So how do we extend, first, the success of SPX where we decided to move into XSP, which is a mini version of the SPX, 1/10 the notional size of SPX, same size as Spider. So very retail friendly. So the first expansion is actually opening up this daily defined outcome strategies for all and that was the move into XSP, and we've seen some uptick there as well. And then back to the formation of your question, the origination of your question is how do we extend these dailies to institutional? Your own trading desk here has larger traders who love this type of exposure. So there is institutional adoption. It's just not at the frequency that we see the 1, 2 and 3 lot trades coming from more traditional retail platforms.

Got it. Let's talk a little bit about pricing. So the nominal growth in the product. At the same time, you kind of hear inflation is everywhere. You guys obviously have some pricing power here as well. I'm not sure at what point you would want to lean on that pricing power. But when it comes to pricing of these products and the SPX complex broadly, how are you thinking about that?

Let me start before we get into the philosophy of rising price. I want to be really clear, duration -- a contract's duration does not affect the fees that we charge. So that the dailies actually have the same fee schedule as the third Friday and the yearly for that matter. So with that consistency, I think, Brian, the answer...

Yes, I mean the way we've approached pricing and this is -- really is not new is -- and again, it's reflective of our view of where we are in any one particular product growth cycle is we still think there's a lot of runway for growth of the product in and of itself to continue to grow revenues. So whether that's on the transaction side or the non-transaction side, we believe there is opportunity if we wanted it. We don't feel that we need to do that. We'd rather save that for whatever the occasion might be. We like our competitive positioning kind of across the board. We like being in some products at a discount. Sometimes that's a way in. Sometimes it's a compelling offer that we can make, particularly on some of the market data products that we have. And so we'll look at that across the board. But I think if your view specifically on the transaction side, we are not making a lot of changes. And in our client meetings, which I've been able to fortune enough to sitting with them, they're very appreciative of the fact that we are not raising prices around the transaction side. They are feeling that pressure just like everybody else is on that either supply chain or cost side. And so to see that direct input into their overall trading, I think they're appreciated. And that plays into their overall use of the product and where they see they continue to make the economics. So again, we like that gap that potentially grows if others are increasing price, and we just have not seen a need to have to pull that lever.

Yes. That makes sense. Let's talk about the VIX a little bit. If we look at VIX activity, both on the option side and the future side, it's been fairly viewed this year. So a little bit of the opposite of what's going on in the SPX. What would it take for volumes, I guess you get going here? That's part one. And part two, are there opportunities to enhance VIX offering in the same way you did with SPX in order to sort of expand the addressable market? And if so, if there's a way you could frame that, that would be helpful.

I think there is a way to view volatility and exposure in different time segments than we do today. VIX in particular, is a 30-day -- a measure of the 30-day implied volatility S&P 500, it just is. But that is not to say that we can't come up with a volatility contract that we're able to represent in short-dated duration. But the way that VIX is constructed, it would just -- it would not be the measure of VIX that we all know and the revenues point that we all know. That's first. So there's something to do there, but we might have a little different view on what exactly that is but involve contract for sure. As for the difference in growth, we've identified one of them, right? There isn't a short-dated vol contract today. And then we really look at the stack and the exposure that our users will be looking at in the 500 and hedging and using the 500 as a tool, the SPX as a tool or VIX futures and options. And in any given market environment, one of those contracts we maintain because we're representing what our customers tell us. One of those contracts, the expected outcome and/or the effectiveness of the hedge or the ability to monetize that hedge, one should outperform the other. One environment today that you're getting paid for optionality, meaning you can buy exposure in the S&P 500 based on the implied move of the 500 and see moves, daily moves yesterday, this morning that are outperforming and the movement is greater than the implied move that you just purchased. So optionality is at a discount. And the ability to then monetize hedges in the 500 have been incredibly efficient, and that has been the pivot and the focus for those that are looking at the exposure in the U.S. market, preferring the S&P 500 over VIX. That is not always the case. So non-strike specific hedging that your portfolio is not sensitive to the overall levels of 500, but in the movement around, VIX is still the preferred method of hedge. And that's why VIX has gone to 0. We haven't seen that volume fall off, it just has not grown VIX options at the rate that SPX has. There is a natural rotation in this proprietary product set.

Got it. Got it. All right. Let's spend a couple of minutes on the multi-listed options space. I think many of us have been surprised that it's been incredibly resilient after seeing robust growth after COVID, sort of continuing through 2020 into 2021. And if you look at this year, volumes held up probably much better than people expected. So if you could unpack that a little bit. And as you think about your own positioning within multi-listed options, you picked up some share. It's a fairly crowded space. So both the durability and the multi-listed options as well as your market share strategy in that part of the model.

So let's start with why has it been sticky. If we take a delta one trader or a stock trader and introduce basic strategies that are available by trading options, we changed the payout scheme. The binary nature of being right if you're wrong or wrong if you're wrong goes away, you can change that payout scheme. That's an incredibly powerful tool, and that comes with education. So you've got a core holding, Alex, that you have, that you've enjoyed for years and years. And in this marketplace, perhaps that holding is down a bit. Maybe it's down with the S&P 500, it's down 15% to 20%. There's recovery to that position that just says start overwriting that position. That's pretty cool. And once we teach that, that's pretty sticky. And what happens then when we're back up now and you're above water and your position is terrific, and you don't want to give up that position, we teach you to hedge that position by buying simple puts. That too is sticky. So once a delta one trader, an underlying stock trader learns how you can change the payout scheme and the risk profile by adding derivatives, that application doesn't go away and that tends to be a very sticky customer. Those are the customers that we're after. That's why everything we do at Cboe comes with a component of education around it. We want that sustainable investor and teaching the flexibility and the customization that derivatives offer. That's part of the art. So we do think that's sustainable, and it should be around for a while.

Yes. Okay. And then in terms of market share and just approach to kind of competitive dynamics, yes so we have seen. It is a very competitive space. It is a little different than, say, the U.S. equities markets as far as the concentration of competitors and the sensitivity to various pricing schemes and incentives. And I think with the inflow of competitors and some still to come and where potentially they come in, we've been pretty consistent in our approach of looking for that kind of, I would say, making that long-term net revenue being kind of our goal versus, hey, I need a 32% market share and I don't care about capture. We look at the combined picture. So we're not going to chase share with that negative capture. So we've been able to kind of maintain that capture, that price at a pretty good level. I think the strength of the index products, certainly on those exchanges helps the flow of the multi-list as well. There is some -- I think there's some help there as far as that concentration and the ability to leverage some of that flow. But overall, it's pretty consistent as far as where we're going, maintaining that price and looking at kind of that top line versus any nuances in change in capture and from one quarter to the next.

Great. Okay. Let's shift gears a little bit. I was hoping we can touch on the European equity business. Sometimes it gets lost in many different discussions, whether it's the SPX and VIX, but it's been a really big success story for you guys over the course of this year. I think the latest we have about 26% plus market share in the fourth quarter in European equity. So can you help just kind of go through some of the sources of market share gains? Is it pricing? Is it capabilities? Which one kind of wins over? And if you think about the market share ceiling for you in European markets, what does that look like?

Let's start, Brian, really about data ends.

Sure. It is -- I was -- happened to be with them, that team last week. And it is -- and I was able -- again, fortunately said I'm some of referring to some of the client meetings, was sitting and listening to a review of the flow of what was happening. And essentially, it is a, I'll call it, a good old-fashioned approach of leveraging the data and analytics that -- of what those books offer, how each of those clients can improve their execution whether it'd be agency flow, whether it'd be principal flow, whatever it is, and the metrics that are most important to them for their particular firm because they're all different. It might be a best x, it might be time to fill, it might be a level of toxicity whatever it is, we're able to cater to those metrics, demonstrate in a very data-driven approach from multiple different angles that say using this order type on this exchange, in this time, trying to get this outcome will drive better results for you. Here are some scenarios, take a look and try it. And so over that time, over the course of, call it, a year when we've seen that progress, that's been a client by client conversation, uniquely paired data analytics just for them and clients have taken advantage of that, and they've seen improved results. I would say also, it's not an accident that a comprehensive offering with BIDS since that acquisition of having it show up as the largest block trading venue in Europe is not a coincidence that, that's occurred after the acquisition of BIDS. We had a partnership before, but now with the ownership, I think we've been able to work better in conjunction to leverage that dynamic and that product offering with clients so that shows up not only on the Lit but also on the block trading menu.

And I guess as you think about the ceiling in the market share, 26%, I think you guys are the highest at this point. But it's, again, fragmented, not too dissimilar than what's going on in the U.S. Different dynamics with listings and things like that. But could it go much higher?

It can go higher. We believe it will go higher. We're planning on it going higher. There's probably going -- I mean obviously, the area that we don't compete, which is similar to U.S. equities market structure. There's an auction piece that we're not competing in with as the primary listings venue of the particular stocks. So we don't have access to that in any significant way. So there'll be ultimately some cap. But right now, we don't think we've hit it.

Got it. And no plans to still, I guess, introduce a listings offering in the European markets?

I mean, right now, as far as the listings go, we continue to explore the ETP side of things. I think what's interesting and as you think about corporate listings and where that is and the brand required or the infrastructure required, we do have this interesting, really unique cool asset called NEO that does have a listings franchise, primarily in Canada and looking to take that expertise and that approach that could be a broader opportunity, again, global, obviously will take time to develop. But it's not an immediate. Here's how we grow share is we're a corporate listings franchise in Europe.

Got it. Well, staying on the European business for a second. I would like to follow up on the derivatives business there. You guys acquired EuroCCP a few years ago. Obviously, it helps to develop a much more robust ecosystem for equity derivatives trading on the continent. I think revenues have been fairly range bound in that part of the model. So maybe update us on the strategy, where you guys sort of stand there? And what is the next steps you're looking to take and also what are some of the biggest hurdles in moving that market into more -- to develop in the derivative markets.

We don't want to move into derivatives, but after, I think telling the clear story is really a great one on its own and in the securities world before I get into derivatives, all right?

Yes.

So if we start with that acquisition, right? So strategically, we are already an owner, a 20% of then EuroCCP, now Cboe Clear Europe. And we had a solid market share position and we saw an opportunity to buy it because strategically, we knew that to be able to launch a derivatives franchise in Europe, we needed a clearing capability. We did want to rent it. There's a whole lot of issues with trying to rent something or get somebody else to do something. So we know owning an entity that could help us do that was very important to us. So we had that as a long-term objective to really helping facilitate that derivatives launch, which we'll talk about in a second. But if you look at the core of what we bought, even if we don't have any incremental revenue or earnings from the clearing, this has been a real home run of an acquisition for us. Because not only has it been able to take advantage of the incremental volumes that we've seen there, it has grown market share since our ownership. Probably I'll call it, 3 to 4 percentage points. It is now, we believe, the largest clearing venue for equities on a pan-European basis. And that, again, through its competition through its interoperating clearing model, its preferred clearing model, its exclusive clearing model, all those things it's doing 1 client at a time and offering basically a service to that has really been a really nice kind of end result that's put us in a really, really strong position to your point. That whole ecosystem is now incredibly strong in Europe with the #1 equities franchise as far as market share goes, as far as trading, clearing and now block trading and equity side. So that is a very strong, compelling offering broadly as far as that presence that we think sets us up well for the derivative side.

So we launched 16, 17 months ago, Cboe European derivatives complex and the goal was not to take share from the incumbents. Remember, the story was to actually increase the pie and the amount of derivatives that were traded in Europe. We -- our customers told us that they favor the U.S. model, the market model in U.S. derivatives that has a continuous quote, a liquid market that's accessible for all users. And then from a liquidity provider's perspective, the global liquidity providers that are in every market around the world are frustrated by the European model that tends to be an indicative quote, quoted by those global equity providers and then traded away off exchange in a bank not that, that's bad. But the reward for posting liquidity is those markets tend not to be great. They are indicative. In the U.S. market, the reward for posting that liquidity is you actually get to trade. The SEC says that in derivatives in the U.S., you can't trade away from the listed market. There's not a dark pool. There's OTC trade, but you don't have the benefits of clearing in the scale and the offset that you do in the U.S. So we imported that model. Reward liquidity providers have a continuous 2 sided quote, develop your own country indices using the data from our own equities exchange. So our highly correlated indices in Europe represent the same exposures as the incumbents do, all cleared at 1 clearing house in 1 CCP instead of 3. So we've built in natural capital efficiencies. We've built in the incentive to quote and the reward for quoting and the buildup and the ramp-up and the onboarding has been slower than we thought in a market that is completely different than we thought when we set out to develop this. So it's steady as it goes, but slower than we thought. We are committed to this because our customers tell us that we're on to something and as much as we will have announced that we will go into launching single name options at the end of next year. So a slow, steady, slower than we thought, but we are committed and the build, we think, and the potential is there.

Got it. All right. Why don't we spend a couple of minutes on one of the other new initiatives you guys started, which is Digital. Obviously, lots of topics in this over the last few weeks. But I guess curious to get your thoughts on implications of the FTX debacle in the crypto ecosystem and your own prospects and kind of how you think about Cboe Digital on the way forward?

Okay. What we set out and announced last November was the purchase of the remaining shares of ErisX that Cboe didn't own. So we were a founding investor in ErisX. We saw great potential in the direction that ErisX was moving in Digital, and that is highly regulated, transparent and liquid market. We love that the trust in a market with that as the backdrop and the founding principles that an exchange or an exposure is built on. We also -- we did not have a foresight that there would be an FTX event, but really favored the traditional model, where customers are represented by their agents and their brokers and agents are members of our exchange. We are in the business of operating and exchange. We love that model. That is a lot of trust in that. It is not subject to the conflict of interest that ultimately we think was one of the main components of the FTX debacle. So with that is what we set out and what we announced in November. We also said we were building a consortium of syndication of like-minded investors for a minority stake. And at that time, we didn't have the name of that minority stake and has since made that investment finalized in the public. So crypto-native brokers, we all know, and global liquidity providers interested in the same model of transparency and accessibility and trust that we maintain and run all of our markets. So the vision that we had, I think, endorsed in a very, very big way, unfortunately, negative and having many investors in the U.S. and around the world fall victim to mismanagement, conflict of interest and total lack of governance. We do have this other model now endorsed by the syndication and really can't wait for the onboarding of those syndicate partners, which begin an experience for customers that is consistent with every other asset class and lives up to the expectations that they all thought they had with FTX, but they will certainly have with Cboe Digital.

Right. Right. Got it. All right. Why don't we shift gears and kind of blend maybe some of the financial discussion along with the strategy here. You guys have been fairly acquisitive over the years for a lot of strategic reasons. So you have a significant amount of new initiatives. So as we think about your global footprint today, are there still things that you need to fill inorganically? And as a subset question, probably for Brian, capital returns always very topical for Cboe, balance sheet in good place. Buyback, maybe starting to pick up a little bit, kind of priorities for 2023 between dividend growth, deleveraging and buybacks.

So I'll start first, Brian, will get you capital. So setting out to build the world's largest network operator in geographies and asset classes that are open for competition. That is really what we started out to execute on, and that's you'll see these -- the M&A and the transactions that we've had in the past really feed that direction. We want to be everywhere that's open for competition to extend a very uniform, a trusted experience for our customers, not dependent on asset class or geography. So that's the geographic reach. That's the approach. So are we looking for anything? If the geography is open to competition, we will look to be there, starting from scratch, Cboe's derivative exchange in Europe or like the purchases we've had in Canada, Japan and Australia of late. We are -- we look forward to both. We want to be there. We want to be there in scale. We started in Canada with MATCHNow, that's not scale. We further a larger footprint by the purchase of NEO. So is there anything we have to do tomorrow? No, there's not. But there is that view as the way that we look at the world from our customers and our shareholders' perspective. But Brian?

Yes. And if you look at our capital allocation and what we've done over the last several years around the various alternatives that you highlighted, Alex, around dividend growth, share buyback, delevering and/or inorganic opportunities, it's been roughly a -- I'll call it, a 50-50 give or take 5 percentage points around spending those dollars for inorganic future growth opportunities and/or existing and then, I'll call it direct return to shareholders between share buyback and dividend growth. And so the delevering, we're getting to a position on the leverage ratio, where the marginal benefit or the benefit of that next dollar of buying -- paying down debt or share repurchase is leading much more towards share repurchase as far as where we were in the comfort level. And what we've always said is we want flexibility in our balance sheet if we see it spike up and then we wanted to get back to a level that we feel more comfortable around. We are approaching that level, absolutely, both through earnings growth as well as paying down some of that debt in this environment. So I would expect us to see that a very consistent capital allocation approach going into next year, similar to what we've done. If you look at and you track it over the last 3, 4 years as far as that split with, again, with a more lean towards share repurchase, given where we are in the leverage ratio.

Great. Talking about Data for a second. So when we get Data and Access Solutions in 2022, another really big success for the firm. If SPX maybe was #1, this is probably #2 or maybe even in reverse order, well exceeding your original guidance and expectations. I think you're on track to do 10% to 15% organic growth there. As you look forward and you kind of look at the lessons learned from '22 about both sort of durability and sustainability of that growth. I think your target is 7% to 10%. How do you think about that 7% to 10% in the building blocks to kind of...

Yes, and that's a perfect setup for '23 of that those continuing, both of those that you mentioned, both drivers for '23. We absolutely continue to see that, and on the D&A specifically around that. The drivers for '23 are not going to be materially different than we saw in '22 as far as what we see, right? So we're continuing to see demand for people to buy capacity, right? People want capacity. That's a little bit -- that's not so much the new client as the existing client wanting more and more capacity from where we are on the Access side. On the market data side, what we're continuing to see is a very strong pipeline. We're continuing to see incremental -- we put incremental investments in both people and marketing in some of our non-U.S. jurisdictions to sell U.S. data. We're continuing to see that to be a largest portion of the growth in the market data sales. So we're continuing to see that strong pipeline in that delivery, we're continuing to see some leverage out of new delivery vehicles with access with cloud, right? We made that investment over the last couple of years as far as that goes on the expense side, we're seeing that turn positive with respect to some of the cloud delivery as far as promoting some of that growth. And then we have plans around within the '23 and '24 around, are continuing to build out our index capabilities and what we're doing as far as those services as well as continued enhancements to our risk management analytics services. So that portfolio of products, we're continuing to see move forward in '23.

Got it. All right. Well, with a couple of minutes left, I do have an expense question. I don't think you were going to -- I don't think you could expect us to not ask one. So as you think about -- you gave guidance for the full year, so any update to that. But again, more importantly, 2022 was a bit elevated year for you guys from an expense growth perspective, any thoughts on '23. And just broadly speaking, how you think about the expense growth algorithm for the company?

Sure. So no update for '22. And for '23, not prepared to give any guidance until our next call, when we'll have all that mapped out, budget, everything is there is approved with our Board. But I would say, as you think about -- I'll reiterate the points that I made on the third quarter earnings call, one is that we're obviously at a higher level than we were, say, at the beginning of the year. So we'd expect, I'll call it, that level to continue to flow into '23. We haven't seen the inflationary pressures around wages and comp from that 7% to 8%. We haven't seen that waiting. We don't see any signs of that despite some of the market kind of reads, we haven't seen any easing of any of that. So we still expect that into '23. And we'll continue, as you think about the framework continue to evaluate high conviction revenue opportunities at the end of the day, right? So you can't just talk about expenses, and this is not just you, Alex, meaning one needs to make sure they continue to look at the revenue growth opportunities that we've been able to deliver on as well along with the -- with any expenses that are accompanying that. So like I said, we're very excited to continue to pursue those opportunities that we have a lot of conviction around.

All right. Well, we've got a minute left. So if there are any questions from the room, let us know. All right. I'll leave it there. Guys, thank you very much. Thank you for being here.

Thank you.

Thank you.