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

Good morning, everyone, and welcome to the 24th Annual Credit Suisse Financial Services Forum. This is Gautam Sawant, Credit Suisse's equity analyst covering U.S. exchanges, and it is my pleasure to introduce Ed Tilly, Cboe's CEO and Chairman; and Brian Schell, Cboe CFO. Cboe is a global securities and derivatives exchange operator and is expanding its services into new geographies and asset classes. Ed and Brian, thanks for joining us today.

Great to be here. Thank you.

Let's begin with your macroeconomic outlooks. Can you begin by highlighting any changes in client behavior developing across your global platform?

I think what we saw the engagement across the entire globe was the change over the last couple of years and higher volatility. And so every asset class, we saw engagement certainly in the U.S., in Europe, FX led by rates the Japan market and Australia as well. So there's just been more engagement. I think of late, the trend has certainly been into derivatives in the U.S. and in particular, looking at the macro environment, the engagement of really, really short-dated options. Now we have focused over the last year or so on the growth of short-dated options, but since May of last year, now that we have the S&P 500 expiring every day, the engagement really is in outcome-based investing based on the news of the day or the move of the day that I think is the greatest trend.

Macroeconomic uncertainty could be an ongoing contributor to trading activity in 2023. However, this year, the VIX has declined to a 20% level from a 25% level in 2022. And you speak to how Cboe can achieve its 7% to 9% total organic growth outlook for 2023 and 5% to 7% medium-term organic growth outlook if markets enter a sustained period of lower volatility?

Volatility we've seen over the years, ebb and flow. We had incredible growth in sustained low volatility. So low teens pre-pandemic was one of incredible growth in Cboe's proprietary products. So having a derivatives complex, there is a strategy of really for any market environment or a very perceived market uncertainty. So the ebb and flow volatility is normal. Volatility is mean reverting. So not surprising to us that volatility over time goes back to the mean. But that is not to say that there is certainty out in the global market. The knowns happen to be knowns. The unknowns happen to be knowns. We are watching monthly the change in unemployment. We're looking at Fed announcements here. So there's really -- the events and the compression on vol is just being prepared for and expecting changes to those known unknowns. The growth from us comes from greater adoption, and that is the move that we've seen since the pandemic from Delta 1 into derivatives. As I said, in the U.S., that's been an incredible movement. For us and our growth, our other business lines and Brian will speak to the DnA business, in particular, what that means as the core businesses around the globe continue to grow with adoption and activity. But Brian, maybe a little bit on what that means for DnA in particular?

Yes. I mean the broader story there is you have the macro backdrop, but it's really -- and you heard Ed talk about some of the things we've done is about growing that access and distribution part of that, right? So whether was on the transaction side, we had 24x5 Tuesday, Thursday, addition to the weekly complex across the proprietary complex, you have further distribution in different geographies, incremental products, incremental data feeds, incremental analytics, work around the index complex and leveraging the cloud per se. So it's been a really nice kind of ecosystem around the overall growth, complementing kind of across the board.

Really does feel like the market is digesting responding to economic developments, interest rate expectations and investor sentiment at an accelerated pace. Which of the Cboe products do you see benefiting from this environment?

Well, I think it's, again, looking at the trend and listening to customers. And for us, again, the fastest growth we saw last year continues and then continued through January was the 0 days to expiry engagement, and that happens to be in our proprietary complex, the S&P 500. The ability to have a new strategy each and every day that can play out either as anticipated or in defining the outcome, if you are wrong, limiting the downside and being able to take full advantage of a cash settled nature of the S&P 500 means that at the beginning of the day, your opinion can be limited and risk. And by the end of the day, the settlement, the position goes away, and it's reconciled by cash either coming your way or limiting the risk, the amount that you paid in premium, for example. So the trench, we watching that continue. And we've only been at this since May on having expiries every day. And we see the adoption in days where the 500 has a big range. 50-point pool rate range. And in days like yesterday where it's much more compressed. So the engagement has not really changed given the daily move. So we think there's much more adoption. And that's in the 500, the large institutional size SPX. We've also seen the steady growth in XSP. So XSP is 1/10 the size of SPX, much more retail-friendly. So we're hopeful that as 0 day strategies catch on, we have a contract that is bite size and appropriate for retail. So we'll look for that trend and build from the base that we find ourselves today.

The SPX complex has been a key area of focus for investors and the recent market structure innovations you put through have led to pretty solid growth. Can you help us understand the segmentation between institutional and retail investors in that channel? And maybe what is the market missing in terms of this growth outlook over the next few months?

Both institutional and retail have always had interest in the 500. You don't need to be a stock picking expert to participate in the more broad market and the 500 is the country's benchmark. So from institutions, the S&P 500 with its large notional size, the SPX contract has been the contract of choice for retail, retail tends to move toward the ETF SPY. So interest in the 500 has been sustained years and years. What the case we make is that the European settlement deferred tax treatment of cash settled derivatives are really built and more appealing for all users. And our job is to educate retail into the awareness that the cash settled European XSP is an incredible contract compared and looking at side-by-side next to SPY.

And as you think about the growth channel for SPX, how does that compare to the VIX complex? How is VIX products trended this year?

So VIX products throughout the year, steady growth in options on VIX. As a matter of fact, yesterday, you can't plan this, but we had a $1 million contract day in VIX. So the utility and the optionality embedded in the VIX option complex is starting to show signs of adoption again in this market. I think really simply, we've had a pretty nice run up in the more broad U.S. market. And rather than give up those positions, the leverage and the hedging power of having a VIX options strategy in alongside the 500 strategy is really starting to show up again. So -- and that is not at the expense of -- or instead of having S&P 500 or SPX exposure. So the complex is actually working together quite nicely right now. And market environment where both the SPX and VIX options are really finding great use.

Growth within the U.S. derivatives market has been very positive. But can you remind us where the pan-European equity and index options build out stands? What are some of the potential revenue and margin impacts over the next 3 years?

Do you want to start, Brian, I think -- and really this is a story that starts with secure clear now and it really is because of the CCP purchase years ago where we find ourselves today.

Yes. So that was enabled by -- remember, that was started as a consortium to continue to provide alternatives for pan-European clearing as well with respect to that structure. And we had the opportunity to take the entire franchise with respect to the clearing and help shape and help preserve and help continue to promote competition and clearing in Europe. And they enabled -- that enabled us to be able to launch the European derivatives efforts. Again, listening to customer feedback of this is what we would like to see from a market structure standpoint, it looks a lot like what you see in the U.S. market structure as far as being able to have some on-screen liquidity and what that looked like. So that started with us being able to have the infrastructure behind that from a clearing perspective, to be able to offer that through the exchange. And we haven't wavered from our expectation of where's this going. We're actually starting to see increasing volumes, albeit the volumes have come slower than we would like. We knew it was going to be a longer-term build. We knew it was going to be a multiyear exercise and so I think the last several quarters, even last month, we continue to see increasing volume. We've seen increase in open interest, looking to continue to add options to that platform, continue to build out that complex. We put a target of roughly EUR 25 million on a revenue standpoint 3 years out. We -- about a year ago, we extended that just given what we had seen what was going on with some of the conflict in Europe with respect to Ukraine and Russia and every -- some of the other items that were going on there, we saw some of our market participants said, "Hey, we need to address these things from a priority. We still want to do this, but we saw them shift and it was like, we've got it. We're ready. And so we've seen that, but we started to see that volume starting to come on. We started to see more and more participants come on board to that -- to the exchange. Again, so we're excited. Our confidence in that effort as it waivered. Again, it's just a little bit slower. And to Ed's point, the underlying ability to do that was the Cboe Clear ability to offer that and to asset provide that infrastructure, not for the existing -- not only the existing equities business, but again, the derivatives that people were looking for.

Sticking with the cash equities business, can you speak to the recent success of Cboe European equities? And is central clearing across the different regional impacts or different -- is the central clearing across different regional markets impacting order routing decisions?

Two different -- great question. I'll take the first aspect. And I think, Brian, you can hit clearing for us and the success we've had pan-Europe on the equity business really is in execution quality and sharing the data with our customer base that the experience on the Cboe network across Europe is second to none. So we are showing by engaging with us and trading on our platforms the incredible execution quality that customers are enjoying. That's driven a great amount of our success. So -- and I think, Brian, back to the clearing aspect is for us bringing that all together and been an enabler, but really for us, it's execution quality and really at the heart of the experience is what's best for the customer.

Right. And on the -- and they are clearly separate from a regulatory standpoint and everything else, but the ability to have that pan-European ability is that any product innovation that does occur on the equities platform, in addition to what kind of Ed talked about the success ramping around the execution quality is it does enable an ability to facilitate and bring that to market to ensure if there is product innovation, having that underlying capability is a nice competitive advantage to be able to make sure that, that occurs. You're not waiting on someone else to be able to clear a nuance or something as far as what you're presenting from our client demand. As far as the clearing operations, it's a fairly similar story actually as far as being very competitive offering from a tiering of pricing structure, services, continue to enhance our technology has really been a really nice success story that is allowed to become, we believe, based on market Statistics, the #1 clearing entity as far as on pan-European clearing basis for equity. So that kind of underlying infrastructure and what has enabled it to happen, again, it's not an accident. Again, it's -- and so we see that combination and what we're doing there to be very compelling to the European community and a very competitive to not only the clients, but it's been a net revenue growth for us for Cboe. So it's not -- we're not giving it away. We're pricing it competitively and we're seeing our revenues grow.

Cboe has a similar opportunity in Australia, given bids is expected to launch at the end of the quarter to help modernize regional execution have Australian regulars considered giving Cboe an opportunity to modernize clearing and settlement?

Thank you for acknowledging the rollout. And part of the global expansion for us is a technology migration. So what you referenced is not only is bids expanding in Australia, but Cboe technology to the end of the quarter as well. So we'll be running the Australia operation over the same technology -- core technology platform as the U.S. and Europe and Canada. And then following that at the end of the year, we'll do the same thing in Japan. So Cboe tech -- we'll be running our PTS in Tokyo, and BIDS will expand then into Japan. So that is part of the power of building networks. It is easy once the court has been established and BIDS, it's been the U.S., Europe, Canada, that adding geographies onto the same technology platforms allows for that block trading mechanism to be expanded as well. But Brian, maybe a follow-up.

Yes. I mean with respect to the clearing, while it's not off the table, I think Ed's point, the other opportunities are just immediate, right? There's a much higher ROI, and the clearing is it would take a longer time, certainly not off the table, but I think the focus on the technology migration BIDS, continue to grow market share and frankly, continue to expand our global listings. We already have a very, very strong ETP listings presence already there in Australia. I think we're #2 as far as listing goes there, similar to where we are in the U.S. So being able to potentially with respect to dual listings on the corporate side lot of really good opportunities that are shorter term as far as being able to bring those results of that investment to the bottom line and leveraging that existing kind of core kind of market share size and what we've been able to do are just really interesting opportunities. Again, really strong relationship with the regulatory body on the basic. But again, clearing, great, but it's -- those other opportunities, I think, are more the forefront.

I think Brian brings up a good point. When we -- when we view our regulators, it truly is in a partnership and being sensitive to what's right for each jurisdiction. So while expanding the execution facilities around the globe, we are collecting regulators as well and building those relationships and really going into markets with a pretty known case that we're a trusted market operator. So any expansion beyond the core equity platform will be in consultation and cooperation with our regulators in each of the home markets. It's really important for us to point that out. All of the markets we operate start with transparency and trust and highly regulated and a degree of oversight.

I wanted to go back to listings. Within Canada, the acquisition of NEO has expanded listings capabilities beyond ETPs to corporate listings. Can you share your outlook for launching corporate listings in new markets like Australia?

Maybe just depend just the cross-border opportunity.

Right. So again, we did talk about this, and we're very excited about what that looks like, right? So as from a global listings perspective, you've mentioned all of the various, I'll call it, franchises across the globe right now with respect to our presence, right? So we have this terrific buildup of our ETP presence here in the U.S. with being the #2 and continue to capture a more than fair share of listings that come out every year. We are the second largest in Australia as far as capturing those. We're continuing to have success with NEO with bringing that into the Cboe fold as far as those ETPs. So that has been the traditional focus. But with NEO, now we have this corporate opportunity, right? They have 56 listings already in Canada, again, more of the emerging market and finding that sweet spot there. But we know that a lot of issuers looking for increasing global access to capital and liquidity, which, again, the to facilitate each other. So being able to have this ready-made network. Again, there's some work behind the just turn on. But the Cboe becomes a very attractive alternative entities who want to list to get access to multiple markets because we can bring a, I'll call it, a common framework for a technology, a common framework for a, I'll call it, a legal framework, albeit, obviously, every country is going to have different regulatory requirements and listings, requirements global liquidity provider set that, again, that consistency is very important both to the providers as well as to the investors across the globe. So that rollout that consistency, that underlying brand name of being able to build that brand awareness about what Cboe does is very important. So we're really excited over that build for the next couple of years of building that capability in each of those, I'll call it, big exchange markets of where we are as far as the U.S., Canada, Australia and seeing that happen. I guess, we think have a really solid start to that.

Could you expand a bit further on how globally listed ETPs could encourage continuous asset price discovery? And if that could attract more ETPs of the platform?

We think that it does because like I said, if you look at the global nature of the investment community of the liquidity providers, the market makers, they -- like I said, they're in the multiple jurisdictions and the extent that we can continue to connect that together and make it easier, not just for them, but then their customers, those investors to be able to hook in and understand, we think -- like I said, it's an overused phrase, but it's very true is the liquidity of the gets liquidity or that common framework is very important to that entire community. So us being able to provide that standard and the market data of understanding that and what that looks like. I guess, Like I said, we're very excited because we -- just listening to that customer feedback, we wish we could or we wish you would, right, fill in the blank, and that is how a lot of time we have chosen the investments that we have made and this international expansion is to help facilitate that incremental volume. So we do think it adds incrementally to the platform, and we do think it's going to bring incrementally issuers to the platform.

Given all these exciting developments on the transactional side, how do these initiatives complement the data and access segment? And can you also touch upon tailwinds propelling 7% to 10% medium-term organic growth?

Yes, so this is something that we've continued to be very excited about to highlight, and I think you've seen it in the overall results overall with the double-digit teens organic growth that we've had historically. And then with the strong leaning into '23 is if you look at those initiatives, and again, it's not independent of a transaction side because we think they actually feed off of each other with the growth, but -- if you look at the market data, the real-time market data and access, you've seen a tremendous growth rate rise from the quality of the data, the quality of the market share continue to arise. You've seen increasing access, right, as you've seen incremental volumes, but you've also seen incremental I'd say, market presence in a lot of international jurisdictions. So some of that tailwind that you're seeing is again, we'll go back to access and distribution is, again, leaning into that theme, right, is introduction of cloud, which is an investment we started making a couple of years ago, which we've highlighted is we've seen a tremendous amount of that growth independent of local markets is a lot of international demand for U.S. data both from the analytics and then the access. So the cloud has really enabled more and more people to take that in the framework of what they're accustomed to taking that market data in. So we think that as a huge Tier 1 and continuing to grow, right? So we're also leaning that with incremental cloud initiatives, incremental data being added to the cloud, most recently with our European market data. And seeing more and more participants take that offering. As far as the other 2 parts of that DnA business you referred to is on the index business, as you've seen us leaning also into providing, working with the largest AUM issuers, a lot of defined outcome as far as creating that index and enabling them to grow their ETP or launch new complexes around the defined outcome space, which people have really seen the power of that, particularly after 2022. And what that looks like and what that affords them to. And then the last piece of that is the risk management analytics piece is that global offering of how do we help people with margin compression, how do we people with a global analytics framework around derivatives that's just a best-in-class. It's not a spreadsheet somewhere behind the scenes that's looking at this. So these tools again, across all of the platforms, expanding the access and expanding that distribution, expanding with new products is really helping to support that growth rate that we've talked about that target of that 7% to 10% that we talked about in the medium term and the success we've had over the last couple of years in that business.

And can you expand on the opportunity to bundle global data at lower cost than incumbents? And what is like the demand for multinational financial institutions for that data? And how does that improve their ability to save money in the face of a recession or compressing costs?

Yes. I think that what depend here's what we're seeing is they've given us feedback of some users may say, may not need the expanse of all this data. I may need reference data. I may need reference data from different markets. And when you can able to bundle that and really save that money. And particularly on an enterprise basis, that's where you start seeing demand, right? Because anytime you switch a market data vendor or add something new, there's some work on the back end that they must do. That's a real cost for them to be able to take a new feed depending on the protocols that they have. So continuing to listen to them, and this is how it's going to help them business. That's why we've continued to modify the products to be able to pull that bundling and unbundling of data that is most applicable to them and odds are, it's not just them. There's going to be multiple people in their situation that they're going to see the Canadian or call it a more complete North American perspective of equity market data or they really need more around what they're looking at in Japan as far as where a data feed is coming from or we'll see more and more of the European and the U.S. So its listing of that feedback and that bundling has really kind of given us a nice road map to be able to continue to provide new products. Again, looking at how does it save them money, and it becomes a new revenue stream for Cboe that may not have assisted before because somebody is going to be trading is going to need that depth of book data in all of those markets. going to need that no matter what. So they may not be switching per se. But like I said, other people may have different needs that is just we're in a unique position to be able to provide that, that others just can't right now.

Brian. Cboe has pretty robust growth prospects in 2023. How are you able to balance near-term margins versus investing in the future?

Yes. So we take a -- we've been very transparent about what our investment objectives are and what we think that's going to take. And I think you've seen really strong revenue growth in the last couple of years. You've seen us also then lay out here our investment plans that we're going to invest today dollars. we are willing to sacrifice some margin compression in today dollars for that longer-term revenue growth. And we've been very clear about where we're driving those expectations. So we have set longer, call it, higher than industry averages as far as revenue growth expectations. And again, you've seen some of that expense expectations being higher than maybe some of our peers. But again, it reflects our higher revenue and earnings profile as well. So we take a look at it. And so as long as we believe we have that opportunity to grow that long-term revenue and long-term earnings, we're going to continue to try and highlight those investment high-conviction opportunities that we have. We're going to be very, very mindful, though, of growing earnings. This is not about just expense and spend. This is about being very calculated investment by investment initiative by initiative. And frankly, if something is not working, we'll turn it off. As soon as we see it's not working, we're going to turn it off and hopefully sooner than later, but there are a few items that are going to require that spend upfront, and we have a lot of conviction around that we're going to pursue. And like I said, it's going to take a couple of years. It may take a '22, '23 spend for a 24/25 revenue payoff, but we believe, and we think we have a track record of those investments with that revenue growth in the longer term.

I just wanted to follow up. As we think about spending 24, 25, do we think about a step down in terms of total expenses?

So to be careful, I want to provide guidance for '24 and '25 in what I think what -- as we look at that longer-term growth rate, as we look at our longer-term modeling and investment opportunities, as we look at us to continuing to start to scale up, we would expect a moderation certainly of that expense growth rate in '24 and '25 as some of those -- we see current initiatives rolling off in '23, we have some duplication of our expense cost structure going on right now. we, for example, migrate platforms as we build out, say, APAC and BIDS that may not need as much of that spend or will go away as those integration projects come to completion and build outcomes on completion that becomes to a little bit more of a steady state as far as the growth rate. So we absolutely would expect to see some of that moderation in '24, '25 in conjunction with incremental revenue growth as we've talked about.

What are Cboe's capital deployment priorities for 2023? And how do you think about the mix of organic growth de-leveraging following mergers and acquisitions and repurchases versus growing the dividend?

Yes. So I think we've been very clear about our priority around organic, right? So you've seen our expense guidance about that continuing to be able to fund that future revenue growth, even if it's on the back of an M&A transaction, that came a year or 2 years ago and then being able to grow that organically once we have that infrastructure in place or adding infrastructure to enable that incremental organic growth. So that's always going to be the #1 priority as far as that organic growth. And then from the M&A front, we've talked about that those transactions have always been about continuing to get us to scale in getting those opportunities, leveraging our core. Independent of that, I think our balance sheet is in a really good position as far as our leverage ratio. So I don't see the incremental benefit of continued de-levering. If there's some opportunity, we'll take a look at it. But it's really -- I would say it's been more about -- we see an opportunity around share repurchase that we've said -- we've always said that we will repurchase shares opportunistically. And I think we're going to lean into that. As far as the dividend goes, I think we've always been competitive as far as taking a look at where we are, the dividend payout ratio, does it make sense. We want to continue to grow it. And so we won't change that. We'll is sacrifice it. But as I said on our earnings call, we would see that we expect there's a greater opportunity for share repurchase, independent of, wow, there's this M&A opportunity that had come up, we're always going to want to look at that, should it arise. But again, I think the focus will be more on share repurchase and dividend- outsized dividend growth rate.

At this point, we can pass to take investor questions. Please raise your hand, and we'll bring forward a microphone. And while we're getting this square away, how is the Cboe digital opportunity evolve? And what is your outlook for the business?

So as we set out to really bring transparency to the digital experience for customers, it was really with the customer in mind. The philosophy that a new asset class needs to or the expectation should be different than the established asset classes really didn't make much sense to us. So in the digital vision was to continue to partner with introducing brokers and intermediaries that add to the experience. So the Cboe digital road map is to do just that. That is a syndication that we built with the customer in mind, our market quality to date, for example, in Bitcoin is second to none with the onboarding of many of our syndication partners. That market quality is pretty terrific. The transparency and transaction are very, very clear. We're still waiting for CFTC approval on margin futures. And then we're into the next phase of the rollout of Cboe digital. We, like every other exchange and then some of the platforms that continue to operate in the space are still looking for regulatory certainty around oversight. But in the meantime, where we have certainty in the 2 Bitcoin we'll just be concentrating on the experience, the rollout and the onboarding.

And just to add to that also is the -- we talked about some incremental products back to your DnA and the growth and adding new products. We're adding we've just added is the market data to our existing Cboe feeds as far as it's coming from the digital channel. So that tightness of that spreads, where they're seeing trading on those core coins that we have do listed on that platform. We've added that market data distribution again, to continue to enhance the value that people are seeing coming from Cboe.

And with that, I think this is a good place to pause. Ed and Brian, thanks again for joining us today.

Thank you.

Thank you.