CME Group Inc. (CME) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the CME Group 2020 Annual Meeting of Shareholders Conference Call. [Operator Instructions] I would now like to hand the conference to your speaker today, Terry Duffy. Please go ahead.

Thank you all for joining us this morning. We hope you and your families are healthy and staying safe. And we welcome you to the 2020 CME Group Annual Meeting of Shareholders. As the gentleman said, my name is Terry Duffy. I'm the Chairman and Chief Executive Officer of CME Group. In light of COVID-19, we made the decision to hold this meeting virtually for the health and well-being of our shareholders. We recognize this is not how you are accustomed to our shareholder meetings, and we thank you in advance for your patience and your understanding. So that we may address your questions from our shareholders of record during today's Q&A session, I ask that you please submit them now and please limit yourself to one question. These are extraordinarily difficult and challenging times for all of us. The COVID-19 pandemic has taken a devastating toll on human life and created unprecedented uncertainty around the world. It has also changed our daily lives in ways that seemed unimaginable only a few weeks ago. The heroes in this crisis are clear. Our sincere thanks go out to the entire medical community fighting this disease on the front lines and aggressively working towards a vaccine. We also want to thank the many first responders who continue to risk their lives to keep us safe. We are proud of the resilience of our team and how they've risen to this new challenge. Our employees continue to work incredibly hard to help our customers and partners navigate through this unique period with its increased uncertainty and volatility. Our systems and processes have performed extremely well with peak order traffic with very consistent response times. With that being said, let me remind everyone who is joining me on the call today. I have Kathleen Cronin, our General Counsel and Corporate Secretary; and John Pietrowicz, our Chief Financial Officer. Also, in attendance, in listen-only mode are members of the CME Group Board of Directors and our management team. A representative of Broadridge Financial Solutions, our independent inspector of election, and a representative from our independent registered public accounting firm, Ernst & Young, are also on the call. You will find the proxy statement, the annual report and today's agenda, along with the rules of conduct and information regarding our forward-looking statements posted in the bottom-right corner of the web portal you are listening to access this meeting. As set forth in the agenda, we will conduct 2 separate Q&A sessions. The first covering the official proposals to be voted on today and the second covering the general business of CME Group. Only validated shareholders as of the record date may submit questions in the designated field on the web portal. If you haven't submitted your question, please do so now. After the conclusion of today's formal business, we also will have a financial presentation by John Pietrowicz, our Chief Financial Officer. Now Kathleen Cronin, our Corporate Secretary, will present. Kathleen?

Thank you, Terry. Shareholders of record at the close of business on March 9, 2020, are entitled to vote at this meeting. Materials related to this meeting were furnished to all shareholders of record beginning on March 18, 2020. Information regarding the change to a virtual meeting was filed with the SEC and made available to shareholders on April 16. A list of registered shareholders entitled to vote at the meeting has been made available upon request for viewing for the past 10 days and is available for examination by any shareholder of record during the meeting through the web portal. I have been advised by the inspector of election that a quorum is present for all proposals, either in person or by proxy, except for part of proposal 4 relating to the election of the Class B-3 directors. In the absence of a quorum, no valid election of the Class B-3 director can take place under our charter and bylaws. As we disclosed in the proxy statement, if we did not achieve a quorum for a proposal, we would not adjourn that portion of the meeting to solicit for more votes. As a result, our existing Class B-3 shareholder, Liz Cook, will become a holdover under Delaware law and our bylaws and will continue to serve until her successor is duly elected at the 2021 Annual Meeting or her earlier resignation or removal.

Based on the secretary's report, I declare that this meeting is duly convened for proposals 1, 2 and 3 and for a portion of proposal 4. The polls for voting on all matters are hereby open at this time. It is now 10:12 a.m. If you have previously voted, there is no need to vote today. The polls will close after the proposals have been presented. All votes submitted today during the meeting will be subject to final verification by the inspector of election. The next order of business is a description of the matters to be voted on at today's meeting. Kathleen, please present those now.

All proposals presented today are described in our proxy statement, which may be viewed on this meeting's web portal. The first item is the election of 17 equity directors as set forth in the proxy statement. Item 2 is the ratification of the appointment of Ernst & Young as our independent registered public accounting firm for 2020. Item 3 is the approval of an advisory vote on the compensation of our named executive officers. Item 4 is the election of 3 Class B-1 directors and 2 Class B-2 directors as set forth in the proxy statement. The Board of Directors has recommended that shareholders vote for proposals 1, 2 and 3. No recommendations were made in connection with proposal #4. Terry?

Ladies and gentlemen, this concludes the introduction of the proposals to be presented at the meeting. We will now proceed to the Q&A session related to the proposals being voted on today.

Mr. Chairman, I can confirm that we have not received any questions relating to the proposals for today's meeting.

Thank you very much. With that, I hereby declare the polls closed as of 10:14 a.m. Central Standard Time. Now I'd like to ask Kathleen to present the preliminary unaudited report of the inspector of election.

The inspector of election has tabulated the preliminary voting results relating to proposals 1, 2 and 3, which show they were approved as recommended by the Board. The preliminary voting results also show that in the election of 3 Class B-1 directors, Will Hobert, Patrick Mulchrone and Robert Tierney have been elected. In the election of 2 Class B-2 directors, Michael Dennis and Patrick Maloney have been elected. As we previously reported, Liz Cook will holdover as the Class B-3 director. These results are subject to final verification in accordance with the SEC rules. We will file a report containing the final tabulation with the SEC within 4 business days.

The report of the Corporate Secretary and the preliminary voting results is accepted, and that completes the formal business of the shareholder meeting. I hereby declare that the 2020 Annual Meeting of Shareholders is adjourned as of [ 10:10 ] and 10 Central Standard Time. Now I would like to give a few remarks as it relates to our trading floor before I ask John Pietrowicz to give his comments on the financials. As you know, we took action in March to close our trading floor based on medical guidance. Now 6 weeks later, the coronavirus remains fluid in our state and around the country. Recently, other companies have talked about their time line for reopening trading operations. Our situation, however, is complicated by the unique nature of open outcry trading in our markets. As anyone who has traded in an open outcry pit can attest, there is no way to effectuate social distancing requirements. Solutions that may be practical for other trading environments are unworkable for our trading floors. At this time, I can't provide certainty as to the date the floor will open. I can tell you that the earliest we will open the floor will be 3 weeks after the lifting of the Illinois stay-at-home order. Even then, we will not reopen unless it is permissible under local, state and federal guidelines. When we are able to reopen the floor, we will do so in a phased manner, beginning with the opening of Eurodollar options pits. Because the nature of open outcry prevents social distancing and other measures we expect to put into place by -- and other measures we expect to be put in place by other businesses, we will encourage traders, clerks and any other people that request access to the floor, facilitate trading, take precautions and consult with their own doctors and experts on whether to return to the floor. And if so, what precautions they should take. Finally, I cannot stress enough that we will not be able to guarantee the safety of traders, clerks or other trading personnel that choose to access the trading floor. It will have risk and will continue to have risk until there is a vaccine or some other cure for this disease. For that reason, anyone that would like to resume trading on the floor or access the floor to facilitate trading will be required to sign a waiver of acknowledgment and accepting the inherent risk this disease presents in the open outcry environment. I'll be happy to take more questions on this as the meeting goes. But with that, I'd like to turn the call over to our Chief Financial Officer, Mr. John Pietrowicz. John?

Thank you, Terry, and thank you all for joining us. The first quarter results are very strong as we helped our global customers manage risk 24 hours a day. With a heightened level of volatility, we reached record quarterly trading volume, revenue of more than $1.5 billion and an adjusted EPS of $2.33. You will find a reconciliation between our GAAP and non-GAAP measures on the last page of our Q1 earnings release available on our website. The entire organization managed expenses very carefully. Our adjusted expense base, excluding license fees, was 4% lower compared to Q1 of last year. This resulted in a very strong operating margin for the quarter. The investment in our technology and the dedication of our employees served our clients well during this unprecedented time as first quarter volumes reached all-time highs across many different product areas as our clients around the world managed risk. Average daily volume for the quarter was 27 million contracts, up 45% from the first quarter of 2019. We've made a significant effort to increase our global sales presence. We began to make an investment several years ago to deepen our client coverage around the globe and has proven to be very effective. Today, more than half our sales staff is based outside the United States. We have sales professionals in 19 cities located in 15 countries around the world. Our volume in the first quarter from clients outside the United States was particularly strong, averaging 7.3 million contracts per day, up 56%. As a result, clients continue to be able to manage their risk across all products in all time zones. Risk management is always a focus at CME Group and it proved resilient through this crisis. In response to increased levels of volatility, we raised margins on many products across most asset classes. Our sales, product management, clearing and operations teams have worked closely together to handle client engagement during this pandemic with client interactions at a record high. Client feedback consistently mentions that our proactive outreach stood out compared to others in our industry. The market environment was very challenging for all of us on a professional and a personal level. I am very proud of the dedication of our employees as they help our clients navigate through this difficult time. We also appreciate the trust that our clients have in our ability to deliver results. During the quarter, CME Group paid out $1.2 billion to our shareholders in the form of our annual variable dividend of $2.50 per share and our regular dividend of $0.85 per share, which is up 13% from a year ago. CME Group's cash at the end of the quarter was approximately $1 billion. We believe our innovative and unique return of capital policy continues to serve our investors well. Since we adopted this policy in 2012, we've returned $13.5 billion. In summary, we are very pleased with the performance of the company. Our employees adapted to the challenges of this environment and work relentlessly on behalf of market participants. Our global employees, along with the investment we made in our technology systems and processes, ensured the markets operated well and risk was effectively managed. I'll now turn it back over to Terry. Thank you.

Thanks, John. We will now proceed to the Q&A session relating to the general business of the company. We will pause just for a few moments to collect the questions being submitted via the meeting portal. And then I'll ask Meg Wright to go ahead and read those questions to me as they come in.

Sure. Mr. Chairman, we did receive a few questions relating to the trading floor, which were answered in your prepared remarks. And then I'll go forward and read the other questions we've received relating to other business-related matters.

Okay.

With the success of E-micro equity futures over the past year, are there any plans to add additional Micro futures contracts?

Well, thank you for the question. The Micro contract has been obviously very successful for CME Group. One of the ideas going into the Micro, as you know, people that have been in this business for a long time, we saw the valuation -- the growth of the S&P 500 in pricing, which made it an extremely large contract. And then we created the E-mini in 1997 to the smaller version and then the contract, obviously, is still growing, not just in volume-wise, but in the valuation of the S&P 500. And it made a lot of sense to continue on with the Micro contract, which suited a lot of not only just professional retailer but professional needs in general because of the pure size of the value of the contract. So that was really the genesis of bringing forth to Micros. And now there's been a lot of talk, because of the success of that, why not do it in every single product. A lot of the products have not had the same growth in valuation like the equity markets have. And for our standpoint, we think our products that we have today fit the needs of the risk management that people would have to use those products. Again, I think more of the valuation of the equity pricing going up that was -- helped to make the Micro so extremely successful. We will continue to look at this product line and decide if we want to add it to other asset classes. But as of right now, we will continue with the equities only on this product line.

Okay. Moving on to the next question. Are we near a stock split?

A stock split is something I was very much a proponent of when we did the first one. We did the 5-for-1 split many years ago. I think it suited the company quite well. It helped diversify our holders into a whole new group of people. When you look at the price of the CME since it went public in 2002 at $35 a share, roughly, it's come a long way. And then, we did the 5-for-1 stock split. As of right now, we're always looking at what is in the best interest of our shareholders, whether to split the stock or not. And we'll continue to monitor that, but there's been no decisions made.

Okay. Moving on to the next question. What is the rationale for taking away the rights of members to nominate their own representatives for the B share Board of Directors?

That's a great question. So obviously, we had a -- over the years, the company has evolved immensely and the core rights are exactly what they are. And we wanted to make sure we never infringe on the core rights. This was not part of the core rights to keep the Nominating Committee. We were having trouble over the years making sure that they could actually get candidates in to be interviewed and to decide that they want to run. The process got a little bit unruly, and we felt that we -- streamlining the process under 1 Nominating Committee made a lot more sense. That being said, we obviously are very aware of the qualifications that all directors must have and we're also aware that the representation that originally comes from the B Directors is very valuable. And we'll continue to make sure that we go on a path that the people that are -- have the qualifications under the Class B Directors today will have those qualifications tomorrow. So we just thought this -- the process -- it was time to streamline it and make it more efficient. Meg?

Sorry. Next question. What is the future of the B shares?

I mean the future of the B shares, I think is the same as it's been historically. I mean the B share is something that people use to either access the trading floor or to get a different rate than a nonmember. And that is exactly what they're there for. What the future is, it's really difficult for me or I think anybody else to predict. If you're talking about the value of the B share, I don't know, markets go up and down. If you're asking the question, are they going to exist? There's no plan in place right now to extinguish the B shares. So if that is the question, and this is the hard part about doing a virtual meeting, I'm not quite sure what the question is referring to, whether it's the valuation or the likelihood of these things surviving. But there's no plans that myself or the Board has in extinguishing or eliminating the B shares. Meg?

Yes. Next question. Any consideration to adding a cannabis futures contract?

Cannabis futures. Obviously, that's -- I don't want to call it controversial because I think we're probably behind that. As you know, CME Group is a federally regulated entity, and cannabis is not a federally allowable product. It goes state by state, still to this point. So I don't even know if we could have the ability to list that contract under the law. I'm pretty certain we cannot. And I can ask Kathleen to jump in if she wants to correct my answer. But I've said this before. I think when you're looking at cannabis and how people are saying is very much in vogue and how more and more people are using it for all these different reasons. A lot of them are supposedly very good. I look at this and I say, it's not a soybean contract. It's not a corn contract. 9 billion -- 7 billion people need to eat every single day. 7 billion people don't need to use cannabis every single day. So I don't know if we would have the same reach as other products that we participate in today that are needed to risk manage globally. So I'll give that from a practical standpoint. And then from a legal standpoint, I don't believe we have the right to list a contract that is not federally approved by the government. Kathleen, do you want to add to that? Or is that acceptable answer?

Okay. I can move on to the next question, which is a follow-up question regarding the opening of the floor. 3 weeks after the lifting of restrictions of the state to open the floor is for Phase 4 or Phase 5. And then they ask, Phase 5 is a vaccine. So are we waiting for a vaccine to open the floor?

No. I didn't -- I don't know what's Phase 4 or Phase 5. I don't know what they're referring to. Maybe if you reread that question to me, I'm assuming that's some Illinois language that is being used by the governor on his phasing process. So Phase 5 or maybe that's the general language used by the Trump administration, I'm not sure. So Phase 5 would be the vaccine, I assume, is what they're referring to. Are we waiting for that? No. We're waiting for, if the state, local and federal officials say it's okay to have more than 10 people, more than 20 people, more than 50 people gather into these certain locations, then we -- as long as we abide by that. Now just to give everybody a sense of the trading floor population, between clerks, members and CME has roughly 54 employees down there. On a good day, potentially during rolls or others, there could be up to 1,100 people accessing that trading floor on a single day. So I think the average is closer to 500 or 600. And I don't know if 500 or 600 people is going to qualify under a particular phase that the government has laid out. I don't think they've gotten that specific. So once they say that we are able to go forward, we will go forward 3 weeks post, as I said in my prepared remarks, but we will go forward with everybody needing to sign a waiver on that. As I said earlier, it's impossible for us to take everyone's temperature. It's impossible for us to make sure everybody keeps their mask on and be responsible for that. It would just -- it would never work. And it's impossible for us to police social distancing in a trading environment of options and futures. As we all know, those are very close proximity transactions that people are next to each other. And I did it for 22 years myself. So I'm very much aware of how the open outcry trading proceeds. So -- and as long as we are allowed to open that floor, we will go forward and open that floor 3 weeks post that approval.

Okay. Moving on to…

We don't need a vaccine or therapeutics. I need to have the fed -- the state, federal and local governments allow us to have open what we have in place today. And then as I said, the guidelines will be to sign a waiver.

Moving on to the next question. How is CME using B shares to increase volume in new contracts?

CME is always looking to create liquidity in all of its markets. We have several market-maker programs through all of our different asset classes at different times in the contract's history, depending on what's going on. So as we all know, there's a large portion of the trade that goes on in CME's roughly 17.5 million ADV, which is where we're at trending about right now year-to-date ADV. That -- a big portion of that is used by member trading or B shareholders. So a lot of the products that are being -- the liquidity that's being facilitated is done by members or B shareowners, as you like to refer to them as. So yes, B share -- liquidity providers are extremely important through programs, and most of them do have B shares. Obviously, not required, but a lot of them do.

All right. Moving on to the next question. How has the closure of the trading floor hurt the revenue of the exchange?

It's -- and John, you can jump in here as well. I will tell you that the overall business in -- we'll just use Eurodollar options as the main catalyst because that's the largest product that's on the floor. That has not changed since the day we closed it as far as the volume was. Now obviously, the last 2 or 3 weeks have slowed down a little bit after the intense volatility that we saw in the prior 1.5 months. And then we also have a tremendous amount of policy difference that have come out with the Fed, and other stimulus plans that could have impacts on the Eurodollar options contract. But at the same time, we're seeing -- with the issuance of over $3.7 trillion coming out from the government and the Fed not suggesting it's going to acquire all that on its balance sheet, these -- a lot of these could have coupons associated with it, which would mean that people are going to need to manage that risk through our treasury complex. So we're extremely -- we want to make sure we can manage that risk, which we will always be able to. So I don't believe the liquidity has changed dramatically. And from a revenue standpoint, it did not change during -- if you look at the period from the day we closed to where we're at right now. Because you have to factor in, there was some extremely busy days and some slower days. So John, you can maybe give a little bit more of an indication of the numbers.

Sure. Thank you, Terry. Yes, when we take a look at the percentage of options as a percentage of futures, it's been relatively consistent post the floor closure as we've seen historically. So from that perspective, it's been relatively stable. It's something that we'll continue to analyze. And in terms of the amount of revenue generated, no, it hasn't been really any material change from pre floor closure.

Thanks, John. Meg?

Next question. I assume most employees are working remotely. How are they adapting to that?

It's a great question. Julie Holzrichter, my Chief Operating Officer, is also on this call. So I'm going to let Julie talk a little bit about how we're doing on the work-from-home. As you know, CME Group has roughly 5,000 employees throughout the world. So it's a population that's very diverse in nature. So Julie, why don't you give a little bit of an update on how the work-from-home is going?

Thank you, Terry. Yes. So CME Group was able to transition to a work-from-home strategy very early, actually prior to the stay-at-home order was actually received. We were able to do that successfully. The majority of our staff are working remotely. And we are experiencing extreme productivity. We've had great collaboration due to the technology that we put in place that allows us to interact with our clients as well as with each other. We've been very, very pleased with the process. And our employees have indicated with a high -- and within the high 90 percentile that they find that the work-from-home experience has been very well for them. So we are really confident that we can continue to work in this situation for as long as we need to.

Thanks, Julie. Meg?

Next question. Please comment on prospects for state or federal government to impose a transaction tax.

For state or federal government to impose a transaction tax?

State or federal government to impose a transaction tax.

Sure. Thank you. As we all know, and people have been around this business a long time, the financial transaction tax has been proposed for probably the last 30 years or so. And we have been able to make certain that we continually educate elected officials on the detriment of trying to impose a transaction tax on a business that would be detrimental to the consumer. So I say that for the following reasons: if the spreads widen between the commercials and the other participants in the cash market, someone's got to assume that risk of the extra cost. And if the trader embeds that into his spread, it's going to eventually fall to the consumer at a higher cost because the risk management just went higher. So it's truly a penny-wise, dollar-foolish proposal. I've been arguing this for over 19 years now on that exact argument. And I think it really resonates with people when you remind them that you're trying to score -- I don't know how many billions over 10 years, it's a small amount. And at the same time, you'll be impacting liquidity that will be pricing in that transaction tax. So everybody thinks the trader will pay for the tax. The trader will just embed that price into a spread, and eventually, the consumer will pay for that, and that's not a good outcome. So again, I think there's going to be a lot of proposals, especially in lieu of where we're at today with COVID and with the additional deficits that we are all assuming around the world to fight this disease. And -- but I think we are more than prepared to continue to make our arguments of how detrimental this could be to the financial fabric of the United States and to the consumer. So again, I'm very confident in the information that we have as it relates to the financial transaction tax. Right now, it is always and will be a bright shiny object in any room that politicians want to point to, to say that, that looks like easy money. And then when you walk through how -- what the consequences could be, I think cooler heads will prevail. It doesn't mean it's ever going to go away, though. And I've said that forever also. It's just -- it's still here. So we'll continue to educate. Meg? Counselor, you there?

Yes. Terry, it's Kathleen. I'll give you the next question. It's, please define what extinguishing B shares would entail.

Please define what distinguish...

Extinguishing. Extinguishing B shares would entail.

Well, it's hard to say what it would entail because we don't have any proposals to do it. So I would only be speculating on what it would look like, and I'm not going to speculate. So I'll avoid that question because it's just there's been not any conversations around eliminating the B shares. And if you were to do so, you'd have to have a pretty well-organized plan in order to do so. So I'm not going to speculate on what we may or may not do on something we've not put any work into in the last several months or years.

Terry, the next question is, after the May 2020 crude oil contract was allowed to trade below 0 after it said on the CME website that the minimum low was $0.01, there has been a lot of talk about WTI crude oil traders taking their business to the ICE contract. What is the CME doing to prevent our crude oil contract from losing users?

First of all, the CME has roughly 56% to 60% of the global oil trade pre coronavirus and it still has 56% to 60% of the oil trade today. I can let Julie comment about the web. But we worked with the government agencies weeks in advance of the April 20, May contract expiration -- actually, April 21, but at the April 20, was a day it traded negative. We worked with government officials, and we informed all of our partner FCMs through our advisory notices that negative pricing was going to be available. Now what you're referring to on a website, I would have to refer to Julie as it couldn't go below $0.01 because I don't know anything -- Julie, if you're aware of that, I think that was a recent technology glitch on our website as it relates to the pricing of TI. Julie?

Yes, I'm sorry. I'm not aware of an issue that we had on our website. I will say that, again, roughly 2 weeks prior to the expiration, we did communicate that given the fundamentals that were occurring, we would allow for negative pricing. So we did communicate that to our market participants and our clearing firms. And obviously, we did that because we saw that there was, again, fundamental reasons for us to allow price discovery to occur.

So I think what the question is referring to that there was a -- for a brief moment in time -- I don't have that information in front of me, and some of the people are in listen-only mode, they can't even comment on this because of the way we structured this call. There was a brief moment in time where our website showed pricing that did not go negative, which was erroneous and we pulled it right down. But that was post, post, and that's the important part, of the April 20 negative minus $37 settlement on that Monday in West Texas Intermediate. So it had nothing to do with the website issue. The website was just -- that was -- it was an erroneous information on there for a very brief moment in time which was immediately corrected. I think that's what the question is referring to. But they're 2 separate events, and I think that's the important part of this.

Mr. Chairman, I can confirm that we have no more questions in the queue.

Terry, it's Kathleen. Can we just circle back to that cannabis question?

Yes?

I was having technical difficulties. I believe there are a couple of exchanges that list a cannabis contract that are regulated by the CFTC. So I believe it's legally permissible, obviously, if it otherwise meets the criteria under the core principles. Obviously, there's a number of reasons why we would decide or not decide to list a cannabis contract at any point in time.

Okay. Not to debate you, but there's reasons why exchanges in the United States don't list cannabis stocks, they got to be listed under cannabis. I'm quite surprised that the CFTC would grant the U.S. DCM the ability to list cannabis when it's not federally legal. But that's -- we can take that offline and get more information out to the shareholders. Okay. All right. What I can do is I will put more information out if it's necessary as it relates to the web page on the West Texas $0.01 issue. I am slightly aware of that. It just came to my attention the other day that happened the other day. It did not happen during the April 20 time period. So I just think it's important that we distinguish the difference. If there's no further questions, Meg or Kathleen?

No.

Correct.

Okay. Then I would just like to say that concludes our meeting. A replay of today's meeting will be posted on our website within 24 hours. I want to thank you all for attending. I appreciate your questions. I am sorry that I can't be there with you in person at different locations to discuss this. I think these are extremely important times. And I'd like to be in front of the shareholders and answer your questions. And it obviously is very difficult having someone read a question to you from a different location. We are -- but that is what it is right now, but I look forward to the time where we can get together and go through different issues as it relates to the company. So that being said, I wish you and your families nothing but the best of health and safety, and may God bless.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.