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

Great. Thanks, everyone, for joining our virtual fireside chat this afternoon. We are very excited to have the CME Group with us today. I'm Brian Bedell. I cover the brokers, asset managers and exchanges here at Deutsche Bank. And joining us on the phone are CME's CFO, John Pietrowicz. And we're also very fortunate to have Sean Tully with us, who heads up CME's financial and over-the-counter products. I think most people know both John and Sean, but I'll just give just a quick introduction. So John has served as CFO since the beginning of 2015 and has been with CME since 2003, most recently as Senior Managing Director before being CFO in Corporate Development and Finance, which included oversight of new business opportunities. And Sean has been the Global Head of Financial and OTC products since 2014 after joining CME in 2012 with responsibility for the interest rate, equity and foreign exchange and OTC cross-asset product strategies. I know they like to call him Mr. Innovation internally at CME as he's driven the creation of many new futures and options products across the financial spectrum, several of which have been the most successful new products at CME in its history, including the Ultra Treasury bond future, and more recently, the E-micro S&P future.

Anyway, thank you both for being with us today. So I'll start out with some questions of my own and leave some time for questions for the participants. And just quick instructions on that, you can ask questions via the web portal or you can e-mail me at [email protected]. So maybe I'll start with you, John. Can you give us an update on maybe just how work from home is going at CME? And when you might reopen the trading floors? And how exactly would you do that?

Thanks, Brian, and thanks, everybody, for joining us today. Appreciate your interest in CME Group. I think the -- when you take a look at how CME performed in the first quarter, it's not -- it'd be difficult to not be happy with the way things have progressed. Our employees at CME Group adopted -- I'm sorry, adapted well to the remote working environment. We had, along with the futures industry, run numerous exercises to ensure that we were prepared to work remotely should that be required. So I think when you look at the first quarter, things went about as smoothly as you could have hoped during a very challenging time. And when you look at the amount of volatility and the amount of activity we were able to handle, the markets functioned well and the risk was effectively managed. So pretty pleased with the way things went in the first quarter under the circumstances and very proud of the entire organization in terms of how they adapted to those challenges. In terms of the floor, we have not determined when it will be reopened. As you know, the trading floor is a very close environment, which makes reopening it especially challenging. And we'll make that decision along with government and health officials. So we'll update everyone once there's clarity on the situation. But right now, we're continuing to look at different scenarios on how that will happen. And we're going to have to work with the -- with health officials and the government to make that determination in terms of which way we'll go with the opening of the trading floor.

Yes. Yes. That makes sense. And obviously, a lot of -- most of your volume is done on Globex. But maybe...

Yes. Correct.

Maybe to what extent do you think work from home is reducing trading volumes just broadly across the industry in futures? And what are your users asking about in terms of trading functionality and how your support staff is servicing them? And obviously, while trading previously done on the floor has I think largely completely migrated to Globex, do you think reopening the floor would have any significant impact on volumes or we're really at the midpoint?

Yes. Great. I'll take the first part of that. And then maybe, Sean, you can comment on kind of the migration from the floor to Globex with primarily -- it's primarily Eurodollar options, which is traded on the floor. So I think the near term, the entire industry performed very well during the heightened level of volatility. And as I mentioned, we have run scenarios with the industry to ensure that should there be a crisis, business could be handled. There was about 27 million contracts traded a day. And risk was well managed during the work-from-home environment. And again, there are stresses that had to be managed, and I think we did a very good job of managing that. In terms of services to our clients, we took a very proactive approach, which was really well received by our clients. And the feedback we got is that differentiated us from our peers. So our sales force, which we've invested in around the world, really, again, proved very effective in terms of helping our clients navigate these difficult times. So our sales activity through April was up about 150% compared to the same time last year. So that kind of shows you how active we were during this period of time. And when you look at our cross-sells, so we had acquired a couple of businesses from -- when we acquired NEX, which was EBS, which is cash, FX and BrokerTec, which is cash treasuries, we did a lot of cross-selling during this period of time to our cross introductions. And so that was up from -- we did about 400 for all of last year and we did about 290 through April year-to-date. So very active in terms of cross introduction. So really, utilizing all the tools that we have at CME Group and all the resources that we have at CME Group to help our clients with this difficult period of time. Sean, do you want to touch on the trading floor migration to the -- to Globex?

Sure. Absolutely. Thank you, John. I'll first talk about equity options, which -- standard equity options which have been on the floor. Then I'll move over to the interest rate options. And then last, I may add some remarks on the cross-sell. In terms of the equity options business, standard options which were on the floor, prior to the close, we're trading at about 30,000 contracts a day. With the closure of the floor, we lowered the block threshold of our standard options and we have allowed block trading in those standard options. And we're doing about 15,000 contracts a day. So versus the 30-or-so-thousand we did prior, specifically in the standard. Standard options, the people know, are much larger contract size. The -- what's the benefit there? So a lot of it moved to blocks. But in terms of investor benefit, the RPC on our standard options on the floor are less than $1, about $0.92. The RPC of our standard blocks, which is converted to, is a bit over $2. So it's got more than double the RPC relative to about half the volume that's moved from the floor to blocks. In addition to that, the rest, we believe, has moved into our micro -- sorry, not our micro, excuse me, our E-mini options. Not our micro, our E-mini options. So we do believe that we've seen a complete migration of that equity options business from the floor to the electronic relative to those 2 venues. Actually, I have Micro E-mini options, on the mind, why? Micro E-mini is a great innovation that we launched last year, doing about 1.5 million contracts today, this year. Really unheard of in terms of the launch of a new contract being that successful over that short period of time. Why is it on my mind? Well, we announced today that this fall, we will be also launching our Micro E-mini options. So we're excited to launch those this fall. In terms of our interest rate options, our interest rate options transitioned very well from the floor to the electronic trading. If you look at the percentage, one of the metrics we look at is our options, marketplace volumes as a percentage of our futures volumes as some sort of a metric as to whether or not the options market is doing well. And I'm very pleased to say that in 2019, our Eurodollar options were trading at 62% of the average daily volume of our Eurodollar futures. And post the closure of the floor, our Euro options trade 62% of our Eurodollar futures. And we have similar results for our treasury futures. Overall, our -- if you think of our interest rate options, in 2019, they traded about 36% of our overall interest rate futures business. And they're trading between 35% and 36%. So almost the same model post the closure of the floor. So those transitions seemed to have worked very well. We also worked hard over the years to increase our electronification and to improve the electronic handshake to make the experience more like the floor. One of the facilities that we created a year or 2 ago now is something called Committed Cross, a special functionality electronically that's more similar to the on-the-floor experience. And it was only trading about 10,000 a day in January of this year. Post the closure of the floor, it has had days as high as 70,000. So a new innovation to go from 10,000 to 70,000 a day, you can see great value added to market participants relative to using it, relative -- as a substitute really for that floor experience. So I talked about -- a bit about before, it looks like everything has migrated well to the box. And in some cases, at a much higher RPC. And then if we move over to the cross-sell, I would just add to what John said. Everything that John said is absolutely correct, but I have an update because I spoke to the head of sales yesterday afternoon. And while we saw a bit of a dip, not a big surprise, during March and April in terms of the cross-selling and cross-referencing, we've had our strongest month ever in May in terms of the cross-selling and cross-referencing and cross introductions. So 278 in the month of May alone, 674 this year in total, if you include what we've done May year-to-date. So that's doing very well and just adds to what John said earlier.

Yes. No. That's amazing. Maybe switching to more conversation about the whole rate franchise. Sean, obviously, you're front and center in this. I've got a whole series of questions, but maybe if I can sort of categorize into 2 main categories. One is the maybe describing -- we can start with this one and then I can go into the series of questions on the second part. But the first part is the drop-off in volumes. I mean, obviously, volumes are extremely strong in -- starting late February and then all through March, and then began to drop off more in April, May. So maybe if you can just go through some of the drivers of the drop-off. Typically, we do see this after volatility surges, but maybe you can bifurcate that between the short end of the rates complex and the long end. And then I'll ask a few questions about growth initiatives, and I know you've been big on treasury issuance and how that could -- that should impact the rates franchise going forward. So maybe just start with the first part, and then I'll go into a couple of questions on the second -- on the growth angle.

Yes. Thank you, Brian. I really appreciate the questions. Clearly, it was a huge volatility in rates during the March and April periods. And March, in particular, obviously, huge volumes, record volumes for the business. What's happened? Yes. When you see a massive spike then in margin requirements on the back of the higher volatility, you do typically see a calmer period afterwards and lower volumes, and that is very typical of the marketplace through the years. The other dynamics I would mention is on the very short end of the yield curve, the Federal Reserve is now expected to remain at 0 interest rate policy for an extended period. And that 0 interest rate policy will tend to -- with the certainty of those FOMC meetings remaining an unchanged overnight rate, you typically see lesser volumes in our Fed funds futures, in particular; and the front Eurodollar futures tend to get harmed somewhat. So if you look here, our STIRs, or short-term interest rate futures, are only up 7% in terms of average daily volume, whereas our treasury futures are up 18%, significantly higher. If you look at what we expect going forward and what we started to see last week, what you're also seeing at the same time is record new issuance by the U.S. Treasury. Folks will probably know the Federal deficit, CBO announced it's expected to be $3.7 trillion this year, which is a record outright deficit. It's also a record deficit relative to GDP. And this year, we expect, by the end of the year, you'll have a record debt-to-GDP ratio for the U.S. government in terms of its entire history, even higher than the debt-to-GDP levels reached during World War II. You saw the U.S. Treasury announced several new larger auction sizes, much larger auction sizes than anticipated by the market. And we see record auction sizes in treasury securities as far as the eye can see. Today, we're having a 5-year note auction, $45 billion worth of 5 years. Next month, we're going to see a larger 5-year auction. The month after that, a larger 5-year auction. So we'll have 3 5-year auctions in a row, each all-time records. Last week, the 20-year issue was the first time the Federal Reserve -- sorry, the U.S. Treasury is now going to be issuing the 20 years on a regular basis. It's the first time they've been doing that since 1986. If you look at the market impact, there are many different ways of looking at it. When the U.S. Treasury announced the much larger-than-expected issuance size, U.S. Treasury, for folks who don't know, publishes around 20-year point on the treasury yield curve. But in that day, you had a 9-basis-point increase in the 20-year point relative to the much larger issuance size than expected. It's expected $13 billion to $15 billion that came out of $20 billion, much larger than expected. So huge issuance for the marketplace to absorb. If you look at that relative to our futures contracts, there are a number of different ways to look at how that might impact us. A couple of things that we've included in our investor deck today. If you look at the 10-year projected deliverable basket for our -- sorry, our 10-year futures, that deliverable basket is expected to grow by 20% over the next 12 months. Similarly, the classic bond deliverable basket is expected to grow by 11% or 12%, and this is with the currently announced issuance sizes. And those currently announced issuance sizes, let's put that -- let's make that clear, that is based upon the stimulus packages that have been passed by Congress so far. So 20% growth in the 10-year basket, 11% or 12% growth in the next 12 months in the classic bond basket. And that does not include what may be another phase of stimulus. If the Treasury, if the Congress and the President pass additional funding, that will mean that they will have even more issuance and those deliverable baskets will probably grow even further. If you look at last week, in particular, we saw some significant growth. So if you look at the 20-year issue last week, that falls into our classic bond basket. And we saw our classic bond futures grow in relative volume. So last year, our classic bond futures made up 8% of our entire treasury complex volume. At the end of last week, the last couple of days, it was 13.3%. So it looks like that boosted growth by about 5 percentage points in our classic bond futures. Likewise, our ultra bond futures, which are longer-term than the 20-year, also grew from about 4.5% to 5.5%, so a full percentage point. In addition to that, I would mention that over the 2 days after the Wednesday auction last week, our open interest in our classic bond future grew by 15%, or about 160,000 contracts. So we are -- we do believe, right, that the -- we're just at the very beginning of the treasury massively ramping up efficiently, and we expect that, it's already been announced, to continue over the next year or plus. And we do expect that, that creates a lot more need for hedging. I hope that helps, Brian.

Yes. No. That's a good -- that's a great rate detail. And along those lines, obviously, with that issuance coming in, that creates some more opportunity, like you said, for trading. I guess what do you hear -- are hearing from clients in terms of different types of strategies that they're thinking about deploying as we sort of move through the year here. And then maybe just quickly on short-term rates, there's obviously a lot of debate about whether the Fed will ever go negative. Maybe if you can just comment on if that happens, can Eurodollars trade negative? Or would you see that as actually helping the Eurodollar trading situation given you would eliminate the lower bound, so to speak?

Sure. All good questions. Thank you. And I'll try and hit a few of them. So in terms of strategy, clearly, on the very short end of the curve, the next [ FOMC ] meeting, there's no expectation of a change in the overnight rate. So reduces the need to hedge that or the interest in speculating on it relative to our Fed funds futures. On the other hand, since the treasury announced a much larger-than-expected issuance sizes, and the CBO, a much larger-than-expected deficit, we've seen a 25 basis point steepening of the yield curve between 2 years and 30 years. Mnuchin has been very clear as President Trump was, even as early as 2016, that he thought even at the levels of rates that existed prior to the COVID crisis, that the treasury should be issuing as much long-dated paper as they possibly can to take advantage of these lower interest rates. So hence, the reason why you're seeing the steepening of the yield curve, and I'm quite confident that a lot of customers are playing that steepening in terms of their strategies. And they're using our futures in order to hedge their overall risk and to implement those strategies. The other thing I would mention relative to, again, the much lower growth. So our short-term interest rate, our STIRs complex, only up 7% in terms of the futures this year. Our LTIRs complex of 18% growth in terms of the futures this year. I would just mention that the RPC in our STIRs futures runs around $0.42, or the RPC, the rate per contract, of our LTIRs, our long-dated futures, are $0.57. So a much higher rate per contract relative to the volume. The other thing I would mention is, if you look at the growth of our complex, we grew, we innovated, and I appreciate you mentioning that earlier. We did a huge amount of innovation further out the curve in terms of deferred options, mid-curve options, quarterly options on the overall futures. We launched the new Ultra Bond futures, the new Ultra 10 future, successful new treasury futures contracts. With all of that, our back end of the curve business has grown tremendously since 2008. So the back end of the curve was 55% of our business in 2008. In 2019, prior to the crisis, we have 72%, even with an active overnight rate changing by the Federal Reserve. So we have seen good growth there. I apologize, Brian, I probably left off one of your questions.

No. That was just on the short rate side and the 0, the potential for the Fed to go negative, which, obviously, is debated. But -- and maybe if I could just actually move to -- I want to make sure I get this question, and that's the transition to -- from LIBOR. With the pandemic and everything, do you still expect that transition to happen by the end of 2021? I know you've been building the SOFR complex. So I guess the question is, do we still expect that transition to happen? And do you expect those liquidity pools in both the SOFR and the Eurodollar to grow into that?

Yes. So we've seen good use of both the SOFR futures and the Eurodollar futures through the crisis. We're very pleased with the growth of our SOFR features. Just as an update, we've got about 47,000 contracts a day. So far this year, we've got -- we recently had an all-time record, 145 large open interest holders, 435 participants. And we had as much as over 500,000 in open interest. We currently have about 460,000 in open interest. We've been running 84% of the global ADV in SOFR futures and 96% of the open interest globally. So very pleased with our growth there. We've also cleared $160 billion of SOFR-based interest rate swaps. We recently had a record month, March, of SOFR interest rate swaps. So we're very excited there. And as you know, we offer intercommodity spread trading between our SOFR futures and our Eurodollar futures. So the easiest way to manage that transition from a basis-risk perspective and the most efficient from a clearinghouse perspective with the portfolio margining we have between swaps and futures. The regulators seem to want to march on at a similar pace to the ones they have already been on. Currently, one of the next major steps in terms of the transition is the transition of discounting of U.S. dollar LIBOR-based interest rate swaps from Fed fund discounting to SOFR-based accounting. And we do expect that to continue to happen this year. So I think there are some challenges relative to the COVID crisis. But I think the regulators are generally trying to continue to march in that direction, and we've seen very good participation in our promise. In terms of 0 interest rate policy, I might hit that for a second. The potential for negative rates. We are prepared. All of our futures and options products can trade with negative implied yields, and they have traded at times with negative implied yields. So we are fully prepared. Our repo business, our BrokerTec already deals with negative rates in Europe. So fully prepared. But at the same time, we've seen several Federal Reserve members talk, I think, generally, not positively about negative rates, so I wouldn't give a big expectation there. But CME Group is fully capable of helping participants address them if they were to occur.

Yes. Yes. And it seems like the base case is it won't happen, but then things do change and obviously, speculation is really what drives your volumes at the end of the day. Maybe just moving to the E-micro contract. It's been so successful on the S&P. Just quickly, in terms of the growth potential for that, I think it's being traded mostly in the retail community. I know the online brokers definitely sees -- definitely are major participants. And then it's been so successful. What is the thought about microsizing? Any other kind of major benchmark contracts in either the interest rate or even the energy complex?

Thank you. A really good question. So the Micro E-mini's doing about 1.5 million contracts today. A huge success, I think, by any measure. The other thing I'd mention relative to investors is we did -- last year when we launched the product, we were very clear that we wanted to ensure a very, very positive experience for all participants on day 1, so they have huge liquidity available relative to trading it, and that we were very pleased with the liquidity, and that obviously did take an investment. And so our net of RPC was quite low in kind of mid to slightly higher single digits when we first launched the product. I'm very pleased to say, and I did talk on our earnings call, that we're more in the $0.11 or $0.12 area now in terms of the RPC on those micros. We did, when we launched, tell investors that we had made the investment and that we would reduce it over the time, and we have reduced it over time. So we're very pleased with that. We also announced today the launch of Micro E-mini options, which we will launch this fall. So we do see further penetration there. But honestly, we're very pleased with the growth of the product, the size of the product and our ability to reduce the incentives as we headlined.

Yes. No. That's great.

Yes. I think one other point on that is the -- it is a premium-priced product. So the fact that it's $0.11 to $0.12, that's really additive to our revenue. We don't see much or any cannibalization of our mini product and it's priced at a premium to our mini product.

Right. Yes. As people went out -- yes. Go ahead.

Yes. Underlining that -- thank you, John. That's a really good point, right? It's 1/10 the size of our E-mini. So that's the equivalent of $1.10 or $1.20 relative to the rest of our complex. And so a very significant premium.

Right. It would be accretive if everyone went to micros, of course. But...

It would be very, very significantly accretive. Yes.

Right. Right. I have a question that came in from the audience here and it's about the counterparty issues around the cycle. So obviously, Ronin had a default situation, but that was really it in what was an unbelievably extreme time frame in March. So the questions around why were there so few counterparty problems during this particular cycle, what would you attribute that to?

Well, I mean, I think the long and short of it is it was really effective risk management. We prudently increased margins along the way to make sure that the trades were appropriately risk-managed. I think our clearing house had done another fantastic job as they always have during these points of stress. And if you'd take a look at our track record, over more than 100 years, we've done a tremendous job during these situations in terms of managing the -- our clients' exposure. And that's -- at the end of the day, that's absolutely critical, and that's what we -- that's what we've done. In terms of Ronin, in particular, it was a very small client. It did not have customer activity. It was their own activity. And when that was addressed, no customers were hurt, no FCMs were hurt and our capital was not touched. So again, I think it demonstrates the effectiveness of our risk management processes and techniques.

Yes. Very good. We have two more questions online. I think we have time for both of them. One is just on the energy complex. Obviously, with WTI going negative for a brief period of time a while ago, maybe just talk about how that benchmark is trading, how you see that positioned versus Brent. And obviously, across that energy complex, maybe sort of the process of -- or the prospect rather, of having that become even more of a global benchmark with exporting.

Yes. Sure. I think the oil market during this volatile time performed as they were designed. So we believe that the optimal commodity benchmarks are based on physically delivered products because that ensures convergence with the underlying cash market. So when you look at the underlying production data for WTI, it's about 10 million barrels per day versus the Brent, which is at about 750,000 per day. So about 93% of the production is in WTI. If you guys have access to our deck, if you look at Slide 23, if you -- since the lifting of the crude oil export ban in 2015, WTI has outperformed Brent every single quarter. In Q2 of this year, we're at about 60.5%, which is the highest percentage we've recorded since we tracked it in terms of share. So if you look at -- when you talk about other kind of other products in the energy complex and I think nat gas is also one we should be taking a look at, and that's another area that we've had really solid performance. In terms of the benchmark Henry Hub contract, we're about 4x larger in terms of market share than relative to ICE, and we've done I think a nice job of electronifying that business and making sure that business has been very sticky with the Henry Hub. But I think the important point is that having these physical benchmarks which converge to the underlying cash markets is very important because it really ties it to the real economy.

Yes. That's a good point. Okay. I think we have time for one more question here that came in. And that's on -- and that would be for you, John. It's about the variable dividend. I think the way you attribute the cash flow from the volumes, that there's a little delay on that. So that didn't -- I believe that a lot of the volume in March did not show up in your balance sheet on the cash side, so a lot of that's coming in April. So maybe if you can just talk about how you're thinking about that annual variable dividend. And I guess just the importance of having a high dividend yield versus some other companies that are cutting dividends. And obviously, in this low rate backdrop, are you hearing that as a more positive attribute from investors? And are you thinking about trying to maximize that variable dividend in that context?

Yes. Thanks, Brian. Yes. We're very pleased with our capital return policy. We know it's important to our investors, and I think we've done a tremendous job being very consistent in the application of our capital return policy. And when you take a look at this year, in particular, when you have a quarter like we had where you had about 1 -- in excess of $1.5 billion in revenue and approximately 70% margins, with incremental margins that were tremendous for the quarter, you produce a tremendous amount of cash. So we've gotten down to our 1x debt-to-EBITDA target. We have about $100 million in commercial paper, which we'll pay down between now and the end of the year. You are correct, the March activity, we have an auto debit that happens in April. And so the cash that we had on hand at quarter end, which is about $1 billion, didn't include March activity. So it's really a tremendous auto debit that we had in April. So in terms of our annual variable dividend, we're still targeting a $700 million of cash on our balance sheet at year-end. That's something that we'll review with our Finance Committee usually in the fall, but we're very -- we're comfortable with the $700 million. And I think our -- then we sweep the balance to our shareholders through the annual variable dividend. I think we're pretty pleased with the performance of the company, the cash generation of the company. We hit our capital targets in the first quarter. So we're pretty pleased with the performance.

Yes. That's it. It's been great, obviously. Well, I think we are out of time. So thank you both, John and Sean, for spending the time with us. We really appreciate it. And I don't know if you want to say any other closing remarks before we sign off.

Sure. Thanks, Brian. Thanks for having us and thanks, everyone, on the call for your interest in CME Group. If you have any further questions, feel free to reach out to us. I hope you and your families are safe.

Thank you, John. Thanks. You, too. Thanks, John, Sean. Bye.

Thank you.