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

Welcome, everyone, back to the Piper Sandler Global Exchange and Financial Technology Conference. We're -- again, we're wrapping up exchanges now, but we're very pleased to have the CME, the Chicago Mercantile Exchange, the Chairman and CEO, Terry Duffy as well as the CFO, John Pietrowicz. So the CME is known for its clearinghouse risk management. It's known for how it sits in between trades. And Terry, you and I chatted about this during the pandemic period. But first, welcome.

But then could you also update us on, as you told me, how you helped dug in at the clearinghouse during the really volatile periods of March and April?

So thanks, Rich, for having John and I. Sorry about the communication gap here and this problem. We are -- the clearinghouse obviously is a critical part of what we do. Yes, I'm very involved with all facets of the business, but the clearinghouse is something that I like to spend a lot of my time in because I think that's exactly what we do. We're about risk management. And I think you're referring to one of the situations that we had a couple of months ago with one of our members that we had to deal with when we dealt with another agency in an expeditious way. But the clearinghouse obviously is handling massive transactions through the Q1 and has been through the last several years, and it's something that we're highly focused on. But we put an infrastructure in place, which, as you know and the people that you talk to, is very much a part of CME Group. And for us, it's just kind of a matter-of-fact part of our business. When we do 50 million-plus contracts in a single day, we don't get overly excited. We just make sure we manage the risk. So we look at it as a normal course of business. Now we are holding almost a record amount of margin on deposit, over $240 billion. And I just think it goes to the prudent risk management that CME has. We will never be a race to the bottom when it comes to margins. As you know, the exchanges set our margins. So we set them ourselves, and we're trying to be very prudent about that. I think some people are talking a little bit about do margins affect liquidity? You got to remember that most liquidity that's created inter day for people to transfer risk is done by market makers which, historically, go home flat, so they are not affected at all by the margins. So the people that are managing their risk in our clearinghouse have not said anything about the margins that are in there with the increase. So all in all, I would say that the clearinghouse has done a really great job functioning through this crisis as we're -- and I don't even want to call it an end because we're not through it yet. But we've done a really good job managing the risk of the clearinghouse.

And Terry, the CFTC Chairman, Tarbert, echoed those comments about the risk management of the clearinghouses that they oversaw when we spoke to him yesterday. But you did -- you mentioned the plus-50 million contracts per day. So this is a little bit record levels. From what we understand, it was the -- operational. There was no downtime. There were not any significant downtime. So I guess my question to Terry and to John as well is what's going through your head as you -- what were you concerned about? What were you monitoring as you put through this type of -- these 50 million contracts per day, big numbers in interest rates, et cetera? Was there any concerns on this?

Well, I think there's always concerns, Rich. And I think if you let your guard down is when you become complacent. If you become complacent, then complacency kills. So we are never complacent, and we are always concerned about making sure the business is running properly. We're investing in it in a very smart and prudent way, especially the clearinghouse, where we have the full fate of our participants coming in there to manage that risk. So we built the infrastructure, but it's an infrastructure. So we got to make sure we have really good qualified people in there, which we do, to make sure that the things go properly. There's been a whole host of issues throughout the years that we've seen in clearinghouses. But I am quite pleased, Rich, to be honest with you, about what's gone through there. And even though when you say what goes through your head when you're doing those kind of numbers, I guess you don't really have a time to react when you're doing those numbers. So if we were putting through 50 million contracts or 17 million contracts, you have to have the same mindset regardless. So we're very focused on that. And we're not looking at just the extraordinary amount of contracts because we're looking at the daily business.

Understood.

And I guess I would add, what's been particularly impressive, I think, is the way we were there for our clients when our clients needed us most and really unprecedented in a unique time period. If you can think about everything that had to be navigated during this period of time, all while putting up a tremendous amount of volumes and making sure that folks could risk management at a time when they really needed the risk management, it was very impressive. And the way the employees adapted to the remote working environment, all of the time that we spent ahead of the actual crisis, preparing for a crisis, we didn't know it was going to be a pandemic. But we certainly -- CME and the industry had practiced and were prepared for such an event. And all that investment we made in infrastructure, investment that we made in terms of the people, the practice that we did to ensure that we're ready for such a situation, I think, really paid off.

Yes. I think, no question, impressive by -- CME operation were impressive and, across the board, the industry operation was pretty impressive. But I do want to talk a little bit about what -- about volumes, potentially at least, and investor concern, is it too much of a good thing? You can have too much of a good thing. The interest rate volumes were a record level in the first quarter. And -- but there is concern about this ZIRP or however way you want to call it. And we know you've done a number of things to sort of buffer it, whether it's a lower percentage from the shorter-duration contracts to plenty of new-type interest rate products in the penetration of the treasury market. But anyway, my question would be are investors -- do you think that they're just too shortsighted about interest rate volumes and what in the buffers that you've sort of put in, Terry and John, when you look at interest rates specifically?

I don't think I have the right to call anybody shortsighted as I see in the world we live today, Rich. So I won't say that investors are shortsighted. I think that we live in a world of instant gratification. We understand that, but we're also running a business that's been around for a long time. We want it to be around for a long time to come. We understand that every day is not a sprint, and we will continue to manage the business. We are doing things that are within our ability to manage risk and interest rates. There's no question. We've seen a slowdown with the Fed policy, not only here in the United States but globally. That doesn't mean that the rate business is going to go away. As we've seen just in Japan alone, I'm not comparing U.S. to Japan, but they've been in negative rates forever but yet, the JGB still trades significant amount. So I do believe that there will be people needing to manage interest rate risk regardless. So we are very positive about some of the new products we have launched. You started to reference them with the different durations associated with them. I think that when you look at our acquisition of NEX, I think having the broker tech business sit on the Globex platform next to our treasury complex will create more and more efficiencies for people that are continually managing that risk. We're starting to see an uptick in the long times a little bit. We're also seeing a tremendous amount of issuance coming out of the government that we think a lot of that will not just go to the Fed balance sheet. We think we'll see that going to other people's hands, which will be mitigated of that risk into our marketplace. So even though we're seeing a downturn in the short end of the market in the 2 years and the short -- in the nearby euro-dollars, we are still seeing good activity in the back part of the curve of our products. So we are optimistic, but I'm not going to say anybody is shortsighted because you'd be kidding yourself to say that there hasn't been a slowdown and there's been a change in Fed policy, which people are uncertain of. I will say, in lieu of what's going on, you have to be very careful with the complete helicopter money or flooding of money by the Fed and other central governments around the world. What does that mean? Over the next 6, 12, 24 months, as far as potential inflation going forward because of the money that's been put into the system, I don't know. I'm not going to try to predict that other than we are prepared, and we are coming up with new ways for people to manage their risk in the rate business. I don't believe it's going away regardless of what the overnight Fed lending rate is today or will be tomorrow. John, I don't know if you want to add to that.

Got it. Okay. I'll move to the next question. That's helpful, Terry. One of the strengths of CME has been its international growth, the volumes that come from customers outside. And I know it speaks to your efforts of the build-out of the sales force, the more focused strategy overseas as well. And I guess, and for Terry or John, how do you think that the international diversification can help if they're -- as we go forward in whatever volume environment it turns out to be? The incremental diversification is expected to buffer some if there are slowdowns.

The beauty of your questions, Rich, is you answer them for us, too, so that's a very kind of you. But let me go ahead and kick this to play, and then I'll give you my opinion in the international. But I'll let John go ahead and start. John?

Great. Thanks, Terry. Yes, Rich. Yes, thanks for the question. And yes, this is an area that I'm really, really excited about. I mean I think when you look at our international growth, it's been really impressive, and I think it also kind of differentiates us from our peers. And really, the investment that we've made in our global sales force really has paid off. Today, more than half of our sales staff is located outside the U.S. We have sales professionals in 19 cities located in 15 countries around the world serving our clients, and we're leveraging the cross-sell opportunities between our traditional futures business and the optimization and cash businesses that we acquired with NEX in November of 2018. So we've had 674 cross-sell meetings, including over 275 in May. And that compared to 400 million for all of last year. So really leveraging our sales staff and leveraging what we acquired with NEX to really reach out to our customers and help them manage their risk. We've also taken a very active approach to customer outreach during this challenging time, and we've received a lot of positive feedback from our clients for doing that. If you take a look through April, we've seen our sales activity up 150% compared to the same period in 2019. So really, our global approach to sales and the global nature of our product set is definitely something that makes us stand apart from others. We've also been very focused on developing liquidity 24 hours a day. So in the first quarter, 24% of our volume came outside of the 7 to 4 Chicago business hours. So European and Asian clients can execute trades during their business hours and feel comfortable that there's going to be adequate liquidity. In fact, we have tools on our website to help clients see and analyze that liquidity. And it's been very helpful in terms of getting our clients really comfortable and being able to analyze that liquidity. And if you look at some of the materials that we provided in terms of some of the slides, you can see that we're generating about 6 million contracts a day from EMEA and APAC, and it's been consistent growth year after year. And so, so far, in the second quarter, we're up in average daily volume in APAC with 3 product areas: energy, metals and equities with double-digit growth. And in Europe, we're seeing particular strength in our equity complex. And year-to-date, our global growth continues to outpace our domestic growth. So in the first quarter of 2020, about 28% of our volume and about 35% of our revenue came from outside the U.S. So our investment that we've made in our people, in our technology and our product development really has paid off and really has differentiated us versus our peers and really has driven our global expansion.

I think John answered it quite well, Rich, so I don't want to belabor it. But I just want to say that I think that eliminating a lot of our costs, being able to create the efficiencies from a central location out of Chicago and grow our business internationally has really benefited us and our participants. So really excited about the international growth of the company.

Got it. Great answer, John. WTI, so the expirations of the most recent contract, June, went a lot smoother than May. And a lot of the supply/demand, the excessive supply and the low demand in storage issues, they balanced out. So I guess these -- they did work out well, and the contract is now trading at a very narrow spread. So are you -- I guess, Terry, are you comfortable with that? And has there been any issues -- follow-up issues with the negative pricing from the May contract?

No. There hasn't been any follow-up issues, Rich. And I think that we saw an extraordinary time in the history of our world went on. And I don't want to call it a perfect storm but, essentially, I guess there's no other way to describe it when you have a complete lockdown and no -- zero demand and a tremendous amount of supply, and you have an expiration coming up. And people who are in the business of taking delivery, they didn't want it because they had nowhere to put it. So I think the Chairman of the CFTC, Mr. Tarbert, said it very well when he came on right after the situation that happened with the May expiration. And then I think we've explained it as well. So we haven't seen any fallout. We're starting to see some demand pick up because of the reopening of some of the societies in different parts of the world. So all in all, I think the WTI contract has priced itself the way it was designed to do, which is have a reflection of what the value of that product is. So from our standpoint, we have not heard any additional backlash. I said to somebody, it would be amazing if I could call to testify on crude oil because it went to negative $37. I remember getting called about a crude oil testimony when it was at $137 a barrel but not at negative $37 a barrel. So it's quite fascinating to see how a product can stir up a lot of interest. But rightfully so, we get it. But at the same time, we are convinced that our deliverable product reflected the true value of that product at that given moment in time. John, do you want to add to that?

Yes. No. That's right. And I think when you take a look at -- and Rich, you hit on it. I mean the spread is narrowed. And you can see over the last April and May, we're up 17% year-over-year. So -- and when you look at where we are in terms of the market share, we're trending to record levels in terms of when you take a look at the brands and the TI. So yes, to Terry's point, I think we're -- it's operating the way it was designed. It's physically delivered. It converges with the cash market and appropriately reflected what was going on in the market at the time where you had oversupply, reduced demand and full -- increasingly full U.S. storage.

Got it. Can we -- I got 2 questions left. One, if we could just go over quickly, John, the CME's dividend policy unique. Could you just elaborate on the mechanics given the upside cash flow you're seeing in the current environment? Any -- yes. So just any sort of quick comments on the dividend policy because I think people are watching that as well.

Yes. Sure. Thanks, Rich. As you know, we've got tremendous leverage in our business model. We've -- the first quarter, we had over $1.5 billion in revenue. If you look at our expenses, excluding license fees, they were actually down about 4%, which kind of -- which generated high margins and record adjusted EPS. So one thing to note that the activity in March was not reflected in our cash numbers in -- at the end of the first quarter. We can get that cash in April. So we had a very large cash month in the month of April. So we think that our dividend policy with our annual variable dividend at the end of the year, we take a look at our balance sheet. We target approximately $700 million in terms of cash that we want to keep on our balance sheet. And then we dividend the balance to our shareholders. It's also important to note that we hit our 1x debt-to-EBITDA target that we committed to do at the end of the year. We achieved that in the first quarter. And we think that the annual variable dividend policy served our investors well. And we think that in light of the current situations that we're all facing, it's going to continue to serve our investors well this year.

Great. Very last question is for Terry, and I wish you could have been here physically. I actually had a fireplace video for the live videos. Hope that we'll get to do this person to person. But my last question. So Terry, you've been Chairman for 18 years for the CME, President or CEO for the past 8. Your contract expires in 2023, so another 2 or 3 years. CME has undergone some change with the acquisition of NEX Group here over the past 18 months. So I guess my last question would be, what would you still want to accomplish? And maybe you'll go on beyond 2023. But what do you still want to accomplish? How do you want to sort of lead if that -- if this is your legacy, the last few years at the CME? What do we do in the last 2 to 3 years?

Well, that's a pretty broad question, Rich. You're right. I took the company public in 2000 -- I became Chairman in 2002 and took it public. I can't believe it's been 18 years already. And 23 years before that, I was a market participant. So I'm 40 years deep into this business, all in -- all through it. So I've seen a lot in my time. And how I want to see the next several years is -- I'm a huge believer in transitions need to be smart, well thought out and do what's in the best interest of everybody that's involved with the institution. So I think that's the reason why CME has got 150-plus-year history today. It's because we've had transitional plans throughout time, some rougher than others. But I'm very optimistic about where the business is at today. I'm very focused on seeing my contract through, what you pointed out, go through 2023. And I think you and I are close to the same age. I'm 61. I think you're somewhere in that neighborhood, so we're not kids anymore. But at the same time, I still think I have enough to give to make sure we get through transitions over the next several years. But I'm going to do it in a very smart way. I got a lot of really good talented young people, and there's other people out there too that you could bring into the organization. But as far as looking at what we're putting together right now with NEX and some of the other international businesses and our core businesses, I'm really excited about in the next several years. So I'm not as focused on 2023 other than I've given my Board my commitment that I will stay through my contract through 2023. And who knows? Maybe I'll go past that, but we'll cross that bridge when we get to it. My focus right now is to make sure I can cultivate good people in the organization, cultivate people that are in the organization and bring them to the next level because that's what will make the next 150 years grow and, hopefully, be more prosperous than the last 150 years, which have been pretty prosperous.

You've made a tremendous contribution to the CME, Terry. Hopefully, you and me are doing this if we both want to beyond 2023, or we're doing something more enjoyable together, I hope.

Yes. I want to echo your comments earlier, Rich. We definitely want to make sure that we're sitting there with your fireside next year. And hopefully, we're together long before that. But I can't thank you for your leadership in the industry and giving us an opportunity to represent our views on our company. But we do miss being with you and all the investors, for sure.

Thank you very much, Terry. I appreciate that. With that, there's no better way to end sort of the exchange portion of the conference. So I want to thank Terry and John, both for the virtual side of it. It's not ideal. We've been pretty flawless, and I think we've done -- we've accomplished our mission. But again, I want to thank them because it's certainly better to be in the physical location where you can see the other person. But with that, we're going to end up, and we'll turn it back. The next session is at 11:30, and it will be -- begin our financial technology segment with Chris Donat. So thank you, Terry. Thank you, John, and that ends this session.

Thank you.

Thanks, Rich.