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

Yes. So we've been focused very much on what a call cross introductions and creating opportunities. So where we are taking existing customers, for example, of the NEX, EBS, OTC foreign exchange platform and introducing them to our futures products, and we're very excited about how that should grow over the next few years. So we're doing those cost introductions. We've seen some crossover in part usage, but obviously, it takes time for people to adopt new products. In addition to that, on the BrokerTec side, in particular, we have seen -- we've been able to do a lot of cross-selling in particular. BrokerTec is the largest repo trading platform for U.S. treasuries as well as the largest repo platform for European government bonds. And in both of those cases, introducing those repo desks, in particular, to all of our interest rate futures products, and we've seen very good growth there. So -- and that will continue. One of the things I'm very excited about is in December of this year, we will be migrating the BrokerTec platform from its existing technology over to Globex. And once we do that, we will be able to innovate on that platform and to grow the volumes out of that platform. So for example, we will be introducing a new relative value trading order type which will allow participants to do curve trades as a single order. So imagine a 2-year, 5-year spreads to trade, for example, 2s, 10s, 10s bonds, all examples. Historically, that platform, in order to execute a curve trade, you needed to leg into each of the 2 securities. This new order type launch from over Globex will allow you to do it as a single order type. In addition to reducing risk and making it easier, we will also reduce the minimum price increment fast rate. So currently, you have to trade the outrights, which means you need the very large minimum price increments on the outrights, much smaller minimum price increments on the spreads. So it will tremendously lower the costs and the risks participants to trade curve trace at left. On Globex, we've got imply technology, which should enhance the overall liquidity on that platform. Obviously, when you enhance liquidity, you also lower the cost of trade, make it much more attractive. How does it do that? Imagine you have an order book in 2-year notes and then you also have an order book in a 2-year, 5-year spread, trades between 2-year notes and 5-year notes, that should imply, and it does on Globex, outright orders in 5-year notes. So we're very excited about the migration over to Globex of the BrokerTec platform. And next year, we'll be migrating EBS over to the Globex platform. So this year, we're migrating BrokerTec to Globex. Next year, EBS to Globex. As we do that, in addition to that, we're taking advantage of the analytics that NEX had that were best-in-class. So in particular, EBS analytics. We have recently added our futures products, our FX futures products to the EBS analytics, which show participants how to minimize their execution costs in the OTC FX market space. So by adding FX futures to that, they'll be able to see when it is advantageous for them to trade futures instead of trading spot were to trade both in conjunction with each other. So over the next few years, as we fully deploy our strategies and the technologies, we should see much greater cross-selling and much greater adoption of both sets of products from the combined set of clients.

Got it. And then, Derek, maybe let's turn it over to energy for a moment here. Obviously, it's been a crazy 2020 in a lot of respects. But for oil, especially with some data futures prices actually hitting negative levels on a headline basis. And obviously, there's been a lot of ink spilled here on the oil complex. So maybe it's just how -- we'll take a quick step back and explain to everyone what the main drivers of energy volumes are besides perhaps just the price level of oil.

Yes. No, great question, Jeremy. I appreciate it. If you look at the energy complex, and oftentimes, we specifically just focus on the energy being crude oil. And to be honest, we've got an $800 million business in energy, about $500 million of which comes from crude oil. And about $300 million of which roughly comes from what's going on, on the natural gas side. So I'll talk about those 2 parts of the franchise because they're actually going in similar trajectory, but we've got an acceleration on the nat gas side. And I'll talk a little bit on why that's the case and why that's important for us given that, that's a higher rate per contract product for us. So overall, year-to-date through August, our energy business is up 9%. That's led by options, up 16%; and futures, up 8%. So that's within the world of energy overall. Based on the significant disruptions that you referred to earlier this year, where you had massive oversupply driven by the Saudis trying to push both the U.S. shale guys and the Russians into a point of pain, they said, we're going to open the spigots, we're going to increase by a couple of million barrels of oil, and we're just going to hammer the market and try to flood these guys out. Well, what they didn't account for was 3 weeks later, COVID actually having a significant demand destruction impact that had unleashed literally within a couple of weeks. So the market was hammered by the dual impacts of massive increase in supply, coupled with the massive destruction on the demand side. And Economics 101 tells you that that's going to bury the price, and that's exactly what happened. We saw crude oil go from $65 down to as low as it traded around $10, $11. We had -- the price did briefly settle at negative on April '20. It came back and for final delivery settlement in WTI sold at $10, and we had 2.4 million barrels specifically deliver on that date. Since then, we've seen the market seek and find a -- what I'll call, a short-term equilibrium around this $40 mark, and I'll talk about that a little more explicitly in a moment or 2. The -- so that's the story on the crude side, and I'll go to the details in just a second. On the other side, you've seen our nat gas business continue to go from strength to strength. So after hitting multiple records both in Q1 and in first half overall in energy and in crude oil and WTI and nat gas, respectively, we've seen continued strength in the natural gas side of the franchise. That business, year-to-date, the nat gas futures are up 32%. Options are up 61%. This is close to a $300 million business for us. So when you talk about the overall energy complex, you got to talk about the 2 pieces of that. As it relates to crude oil, the drivers of volume tend to be across the deferred levels. Volatility, yes, is a piece of that. Absolute price level, less important than the actual trading range in recent times and the shape of the forward curve. And if you look at all of those things in aggregate, I'll come back to the comments I made before. We're seeing the oil market hit relative -- it is sort of finding this clearing price at about $40 right now. And that's a function of OPEC addressing the supply side by actually agreeing to reduce by about 2.5 million barrels a day pulling supply off the market. You saw the questions around brown storage, both in the U.S. and globally, get addressed by a lot of floating storage coming out of Europe and actually going into the Gulf and the U.S. side as well. So the 3 primary drivers of downward pressure and the speed of that downward pressure were oversupply, lack of demand, questions about storage. As I said, supply has largely been addressed by OPEC cuts and U.S. reductions in production as well. We came down from 13 million to 10 million, on top of which the storage solutions have been addressed. What has not been addressed is the demand side. So you're seeing oil settle about $40. If you look at the forward curve, WTI, it goes from the $40 to about $42 over 12 months. Brent is in exactly the same situation. The Brent-TI spread is low and stable. It's about $2, and the forward curve looks exactly the same. So as we come through the pretty significant dislocations in the first 6 months of the year, we found the market kind of sitting at a tight rating range. We've seen oil trade between $39 and $42 for about 2.5 months. It's slightly pulled back in the last week or so. But that's the primary driver. You start to see a $3 trading range in 2 months. And there's just less opportunity. Lower trading range means lower volatility. Lower trading range means less uncertainty. And a flat forward curve just means that there's less opportunities and less repositioning. Now I will say what's putting a cap on demand right now is the demand side. We saw 100 million barrels a day going into COVID. That got reduced down to an estimated 70 million barrels a day of daily consumption globally in crude oil. That's drifted only back out to about 80 million, maybe 83 million barrels. So we're not back up to the pre-COVID levels of demand because shut-ins, airlines aren't flying, cars aren't driving. So the wildcard here now is going to be on the demand side. And that's going to be a function of the speed with which different economies open and the speed with which people start to get back in their offices, back into cars or we all start traveling again, so we can do this face to face. I will say, when you look at the global crude oil market, this is not asymmetrically impacting Brent, and it's also not asymmetrically impacting WTI. This is a global oil impact. So we've actually seen volumes come down in both markets. Market share is static. We had 56%, 57% of the traded volume market share of -- if you look at WTI's percent of WTI plus Brent before COVID, we're at 57% now. Open interest, same thing. We're still at 45% of that open interest. We were there a year ago. We were there 6 months ago. We're there now. So this is not a story of the market deciding to trade one product or another product. This is a global oil story that's put top-down pressure on trading spreads, volatility volumes and therefore, participation in the short term. I will say, as I said before, that the demand side of the equation is the wildcard, and that comes likely with where we go on the vaccine side and the speed with which different economies open. So look for that to be the driver of increased uncertainty in the price. You'll probably start to see a contango exist again in the market right now. It's relatively flat, and the current structure over 12 months and the forward curve is telling you the market is relatively comfortable at these levels. What's important to understand about the other side of the franchise, the $300 million we make in natural gas, is the very reasons why we're seeing downward pressure on the price or stability in that market. It's actually why we've seen price increases in natural gas and volatility rezoom itself in natural gas. To remind everyone on the call, this is a market in natural gas, we own 82% of this natural gas futures and options market. It's a significant part of our portfolio and it's a part of our market that we generally have the largest impact on. So when you look at the reason why that is, we had natural gas sitting at the lowest historical levels of about $1.65, $1.70 up until about 5 months ago, 4 months ago. As we're starting to see global production of gas decrease, that actually means production of natural gas is decreasing as well because gas gets flared or gets captured when you drill wells. So the concern is you're starting to get a very funky looking forward curve and the expectation as we're entering gas season, which typically runs from October, so that April or so great concerns about what the forward volume is going to look like for actual nat gas volumes and access to the market. So we saw that price go from $1.70 to $2.50. And as a result, you've seen that side of the business really take off. So that's a huge part of our franchise. It's a big part of our competitive differentiation versus our peers. And as a part of the franchise that comes through about $1.15, $1.20 rate per contract, which is already high, and it's higher than our oil rate per contract, which is closer to about $1.30, $1.40. So the volumes overall are increasing in energy and outsized proportion of that is in that gas at the higher rate per contract, where we have that majority market share, we've maintained that market share of about 82% on or thereabouts. So that's kind of the overall run through the energy space, looking at the 2 sides and the different impacts and trajectories of those 2 parts of the franchise.

And then, Derek, I think about a little more big picture. Obviously, there's kind of global policy changes on renewable energies, sustainability efforts, both from a investing and from a governmental perspective. So maybe it's a multipart question, but one, how do you view any sort of risk to the energy complex at CME? And then two, you guys have vast experience running financial markets here. Is there an opportunity to introduce green contracts that's happened to the renewable type story? I would think either carbon or maybe lithium for batteries, something along those lines.

Yes. No, it's a great question. It's something we have looked at for a lot of years and continue to work with our customers to look at. I think you've heard from us. You've heard Sean talk about the product development we've done on the financial side. We can talk about all the products we've launched on the commodity side, whether it's the, specifically, Houston contract or the Argus [ decessor ] grades contracts that have 350,000, 400,000 contracts open interest that we launched just a couple of years ago. These are examples of the way in which we continue to partner with our customer base to adapt our product portfolio to suit their risk management needs. Government policy impacts certainly are a factor, but we're more focused on the commitments our customers are making and ideally, but the best product development is done in conjunction in partnership with our customers as they voluntarily migrate, change or adjust their business to adapt to different market conditions. We're all waiting for a mandate to come down to then start to product innovate. We generally tend to land in probably the least optimal place. So our engagement has been always be on our front foot, and this is where our engagement with our global customer base is so critically important. And our customer build-out in Europe and Asia, particularly where we're seeing marginal growth coming in at higher rates for contracts and with greater new client acquisition opportunities, is so important to us. So targeting things like low-emission extraction on the ongoing global evolution of natural gas, as I said, that's a market. We own 82% of Henry Hub. So as the market evolves to managing products that have specific methane requirements or the means to track those things, those are things, as you can imagine, since we are the majority of that market, we're partnering with our customers to develop those over time. So to the extent that there's an opportunity to scale and grow that, that's a function of how quickly our customers want to go there and how we can partner with them and develop those products and provide those products to them over time. Sustainable evolution towards renewables, whether it's solar, whether it's wind, whether it's water, hydro, whatever, there is a long transition period to that. So trying to come back to the question is that, is it a threat over time? Over time, every single one of our businesses is evolving. So for us to be able to see around corners, again, seeing the market evolution through the lens of our customers tends to be our starting point. So we've got a number of carbon products. We've got a number of green products. To be honest, not surprisingly, they don't trade very much because the market is not there yet. So -- and the guys are working in partnership with our customers with an eye to regulation, but really working more with our customers to evolve the business as and when they need it, we tend to see us evolving those products that get adopted over time. But for the foreseeable future, we see that market continuing to want to price discover and managing the deepest pools of liquidity, which in energy as a CME Group by any measure.

And then Derek, you talked a little bit about European and Asian clientele. And then Sean, we talked about the explosion of the user base and the rate complex. I guess just outside this kind of debate around like what -- the things you can't control, the macro, right? Like volatility, speculative environment. I guess how should we think about the more organic blocking and tackling around the extended usage of the futures complex, either geographically or by wallet share from here forward? Because you've done such a great job over the past 5, 10 years, but where can we go from here on things you can control?

Yes. Maybe I'll jump in and talk about metals real quick, and I think Sean's got some stuff to chuck on as well. But if you go to the materials that we circulated to everybody, on Slides 28 to 30, there are some really good examples of that. You use the term market share, which is probably a pretty -- it's both accurate and maybe not quite accurate in terms of how we think about it because we tend to think about market opportunities not as a zero-sum game of moving into a space by displacing somebody else. We think about it as how can we innovate with product evolution, with electronified markets, getting people actionable on screen liquidity during their time zones that allow them to trade more, bring more volume and actually manage their risk more effectively. And I'll tell that story briefly through the lens of metals, and I'll turn it over to Sean, who can talk through the lens of the financial products as well. But specifically on Slide -- I'm squinting, Slide 28 here on the materials. Our precious metals business specifically has been a market that not only do we own 94% market share of, it's been a market that's been our fastest grower for the last couple of years. It's our second fastest product growing this year. I think we're up 13%. I think equities is our fastest-growing product this year. And if you look at the most important -- you look at that graph on the upper right-hand corner, and you'll see we've graphed the trajectory of our COMEX futures volume alongside the LBMA cleared markets, which is the LBMA, the London Interbank Bullion Market, and you'll see going back to the early 2000s, late 1990s, the significant growth of COMEX futures, and it's not necessarily coming at the expense of the overall market. It's not coming out of cleared volumes and centrally or bilaterally transacted markets, it's coming in addition to. So our growth is not predicated on that, simply saying we're going to take somebody else's products, put it on our machine and make it better. It's predicated on our ability to be able to deliver value electronically, futures and options globally and grow that business and extend that business through product innovations, whether it's the partnership that -- and cross listen we've done with the Shanghai Gold Exchange to connect our physical markets to the Chinese physical gold markets. And believe me, that is where all the global demand is coming from. This is a market that is the highest rate per contract product we have, $1.52. $1.52. That's twice the average of the exchange as a whole. So bringing more products in, and this is largely predicated on European and Asian increased client penetration, and if you look at the chart, you'll see we went from 20% of LBMA volumes to 200% of LBMA volumes, not because we took their business, but that business flat lined, and we've continued to grow. That innovation is on the product side, on the operational efficiency side, on the capital efficiency side, on the market-leading options business we've built. So it's an example of where we can add participants, bring new innovations to market and grow business overall, not on a zero-sum game. So with that, I'll turn it over to Sean, and he can certainly talk about some of the work that he's done on the financial products.

Yes. Thanks very much, Derek. I might point people to Slide 10 in the deck where you can see through the first half, right? Over the last several years, we've seen outsized growth in EMEA and outsized growth in APAC in terms of our volumes and client penetration. In particular, it changed a couple of things in terms of investments we've made. 56% of our sales force is currently overseas and not in the U.S. Obviously, if you go back several years ago, the bulk of our sales force were in the U.S. So the combination of investing in greater sales efforts overseas as well as the acquisition of NEX Group has given us a much deeper penetration from a sales perspective to that overseas client base. In addition to that, as Derek mentioned, innovation has been hugely important to better penetrating them as well. For example, some of the outsized growth we've seen this year in Asia, in particular, has to do with our equity complex, and in particular, smaller traders in Asia, in particular, around our Micro E-minis. Our Micro E-minis, we're very excited about doing more than 1.6 million contracts a day this year. And while the rate volatility environment has been extraordinarily low and actually all-time historic lows recently, the equity volatility has been just above median or more mean level volatilities going back to 2007. So not huge volatility in equities, honestly, relative to history, but instead, I'd say, a strong or just above mean volatilities. In terms of that, though, nonetheless, if you look year-to-date, we're up 66% in terms of our ADV in the equity complex because of the innovation. And if you look at Asia through the first half, we were up 111%. And that is because the new park innovation around the Micro E-minis. Other product innovations, we continue to innovate during the crisis. We recently launched a new 3-year treasury futures contract, which we're excited about. Even during COVID and even with the low volatility environment, we had more than 65 firms traded. Recently doing about 5,000 contracts a day. We recently had a peak of 13,000 contracts. We recently had, I think I may have mentioned earlier, an all-time record Ultra 10 Year open interest even in this Ultra 10 Year launched a few years ago. But very excited in the last few weeks, all-time record open interest of 1.1 million contracts. With the adjustments we've made to our FX complex, and in particular, reducing minimum price increments, actually in the last week, we've seen 2 new all-time records in open interest in our euro versus USD FX futures, where we're more deeply penetrating the overseas marketplace. In terms of further innovations, we're launching new tools. We just launched a new FX swap rate monitor, which, for the first time, gives the marketplace visibility, transparency into the largest market in the world, which is the FX swap market so that they can see where the current levels are traded in our central limit order book and on FX options filing, which is the only central in the order book, cleared standardized lower total cost will turn over to the OTC market that exists. We just launched a new FX option Vol converter tool, which allows OTC FX options participants to see our options on listed foreign exchange futures, standardized, clear lower total cost alternative to the OTC market, in the same way they look at the OTC market. So we're very excited about that. Clients are very excited about it, in particular, brokers who are selling our products. Further innovations that we're excited about, we recently launched the new Micro E-mini equity options, doing about 5,000 contracts a day. It takes a bit longer to develop that marketplace versus the futures, but we just launched those the end of August. And already doing 5,000 contracts a day, we do expect that to continue to grow in coming weeks, months and years. We are about to launch new equity total return adjustable interest rate futures. Very excited about that. And I can talk about many of our developments, but those are just a few examples. Actually, I will mention, we are very excited to partner with NASDAQ. We are about to launch the new VOLT Q futures based on the NASDAQ VOLT Q index. Volatility of that's based on the NASDAQ Stock Market Index, which we're very excited about.

Great. And we're almost at time here. But John, let me just leave you in here for kind of a closing thought to kind of look at the growth algorithm for earnings, right? We talked about the top line environment from a macro perspective with both Sean and Derek on things that you can't control, but are hopefully laying the groundwork to capitalize if they do improve on a go-forward basis. And then Derek and Sean just handily went through the more organic algorithm and what things you can control on the top line. But if we kind of bring that down to the bottom line to the earnings level, what kind of expense offsets or levers are you guys able to pull? You guys have always been very great at expense management. But as you kind of look at this, perhaps a bit challenged top line environment, where is the room for kind of expense management to help kind of accelerate or maintain that earnings growth rate?

Thank you. And I think as you can hear from the team, we're very excited about the business. We're very excited that we are really positioning ourselves well to help our clients through this crisis. And when you take a look out over the next 6 to 12 months, whether it's the elections, whether it's the -- hopefully, the recovery from the pandemic, we're well positioned to help our clients through it. From an expense perspective, we are always very focused on managing our expenses. And I think over the last 5 years or so, we've done a remarkable job in terms of making sure that every dollar we spend is extremely efficient. Going into next year, we've got an even more intense focus on our expenses. We're looking -- we're always looking to accelerate the synergies where we can. There's a lot of benefits to our clients for accelerating those synergies, but there's also benefits to CME Group as well as we can manage our cost base. Obviously, in this environment, we have an opportunity to look at how we manage the workforce in terms of remote versus office, also in how we interact with our partners, our clients and our vendors in terms of utilizing more of this remote technology that people are -- have gotten to be very comfortable with. Also we are always looking at prioritizing our projects. And I think we've done a tremendous job. As you heard, we've got a whole long list of innovations that are coming online, and we've been able to do this in an environment where we've been able to lower our guidance of $50 million from the start of the year. So we're focused on it. It's something that I think we're very good at, and we're balancing, growing the business with expense management. And that really leads to our annual variable dividend, which is a way we return capital to our shareholders. When you bring it all together, it's that cash generation capability that we have that really not only -- that rewards our shareholders through that. Our regular dividend, which is $0.85 a share, up from last year, and then our annual variable dividend, which happens at the end of the year as we sweep excess cash to our shareholders. So I think when you take a look at our business, we're well positioned. And hopefully, we are going to come through the pandemic, everybody healthy and safe and get the world working again.

Perfect. Well, I think we'll have to leave it there. But John, Sean, Derek, thank you so much for being here.

Thank you. And thanks, everybody, for joining us. Thank you.

Thank you.