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

Hello, everybody, and thank you for joining us virtually today. My name is Patrick O'Shaughnessy, and I'm the capital markets analyst here at Raymond James. I'm pleased to be hosting Sean Tully, Global Head of Financial and OTC Products at CME Group; Derek Sammann, Global Head of Commodities and Options Products; and we also should have John Peschier on the line, Managing Director of Investor Relations. I believe that there's some functionality for viewers to e-mail me questions that might arise during our discussion, and I'll attempt to circle back to some of those as we progress through the conversation. With that, I'd like to get things underway. So Sean, Derek, thanks for being here today.

Thanks very much, Patrick.

So maybe to kick us off. Between 2015 and 2019, CME posted the highest organic revenue CAGR amongst its U.S. peer group, at least by my calculations. What do you think were some of the biggest underlying reasons for CME's revenue growth over that period? And what gives you confidence in CME's ability to sustain healthy organic revenue growth over the medium term going forward?

Patrick, maybe I will jump in, and then I'll invite Derek and John to jump in as they see fit. But from my perspective, we very closely step into our clients' shoes every day and try and follow their needs. And in terms of doing that, we've been very successful during that time period in terms of product innovation and providing them with the products they need. So if you look, for example, at the first half of this year, new products launched in the financials and OTC unit since 2010 created 3.2 million contracts today in average daily volume and $193 million in revenue in the first half. So very clearly, that new product innovation resonated with our clients, significantly enhanced our revenues and also our volumes. So that was a very big -- positive product results. In addition to that, I think our marketing and sales activities have improved dramatically. We now have 56% of our sales force overseas, and so outside of the United States. With the increase in the tools that we provided to the marketplace, with our investments in technology that are penetrating the marketplace, with our investment in sales across the global marketplace, we had significantly faster growth in Europe and in Asia relative to more deeply penetrating those client bases. So overall, new product innovation, focus on that end client, delivering margin capital, execution, total cost efficiencies and more deeply penetrating alternative marketplaces with a more attractive product. And then that's kind of the financials view. And maybe, Derek, I don't know if you want to jump in from the commodities view.

Yes. And I think just extending that, I think one of the unique differentiators of the CME Group is the fact we've got benchmark liquidity in all 6 major investable asset classes. And we all know, markets don't all rise and fall and have the same cyclical generators to them. So for example, when we're seeing headwinds to certain businesses and certain business [Technical Difficulty] we're seeing significant growth in other businesses. So that countercyclical nature of, say, our metals business, for example, which is our highest rate per contract business at almost $1.52, is a business that continues to go from strength to strength. We've had 5 consecutive years of record volume, record growth. In August, in fact, of this year -- August of this year, we set an all-time monthly ADV record. So we're continuing to see businesses that complement each other when you have challenging market dynamics, but also can leverage one another because that creates opportunities for us, strength in our FX business, open doors for us to be able to sell more precious metals into FX clients, for example, 2 very well-connected business lines. So I think the benefit of the exchange model and the scale and network infrastructure of our business means for us to put more products out into our network, has that network effect of generating volume, which actually generates more volume and add more customers. So it's the additional piece of the product innovation inside of each asset class and the operating leverage in the model itself, means for us to scale, we find significant offsetting growth opportunities no matter what the shape of the yield curve looks like or where the macro drivers are growing.

Got it. And you kind of spoke to some of the areas that have been doing a little bit better of late. But one of the areas that I think has struggled a little bit more has been the rates complex, where volumes start off the year really, really solid and then have been softer in recent months. And obviously, it's a function of what's going on in the economy. What similarities would you draw between the current environment and the post-great financial crisis period? And what differences would you call out right now?

That's a really good question, and greatly appreciate it. Thank you, Patrick. If you look at what's happening in this cycle and compare it to what happened during the global financial crisis, I actually think that's a very useful metric, that's a very useful tool to use to try and figure out what's going to happen next. So thank you for the opportunity. If you look at this cycle, the Federal Reserve very quickly took rates down to the zero lower bound, as they like to say. So they very quickly did that. They did that actually much more quickly in this crisis than they did in the previous crisis. The other thing the Federal Reserve did is they institute quantitative easing, and they used all of the same tools in terms of quantitative easing that they did use during the global financial crisis. In fact, they added many new tools, right, in terms of innovating in the credit markets, doing direct lending where necessary, for example. They used all of the same tools. They used those same tools much more forcefully, much more quickly and in much greater size than they did during the previous crisis. And they added new tools. If we look at some of the metrics then in this crisis relative to the previous crisis, we're already at a 0 interest rate policy. So they did that, obviously, in late 2009 in the previous crisis. But if you look at, for example, the increase in the size of the Fed's balance sheet relative to their intervention in the markets, they did as much intervention between March of this year and the end of July of this year as they did between 2009 and 2013 in the previous crisis. So in terms of their intervention with quantitative easing, they are already at the 2013 levels, if you want to compare us to that particular cycle. In addition to that, I'd like to look at the unemployment rate. If you look at the unemployment rate in that cycle, it popped above 10% and then very slowly came down and achieved 8.3% in January of 2012. If you look at this crisis, we went up about 14%. And today, we're down at 8.4%. So we have -- the unemployment rate has traveled far more than it did in the previous global financial crisis. But what took -- from 2009 to 2012, in terms of the unemployment rate took us from March until August in this particular case. So we're already down to 8.4%, the January -- basically January of 2012 level on the previous crisis. Last, if you look at the equity market round trip. Equity market, some measure of GDP in terms of a way of looking at projections, I guess, of profits and cash flows. So if you look at that as a metric, it took from 2007 until 2013 for -- excuse me, I'm having an issue with my computer. It took from 2007 until 2013 for the equity market to previous highs -- to achieve its previous highs. So whether you look at the unemployment rate, you look at the Federal Reserve intervention, you look at the equity market, they're all similar to the 2012, 2013 level. Last thing I'll mention is in the previous crisis, it took the Federal Reserve -- basically, they started lifting rates. They moved them from the 0 interest rate policy just by 25 basis points in 2015. So 3 years after that 2012 level. Nonetheless, if you look at our historical volumes, 2012 was a low point during that crisis, right, in our rates volumes. So it was a local minimum. So for several different reasons, I would equate to 2012, 2013 as where we are in the current cycle.

That's all really interesting. And I think kind of building off of that answer, when we look back for the rates complex, in particular, it took until 2014 for your interest rate futures volumes to return back to 2008 levels. So it took 6 years for them to recover. I think what I'm hearing you say is maybe we're seeing that recovery time period compressed in this go-around just because of how quickly other metrics and other things have come into play here. Is that kind of the right way to think about it then?

That's exactly right. You've seen, basically, what were years in the global financial crisis are months in this crisis.

Got it. So I think kind of building off of this conversation, I know that you guys point to more U.S. Treasury issuance as a long-term positive for trading activity in the rates complex. But to what extent does it matter who is buying those treasuries? So if the Fed is the marginal buyer, does that lead to more trading volume for you? If the volume -- if the treasuries don't get in the hands of those who are actually looking to hedge the rate risk, so how do you see that playing out?

In terms of the Federal Reserve intervention, again, as I mentioned already, they increased the size of their balance sheet by as much as they did between 2009 and 2013 between March and July. So when they purchase the treasury securities, they don't hedge them, right? So they take that risk out of the marketplace and they simply sit on it. So that eliminates the need for risk management of those products. The Federal Reserve has since, over the last few months, significantly reduced their intervention in the market. They're now down, as we heard Jay Powell said yesterday on his conference call, down to about $80 billion a month in terms of purchases of U.S. securities. While earlier in the crisis, they were purchasing more than the entirety of the issuance by the U.S. Treasury, they are now only purchasing a fraction of the increase in issuance that's happened by the U.S. Treasury. So the intervention relative to the increase in issuance has declined dramatically. And if you look at the last cycle, move to that cycle, so by 2017, the Federal Reserve started to reduce, actively reduced the size of their balance sheet. And when they started that active reduction in the size of the balance sheet, obviously, that also created a tailwind in terms of greater risk that needed to be managed by market participants. One of the differences in this cycle relative to that cycle is -- so you also had a compressed time cycle relative to fiscal authorities, right, intervening by sending out checks to the world in some sense, in many different ways. So what has that meant? That means that we're going to have record -- we have record debt currently for the U.S. government, record deficits. And we're currently at a debt to GDP level that was similar to the peaks reached by the U.S. government during World War II. And it's expected that we're going to be even higher than that in the near future. So we will come out of this crisis with more risk needing to be managed from U.S. Treasury debt issuance than ever before.

Got it. So maybe let's switch gears a little bit and bring Derek back in the conversation here. How does CME think about its energy futures complex compared to its primary competitor? What we hear from that competitor is that it boasts more of a globally relevant product set, and this offers more long-term growth upside. I suspect you probably don't agree. Just kind of curious to hear your views on that topic.

Yes. I mean, it's a statement we've been hearing from those guys for, I don't know, 5 years. Sadly, the data just disagrees with that. I mean it's one thing to say it. It's a different thing to [Technical Difficulty] be supported by the data. So let me talk you through that. On the materials that we shared with the group on Slide 24, we have a specific [Technical Difficulty] on U.S. growth in our business, where we specifically focus on our WTI business. And what you'll see in the data there is we -- as Sean actually mentioned at the top of that, we have put significant effort and work into building our global sales force. Our marginal growth in our sales force is not in Chicago. It's not in New York. It's in London, Singapore and Hong Kong. So our marginal allocation of sales resources is going out to Europe and U.S. Why? It's been both an accelerant to our overall franchise and in commodities, specifically, that's where literally the entire marginal growth for the complex exists. So on Slide 24, very specifically to energy, and then I'll track it more broadly to that. You'll see that the non-U.S. participation in WTI continues to be an outsized proportion of our growth and incorporates a larger and larger percent of our overall business. I mean, our view on benchmarks is we believe in global benchmarks. We believe in products, particularly on the physical side, when they are exported, they become a risk for that importer. When you saw the -- thanks, [ Susan ]. When you saw the export ban being lifted on the U.S. that sat in place for 40 years, you saw WTI go from a regional marker to a global benchmark, such that U.S. crude as it's ramping up from 7 million to 8 million to 10 million to 13 million barrels a day, once we went into COVID, we are exporting 3 million barrels a day of oil. What does that mean? That means WTI pumped in the U.S., goes down to the Gulf Coast, goes on barges and ships to Europe and Asia. The data here exactly supports that growth. So when you look at the global participation in our markets, the point that I think I'm hearing from the other guy is we've got a better product set. Well, we've got the data that disagrees with that. We actually have European and Asian customers that are increasingly participating in our markets because that is the product that's physically flowing into their refineries, into their onshore businesses on for refining product beyond that. So that's what the data on this particular chart shows. If you flip forward to the following chart on Slide 25, this is the conversation we've been having with folks pretty much all year. When you look at how the growth of the business is performing, the market share in our WTI business is exactly where it has been on average for the last 3 years. And I would say true of market share. I think year-to-date, our -- if you normalize that full year-to-date market share, we're at 57% of the trading volumes. Open interest is at 46%, and that has been remarkably static. There's been a range as low as 43%, as high as 48%. And so we're sort of at the middle to higher-end of that open interest market share as well. So just the sense that the market is growing, but it's growing somewhere else is actually not true. Listen, the first half of the year was great for us. We set not only first quarter records in our energy complex, but first half records as well. And frankly, I think, so did the guys on the -- at the other shop. And if you look at the Q3 results, listen, our WTI business is down about 30%, and so is Brent. So the market is not experiencing any pressures to move to one or the other. These are issues that are driving. You've got global overhang of excess supply and demand that hasn't yet recovered and won't likely until we have a full imposition of a vaccine. So there's the concept that somehow Brent is a better product or a different product from WTI, it's just not borne out in the data and the participation in the global growth of the business. What's more important, Patrick, and this directly speaks to the broader energy complex is natural gas. If you slide -- Susan, you go to Slide 26 and 27. Slide 26, you've heard us tell the story. We have invested in our natural gas business. This is a market that we own 82% market share in this, the Henry Hub futures business. You've seen what we've been talking about, a market that globalizes where you have U.S. natural gas being produced at the lowest marginal rate that's liquefied in the form of LNG, liquefied natural gas, put down to the Gulf, put on boats and shipped out to Europe and Asia. Now that you're actually connecting physical flows of natural gas, not surprising that JKM, the marker in Asia, TTF and NBP in Europe are converging to the lowest marginal price in the U.S. because we're creating the very efficient market that we all said the world economy benefits from. You've got prices coming off $9 to $2.50, and this is a market where we've actually seen U.S. natural gas come off the floor from $1.65 up to $2.50. This business for us is up 21% this year, and our options are up 43%. So from a global perspective, global benchmarks, physically connecting markets where we are the central pricing mechanism for those, all the data shows it. And that's -- the growth of that non-U.S. infrastructure and sales force is the support that we're getting from the growth of the business.

Got it. That's really interesting...

To say there is our -- one of the things we love about natural gas is this comes through at a rate per contract of $1.21. Commodities, in general, are priced at a higher rate point than the average as a whole. Gold is $1.52 RPC. Nat gas is $1.21. I think crude is about $1.10. So as we're seeing nat gas outperform and lift the franchise, that's lifting the revenues even faster because it's a higher price point than our crude RPC. So with that, I hopefully kind of touched on the energy complex, I can extend it to gold and ags as well, but I want to make sure we touch on the other points.

All right. No, good. That's really helpful and really interesting. So we've talked about the strength in gold. We talked about the strength in nat gas. But I think this year-to-date, equity index has really been the standout performer thus far in 2020. How much of the upside do you think is just simply a function of higher market volatility as opposed to maybe something a bit stickier and long-lasting for CME Group?

Patrick, that's a really good question. I greatly appreciate it. And Susan, maybe you can remove the slide from the screen, if that's okay. In terms of the volatilities in the equity markets, and maybe I'll look at the volatilities across the financial markets. If you get rates volatility in recent months, all-time record lows, I mentioned it on a couple of calls previously. If you were to look at our Eurodollar future, for example, in the month of July, lowest volatility since the inception of the contract. So extraordinarily low volatility. If you look at the foreign exchange markets, foreign exchange markets in recent months have been in the bottom decile of volatility going back to January of 2007. And so likewise, extremely low -- extremely low volatility. If you look the equity markets on a similar metric, slightly above. So they've been running between the 50th and 60th percentiles going back to January of 2007. So if you look at it from that perspective, it's not that much above the mean volatilities achieved over the last 13 or so years. So the equity volatility is strong, but not outsized on the high side, more slightly above the long-term averages. The real success -- so it's the only, I'd say, business that hasn't had a headwind. And if you look at that business without a headwind, as you've noted, 66% growth in our volumes this year, a tremendous result year-over-year. What's driving that? A significant portion of that is the success of our Micro E-minis. In terms of Micro E-minis, a product we launched a little over a year ago, trading more than 1.6 million contracts at A this year. So a very positive result. Those contracts are 1/10 the size of an E-mini contract and from a risk-adjusted basis, priced at a significant premium. So to the extent -- so we believe that this has penetrated a new client base of active traders. For some of the existing customers, we got much more volume out of them. Why? Because instead of trading, let's say, 1 E-mini contract, they might have wanted to trade 1.5 E-mini contracts, for example. And with that smaller-sized contract, they have the ability to instead trade 1 E-mini and 5 Micros so -- in order to get the exact sizing they want. So that has been a significant benefit to the overall business. In addition to that, we've done well with the equity business in terms of RPCs from a couple of different perspectives. First, we did have a fee increase at the beginning of this year for our equity business. That did enhance the E-mini RPC -- sorry, the E-mini RPCs, so excluding the Micros, number one. Number two, we've also seen very good growth over the last few years of new products that add much more value. So our total return equity futures have an RPC of -- north of $3 per contract, a successful new contract that we launched not too long ago. Also BTIC, a product that's grown dramatically over the last few years, has a very high RPC, significantly higher than the rest of our equity complex, another new contract that adds significant value with a much higher RPC. Last, I'll mention, as we had mentioned on our earnings call, I said that we -- when we launch new products such as the Micro E-minis, we usually start with very significant incentives to market makers in the initial launch of the product in order to incent them to give great liquidity to new customers on day 1. And that costs money, but that over time, we reduce that. If you look at our Micro E-mini RPC over the last 12 months, we did announce on our last earnings call that it had doubled. And that was not relative to any increase in fees, but instead a reduction in incentives. Hopefully, that helps to talk about the equity business.

And Patrick, maybe if I can jump in real quick on the back of the build. I know I touched on it briefly before, but I think it's important to touch on here. And actually, it picks up on some of the comments that Sean was making, both in terms of the focus and being able to make sure that we've got the right product set for customers when market circumstances require them. So to the point Sean was making about the great success we've had in the Micro E-minis, we actually built the Micro E-minis in gold in 2010. We put them out in silver in 2013. They were a product that were exactly, for the reasons Sean had talked about, built for customers for a particular set of needs as and when we needed them. The record levels that we saw in monthly average daily volume in August of a little over 1.1 million contracts, a good proportion of that was a result of customers picking up and utilizing the products that we've developed over 10 years ago for markets exactly like these. As we saw gold scream up through $2,000, we had a ready-made solution for customers to access our deep liquid markets. We have 94% market share in the global gold futures market, so giving retail customers access to that global liquidity pool outside of an ETF, better than any of the cash markets you can access out there. That was a ready-made product in place so that as markets wire, they were able to access the market and grow. More importantly, on this slide, what we actually show here is the significant positioning of CME Group or COMEX futures in, in this case, precious metals, specifically gold. And you look at that chart in the upper right-hand corner here and you'll see that when we build markets, we don't work on a zero-sum game or building a market by taking market share from someplace else. If we're not innovating either through technology, product, capital efficiency, operational efficiencies, then we're not bringing new customers in the market. What the chart is showing you here is we've been able to grow the overall gold market with the preponderance of that growth taking place in CME Group futures. So it's that story of innovation, the story of new client acquisition, not shifting customers between venues. Nobody wins there. Customers win when you bring more customers in. And the data has shown when we were 10% of the market 20 years ago, going to now a market that's twice the size of the London gold market, not because we reduced by taking business from the LBMA, but we brought new customers with product innovation and technology. So again, $1.52 rate per contract. This is a $250 million business, where the preponderance of that growth is happening in Europe and Asia. So sorry to jump on that, but it's a story that picks up on some of the themes that Sean was talking about.

No, I appreciate that color certainly. And I think the conversation about rate per contract actually dovetails nicely into my next question, which is that one of the pieces of feedback I often get from investors on CME Group is say, "Hey, why has RPC trended downward over the long term despite CME's apparent pricing power?" And I think the answer is there's a product mix issue. There's a customer mix issue. How does CME think about RPC and trying to weigh that against average daily volumes and how your pricing muscle kind of fits into things?