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

Good morning, everyone, and welcome back to the BofA Securities Future Financials Virtual Conference. I'm Mike Carrier, the research analyst at BofA covering, the brokers, asset managers and exchanges, and I hope you're all doing well. Our next company up this morning is the CME Group. With us today are John Pietrowicz, Chief Financial Officer; and Sean Tully, Global Head of Financials and OTC products. John and Sean, thanks for joining us today.

Thanks, Mike.

Yes. And before we begin, just a reminder for everyone in the audience, if you do have a question, there's a portal on the site that you can submit a question, and then I'll ask those towards the end of the session.

So maybe just to start, given the timing of the migration of BrokerTec over to blow bets this quarter, since it's timely, what are some of the potential benefits that transition, whether it's on the growth outlook or on the expense side and how you see that playing out over the coming quarters?

Mike, this is Sean, maybe I will jump in. Yes, when BrokerTec's dealer-to-dealer platform is fully integrated with CME Globex, clients are going to get an enhanced suite of government bond trading offerings across both our listed derivatives as well as our cash markets as well as repos. And when we do that, there's going to be a common set of technology protocols and specifications across cash and futures. We're going to have shared services like, MDP 3.0, iLink 3, Drop Copy and CME straight-through-processing interfaces. So very excited about that. In addition to that, we're going to have a robust set of channel partners that are fully adapted to the technology for both sets of products. One thing to note this morning is that while we have already conducted a number of mock sessions or weekend tests, these are weekend mock trading sessions, in order to ensure customer readiness, we have now decided to give our customers more time to get comfortable with the new platform. And we have now -- we're announcing that we're going to be testing the new platform a little bit longer, customers are going to be testing the platform a little bit longer. And the entire migration will instead be done by February 1. With that change in dates, we will still completely make our cost synergies as they have already been announced. It's just a slight delay by a small number of weeks in our current situation. We're very excited, not just about those technology efficiencies that we're delivering to customers, but also new functionality that's going to be available on the Globex platform. Globex has always had, or at least for many years, had implied technology and intercommodity spread trading technology that has been hugely successful in, for instance, our Eurodollar futures. That type of technology has not been available on BrokerTec for U.S. Treasuries. So when we move over to the new platform, we will also be introducing by new relative value trading types. That new relative value trading type will allow customers to trade -- curve trades. So 2-year notes versus 5-year notes as a spread trade, for example, so 2s/5s, 2s/10s, 10s bonds. When we do that, when we introduce that new enhancement, it's going to give several new advantages to our customers. First, today, on BrokerTec, if they want to do a curve trade, they have to leg into the trade. They have to do the 2s and the 5s each separately. Instead now, they'll be able to put in a 2-year, 5-year spread order type that will eliminate legging risk that you would have versus the old methodology or the current methodology. We will also be able to reduce the minimum price increments, so the cost to cross that bid offer spread. And last, we're going to be using Globex-implied technology. Implied technology means that we can take the theoretical order book in 2s plus the order book in 2-year versus 5-year spreads, and that implies outright orders in 5-year notes. So it will also enhance liquidity. So we're very excited about that as one example of using the Globex technology, where we're going to be reducing risk, lowering costs and enhancing liquidity on the platform.

All right. Great. That's good color. And maybe just overall, before we get into some of the different product areas, when I look at the volumes and open interest at CME, some of them have been under pressure, and granted, like 3Q last year was -- is it was a tough comp. But do you view some of the muted activity right now, it's mostly environmental, meaning post the pandemic things kind of resume, we get back to normal? Or are you seeing any other factors due to that inhibited activity?

Well, thanks, Mike, and I really appreciate you having us here, and good morning, everyone. It really varies product-by-product, and each asset class has unique dynamics. In terms of where we see most headwinds in volume is where we see extremely low levels of volatility, and it's really pronounced in interest rates and energy driven by the pandemic, both from governmental economic support and interest rates and demand impacts and energy. We're seeing -- we're not seeing really any evidence of changes in the competitive dynamics. On the flip side, we're seeing strong results in equities for much of the year. Ags are setting records with significant exports, metals reached peak levels in Q3, and natural gas volume has really been outstanding. And I think this really shows the power of our diverse product set. So I would say that you're really seeing kind of a unique environment here with the pandemic, where you've got demand destruction on the one hand and governmental support on the other, which is causing some suppression of volatility. But like I said, from a competitive dynamic, we're not seeing really any changes.

Right. Okay. That's good overall color. You mentioned the one area that we've seen some pretty good strength within on the equity side, including the Micro E-mini contract, how much of the demand in equities has been driven by the retail versus, say, the institutional side of the business? And how has that shifted over time?

Yes. This is Sean jumping in again. Thanks for the question, Mike. We're very excited about the success of our Micro E-mini contracts, trading 1.8 million contracts average daily volume this year, just 1 year after launch and up 430% year-over-year. In addition to that, our equity complex, including micros -- excluding excuse me, excluding micros is up about 26% year-over-year at 3.9 million contracts a year. So we're very excited about it. We're seeing a record number of new traders coming into the platform, in particular, the small active traders. And we're seeing the fastest growth ever of that complex, and we're seeing them around the globe. So in the U.S., Europe and in particular, in Asia. And we're literally seeing on the active trader side, more than 10,000 new traders a month come into the platform. So we are very excited. You can also see from our equity RPCs, that we've got a very healthy mix. Obviously, we've seen enormous growth in our equity complex this year. Yet if you look at our Micro E-minis, the RPC on the Micro E-minis is up substantially this year, now running around $0.13. In addition to that, if you look at year-to-date year-over-year, the rest of our equity complex, excluding the micros, the RPC is also up. So even with these huge growth in volumes, the RPCs are doing very well. So we are attracting new clients, and we've got a very healthy product mix and client mix.

Okay. That's good color on the equity side. And then just on -- moving over to interest rates. John, you mentioned some of the issues around the low rates, and as stimulus has been impacting that part of the -- the product set. I guess, based on like past periods, when we've seen a low rate environment. Do you have a sense of when -- or what you look for to notice like when activity is bottoming or at least early signs that inflection point and how that can potentially impact activity levels ahead?

Mike, that's a really good question. This is Sean, I'm going to jump in again. So when I look at the current environment, there are 3 metrics, in particular, that I'll point out that I'd like to look at. I look at the unemployment rate, the aggressiveness of the Fed in terms of its balance sheet as well as, for example, the S&P 500. And if you look at those 3 metrics, one of the things we can see about this crisis is it is highly compressed from a time standpoint relative to the global financial crisis and highly time compressed, honestly, relative to any economic pullback that I've seen in my lifetime. It is without doubt a V-shaped recovery. So if you look at each of those 3 metrics, they look like we're kind of in that 2013 time zone if you want to compare us to the global financial crisis. So for example, in terms of the unemployment rate, the unemployment rate peaked during the global financial crisis in October of 2009, and then it got down to 6.9% in November of 2013. In this crisis, we went from 3.5% in February to 14.7% in April. And last Friday, we got the information from the Bureau of Labor Statistics that the unemployment rate is down -- now down to 6.9%. So we're currently down to the same level as we had in November of 2013 in terms of the cycle. If you look likewise at the Federal Reserve and the speed of their actions in terms of the size of their balance sheet, during the global financial crisis, it took from September of 2008, again, until November of 2013, the Federal Reserve to increase the size of its balance sheet by $3 trillion. If you look during COVID, it took just from February to the end of June of 2020 for the Fed to increase the size of its balance sheet by $3 trillion. So again, that gets us into that 2013 time frame. Last, if you look at the S&P 500, the S&P 500 originally peaked in October of 2007, and it reached that peak once again post the global financial crisis in March of 2013. Obviously, in February of this year, we had a new peak in the S&P 500. We fell dramatically. And in September, we were back above that peak. So from -- whether you look at the unemployment rate, the aggressiveness of the Federal Reserve or the S&P 500, it looks to me like you are in that 2013 time zone.

All right. Great. That's good context. And then maybe looking at the energy complex, that's another area that's been under some pressure given the macro and the economic backdrop. How are other factors, like the focus on, say, clean energy, competing contracts on the -- maybe the negative side versus the ability to export on the positive side? How are those impacting the business? And what do you think it will take to turn activity around across the energy complex?

Yes. Mike, John jumping in. We've definitely seen some lower volatility in WTI. As I mentioned before, the supply and demand dynamics in the energy space has definitely been impacted by the pandemic dampening volatility. And really, when you take a look at it, there's been a substantial reduction in the number of miles driven and the amount of jet fuel used. So that's impacted the overall global energy space. So when you take a look at the WTI plus the Brent contract, you can see that the CME's WTI, a proportion of that activity is in terms of trading volume, has been in the 55% range. And in terms of open interest, it's been in the 45% range, and that's been fairly consistent over the last few years. An area to point out when you talked about kind of the clean energy space is really our natural gas business, and it's been doing very well. When you look at that business, not only is our Henry Hub futures volume up 26%, our Henry Hub options volumes up 56%. And these are high RPC products. Futures are about $1.15 in terms of rate per contract, options are about $1.52 in terms of the rate per contract. And we've also seen very strong global activity. Our non-U.S. volume in Henry Hub is up 82%. It's up 116% in terms of Asian trading hours for our options business. And the European business is up about 69% in Henry Hub. So I think really, that's showing the global nature of the Henry Hub contract and the importance and growing importance that it has as a global benchmark, especially when you think about liquefication of natural gas, and you can see the convergence of prices globally to the Henry Hub price. So really, really pleased with that, the performance of that product in our energy business. And when you think about clean energy, this is really a good alternative.

Okay. That's good color. And it's a good transition to the next topic, is CME has had great traction if I look over the past decade or so in terms of the international like user base and that segment of the client contributing more and more to the overall volume. When you think about the current penetration [ given in ] percentages of volumes coming from that international base, how much opportunity do you think still exists? And I don't know if it's -- whether you look at it by product or geographies, but what is the future potential from here?

Yes. I'll take that. Mike, very -- we're very, very excited about the international business that we have. And really, when you think about the global nature of our products, it's hard not to be excited about the expansion, our global expansion. It continues -- our international business continues to outperform our domestic activity, and we've invested in a global sales force with the majority of the sales staff now located outside the United States. We've got sales staff located in 15 countries in 19 cities around the world, and we continue to be very active in terms of sales. Even in this environment, we're starting to see Asia open up to face-to-face meetings. We still are leveraging technology for sales activity in the U.S. and in Europe. And one of the things that we are really leveraging is the global nature of the sales force from NEX, which we acquired in late 2018. They have a very global sales force, and what we've been really focused on there is generating those cross introductions, and we've been averaging about 500 cross introductions per quarter over the last couple of quarters, and that's something we track very closely. And so when you think about our global sales force, the global nature of our products, the fact that our markets operate nearly 24 hours a day, I think we've got a lot of runway in front of us in terms of our global expansion. So that's really something that I think differentiates us from our peers. And as I mentioned, when you look at things like the Henry Hub, when you look at our metals products, you look at our FX business, all of them have a significant amount of global activity, but I think a significant amount more to go. So very, very pleased with the performance.

Okay. Great. And then maybe just shifting to RPC, like pricing. How is the mix in products? That's a little bit more visible in terms of how that can impact the RPC. But the members, nonmembers, how has that been impacting it? And probably more importantly, just how do you think about [ yearly ] pricing and even price increases even in environment where maybe volumes are more muted?

Yes. When you look at our rate per contract, generally speaking, our face rate or our rack rate doesn't go down. So you hit on it, it's really more of mix issues. So when you think about it, if you look at it from a product perspective, it's a -- you can have mixes within a given asset class. So for example, the long end of the interest rate curve has a higher RPC than the short end of the interest rate curve. When you look at micro contracts in our metals and equities business, they have a lower rate per contract than our standard products. Then you can have mix shifts between asset classes. So for example, commodities have a higher RPC than our financial products. Then you can have a customer mix shift. So for example, members have a lower rate per contract than nonmembers. Our international customers tend to pay a higher rate per contract than our domestic customers, and our retail customers tend to pay a higher rate per contract than our nonretail customers. So you can get mix shifts within customers. And then also, we have volume tiers. So really, when you look at changes to our RPC, it tends to be those kind of dynamics. One area where we've had a tremendous success is in our micro contracts, and Sean touched on -- in our equity business. When you look at the third quarter in equities, you can see that our -- the amount of volume traded is approaching 2 million contracts a day, and that represented about 36% of the trading volume compared to about 34% of the trading volume in equities in Q2. So a higher proportion of micro activities. And as Sean mentioned, that's $0.132 RPC, up from about $0.125 in Q2. I think it's important to note that when you look at equities, in particular, that both our standard rate per contract on our standard products and the rate per contract at our micro products are all up from last year. So it's really a mix issue, as you pointed out. Also, when you take a look at our metals business, again, kind of on the heels of additional activity -- micro activity in our equity business, we've seen a lot of micro activity in our metals business. In fact, it's approaching 160,000 contracts a day in Q3, up 110% sequentially from Q2 to Q3. And they represented about 19% of our metals activity in Q3, up from about 14% in Q2, and that has a rate per contract of about $0.32. So again, another example of where we've got a highly successful product, both of them additive to our revenue, but you see kind of a shift in terms of activity. And what's really great about our diverse product set and the number of products that we have and our continued innovation is that we've got different products necessary in different cycles and in different environments. So what you end up getting is in some periods of time, you'll see increased activity in one product or one asset class versus another in a different period of time or a different environment. So really, it's this complete suite of products that we have that we can bring to bear for our customers that differentiates us, I think, from our peers and I think really gets us excited as we start to come out of the pandemic.

All right. Great. That's good color. And then you mentioned on the international question just the sales force, what they've been working on. Just curious on -- I don't know if there's anything more to add, but just some of the initiatives that have been in place, like the cross-introduction efforts. How has the traction been on that front?