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

Let's get started, everyone. So good afternoon, everyone. I'm Ari Ghosh, and I follow the U.S. Exchanges here at Crédit Suisse. For our next session, we are hosting a virtual fireside chat with CME Group to discuss strategic priorities and the outlook for 2021 as the company faces an improved macro backdrop and have successfully completed key pieces of migration and integration efforts. It's my pleasure to welcome CFO, John Pietrowicz; and Global Head of Financials and OTC products, Sean Tully, this afternoon. Gentlemen, I wish we were doing this in person from sunny Florida, but really appreciate you being with us here virtually. So thank you so much.

Thank you, Ari. It's a pleasure to be here, and it's good to be able to talk to everybody. I, too, as I'm sitting here in snow in Chicago in my bedroom wishing I was down in Florida with you.

Yes, exactly. Why don't we just get -- jump right into things. So 2020 was a disruptive view of global markets to say the very least. But the macro backdrop has improved here in 2021, and you're seeing that reflected in your futures complex, where volumes improved in Jan, they're holding up in Feb, including rates in energy, which were most impacted sort of from these macro headwinds last year. So why don't we kick things off with a high-level update on early customer engagement trends, which you're seeing across commercials, buy side, sell side, operating, just across the street there and how that compares to what you saw in 2020.

Well, thank you, and good morning or afternoon, everybody. So you're exactly right. We're off to a good start to the year. We're averaging about 20 million contracts a day so far in 2021. That's up from about 16 million in the fourth quarter of last year. Time has been tremendous the last week or so, especially the last 3 days. We do have the treasury role kicking in. We had 34 million contracts on Monday and 30 -- about 38 million contracts last 2 days, and we're off to, I think, pretty -- another pretty strong day again today, Thursday. When you take a look from a customer perspective, the proportion of activity, when you look at the fourth quarter of last year and the first quarter of this year so far, the proportion of activity is relatively constant. So that means that kind of everybody is participating and increasing. We have seen a couple of smaller shifts, and we've seen some improvement in terms of the proportion of trading from banks, hedge funds and commercials. And I think that's reflective of increasing -- large increase in activity in interest rates, energy and agricultural commodities. So good start to the year so far and some real positive trends in some of the areas that were kind of challenging in 2020.

Yes. Let's drill down then some of these segments. And again, it's a good start to the year. Then with interest rate futures, if we start there, again, the rate environment looks relatively more accommodative just given the CPE yield curve. Quarter-to-date kind of volumes are tracking arguably higher than expectations. However, if I look at the open interest trends here, open interest sort of remains a little more muted year-over-year yes. So yes, I was hoping you can unpack some of the dynamics at play here. And if perhaps you should be looking at certain product places that are a little different to gauge the underlying health of this franchise over the next 12 months.

So this is Sean. I'll jump in maybe and talk about the interest rate franchise and interest rate futures and your question there. Thanks for the question. Great question. As you said earlier, there are huge, obviously, macroeconomic headwinds for the interest rate business last year. Obviously, the 0-interest rate policy from the Federal Reserve, in particular, as well as their purchase of more than $3 trillion worth of assets or with a massive increase in their balance sheet. One of the themes that we brought to investors last year was the unprecedented aggressiveness by the Federal Reserve, both in the overnight policy as well as in terms of the speed of taking the rates down. But in addition to that, the aggressiveness in terms of the quantitative basing and the increase in size of the balance sheet, unprecedented in U.S. history. At the same time, another theme that we talked a lot about at something you can see on our new TreasuryWatch Tool, which we launched last year, is in addition to those aspects from the Federal Reserve. On the fiscal side, unprecedented fiscal stimulus, right? Unprecedented levels of new debt issuance by the U.S. treasury and unprecedented debt to GDP ratios, surpassing levels only ever seen before in the United States during World War II. And I think what we said was that the current environment was a challenging one. Nonetheless, that as we came out of this crisis, that there would be far more need for our products than ever before given the extreme reactions both by the Federal Reserve as well as the U.S. Treasury. And that's what we're seeing happening. That's really coming to fruition. So if you look the third quarter of last year, for example, we had the lowest ever volatility in the 8th Eurodollar future or the eighth quarterly, so 2 years out, in its entire history. If you look likewise, at the 12th Eurodollar future of the 10-Year Note, these are the lowest volatilities going back to January of 2007. And in our classic bond future in the third quarter, a 14% ranking in that volatility in the third quarter. So -- sorry, so 86% of the time, volatilities were higher in the Class 2 bond future. Than they were in the third quarter. What are we seeing this year? In this year, through February 19, we're seeing a very small uptick in those volatilities, a very small uptick in those rankings. And you see, for example, the 8th Eurodollar future remains through February 19 at the lowest volatilities we've seen since the beginning of 2007. You see the 12th Eurodollar future at 4%, so still 96% of the time through February 19 of this year, volatility in the 12th Eurodollar future were higher, a 10-Year Note, fifth -- 5% ranking. So in other words, 95% of the time, it was higher. And in the classic bond, 27%. So still 73% of the time, volatilities were higher. Even in that environment, what we're seeing is this tremendous growth in the use of our products, which is what we would have expected and what we did and expect. And in the recent week, yes, we've had the role and the role boosts our volumes, but we're seeing much, much more than that. Another thing in terms of the third quarter of last year. So let's talk about 6 months ago, the first tightening by the Federal Reserve was implied in late 2024. That first tightening is now moving into, as implied by our marketplace, into early 2023. And as of this morning, even potentially in December of 2022. So what does that mean? That means much more of interest to investors, and we have all the products. We launched all of the products that are necessary post the global financial crisis for customers to pinpoint their risk along that part of the yield curve, with the right liquidity, the right products, in order to manage that risk. What are we seeing this week on the back of that are relatively new, only a couple of years old, Ultra 10-year futures, there is also classic bond futures. Had an all-time record volume day in the last week, highest volume ever, even though we continue in a depressed volatility environment. In terms of the Ultra 10-Year future, on February 22, all-time record open interest, all time, all-time even in this lower volatility environment. So for futures in the last couple of weeks, have record average daily volume. So actually, for the month, over 100,000 contracts a day. In addition to that, record number of interests, record number of large open interest holder. So you're seeing as soon as a little bit of volatility comes back into market, we see huge growth in our products, especially around those parts of the curve where the federal reserve might take an action. If you look in the third year of your Eurodollar future, as I said, 2023, right? So the first tightening had been expected in late 2024. It's now moved into early 2023. '23 being the third year then of the yield curve. And so most impacted by the products that we have in terms of our third year of mid-curve options and our third year of Eurodollar futures. So if you look at the third year of the Eurodollar futures, those what we call grains on a product basis, we have 113% growth in open interest year-over-year. We've got 165% growth in the average daily volume year-over-year. And in terms of the 3-year mid-curve options, so the third year, we actually had a record, an all-time record open interest in those options. And we recently had an all-time record volume day of nearly 1 million contracts in those mid-curve options. So in those products that are involved in that part of the curve where it's implied the Fed might do something, we're seeing all-time record volumes in open interest. Now what will happen as we go forward, I don't know, obviously. But if you think about it, our reds have much higher open interest so the second year of Eurodollar futures, and that second year of options, so the options that refer to the second year of futures, much higher open interest, much higher average daily volume than the third year. Third year has much higher volume than the fourth year. First year have much higher than the second year. So just as we move through time, if the yield curve remains where it is even today, right? You're going to see much -- you should see much more trading activity, much larger open interest because that implied Fed movement or the possibility of the Fed moving is much closer in. So we're seeing much more than just the role. We're seeing a huge jump in volumes and open interest in the products that are focused on that part of the yield curve.

Got it. Super comprehensive, Sean. And I think that really helps, too. Moving to Energy, which is another segment impacted by the pandemic last year, market trends here again much more improved, the price of crude recovering nicely. And I think here as well, you've seen some interesting dynamics at play with -- if I think about U.S. crude getting significance in global oil markets, European refiners, processing more of U.S. crude today than they did a year ago. And perhaps offsetting that, some regulatory initiatives around drilling limitations, potential U.S. regulatory changes that might impact the E&P producers as well. So interesting dynamics. So I was hoping to unpack some of these global and structural factors at play. And how that informs your WTI outlook for 2021?

I'll take that, Ari. So yes we've certainly seen a strong start to the year for the global crude oil market with OPEC maintaining their production cuts coupled with the increased demand as there's more usage of crude oil, gasoline and aviation fuel, you've seen an upward trajectory in terms of crude oil prices to the $60 to $65 per barrel range. This is well above the breakeven point for the U.S. shale producers. So we're seeing good participation by our commercial customers. Also, you've seen a return in terms of the exporting of U.S. crude to around 3 million barrels a day. So when you couple that all together, you've seen a strong start to the year in our energy complex. We're averaging about 2.5 million contracts a day, and we're averaging -- so far this quarter, we're averaging 2.8 million contracts a day for the month of February. Now this compares to about 1.9 million for the fourth quarter of 2020 and 1.8 million ADV for the month of December. So really, you could see a strong return in terms of trading activity in the WTI. You also can see the U.S. being an important swing producer and with the shale profitability -- shale oil profitability, I think it sets us up well as global trends towards improving economies and towards the end of the pandemic. You mentioned some regulatory changes. In the medium term, we don't see much impact happening in the medium term. The non-permitting of the next phase of the Keystone XL pipeline isn't really a surprise nor does it directly impact your WTI business. So I think you're seeing some really good macro dynamics, which I think will be beneficial for our energy franchise.

Got it. And then maybe just more broadly, if you can speak to the ongoing diversification within the energy franchise of yours, including nat gas. And clearly, if you think there's any longer-term implications following some of the recent market disruptions that we saw this year.

Yes. No. Thank you. Yes, it's -- really, really excited about the nat gas market. And it's been a huge growth driver for us. In fact, in 2020, we had a record year of about 500,000 contracts a day in our nat gas business. The bulk of the growth is coming from EMEA and Asia as we continue to globalize our natural gas business. 2021 has -- we've seen a very strong start with February. ADV at 655,000 ADV, which compares to 450,000 contracts in December. And as I mentioned, like 500,000 contract for all of 2020. Now we're going to be facing tough comps as we're going to be facing tough comps across all of our business because of such a strong first quarter. So we're going to see some tough comps in natural gas as well. So in addition to the strong global growth, as everybody can attest to, that's been going around outside, there's been a call for a colder weather outlook, which is also fueling the bullish activity in natural gas. Natural gas is a market that we have 82% market share. And given the status of this as being a clean fuel, nat gas, I think, is going to become more and more important and play a larger role in the longer energy transition story. So yes, we've got really good diversification in our business, and I think we've got some good benefits in terms of the structural dynamics as we come out of the pandemic.

Got it. Yes. I mean, the comps are definitely tough. But the good thing is, at least in the first half of the year, it's already embedded in expectations and things like that. So it's all about -- if you're ahead of what people already think is going to happen. I think that's the key driver. And then in looking at the second half of the year, it should ease up there in terms of comps.

I'd rather have tough comps than easy comps, that's for sure.

Maybe moving then to higher RPC products. Again, you're seeing nice growth there. Metals, ags and last year, maybe the macro-related factors sort of actually aided on some of the volumes there, especially across metals. So maybe can you talk about either products, new product launches, users, of these products and growth out of APAC, which I believe, like they're heavy users of this, for example. So maybe how is that changing dynamics over there with new products, new users, sort of adding a new layer of incremental volume and growth looking ahead?

Yes. Great question, and thanks for the question. Yes, I think when you take a look at the -- our entire commodity suite of products, they're very global in nature. And I think they're really poised well to help our clients manage through the recovery from the pandemic. You see it now. China is back in the global ag markets. They're buying records amount of U.S. soybeans, for example, and we're seeing strong acceleration of that in Q1 that started in Q4 2020. And 2020 was already our second best year in the ags market with record activity in Q4 in EMEA and APAC. In 2021, it's starting out even stronger with ADV at 1.7 million contracts a day, that's up 18% year-to-date. And we're seeing strength in our open interest with about 8.6 million contracts in open interest. So we're continuing to see that global participation continue to lead the growth in 202 and as we are the physical benchmark in the ag markets. We have launched a couple of contracts, which are pretty interesting. We've launched our South American soybean contract. So no matter where you are going to get your exports, whether it's the United States or Brazil. We've got a tool to manager that manage your risk. We've also launched a pork cutout contract, which is an augment to our livestock market. The point being that we are constantly looking at innovating across all our markets, including the ag markets. You touched a little bit on the metals side. That has been 1 of our strongest growing asset class year after year. It was our fifth consecutive record year in 2020, and we set multiple records within our metals complex. We had a record level of activity in our precious metals. You pointed out, non-U.S., we had a record non-U.S. ADV inter-metals contract. And not just precious, it's also in industrial bells. So we set a record in aluminum futures and a record in steel futures. That growth is continuing on into 2021, we had a strong start to the year with ADV of about 707,000 contracts versus Q4 ADV of about 568,000 contracts. So again, a good start to 2021. And on the product side in metals, we are excited about the launch of our cobalt contract. As you know, cobalt is an important component in electric vehicles. It's still early days, but we're very pleased with the participation with our commercial clients and end users in developing and designing the contract. So a lot of exciting things going on across all of our commodities businesses.

Got it. And then clearly, last but not least, the equities business coming off especially strong year record e-mini and micro growth that you saw. So I'd love to get sort of your thoughts on the sustainability of the retail boom, which is making its way -- it looks like it's making its way into the futures segment as well. And if you think these smaller retail-friendly or tactical products is going to be the norm moving forward, or perhaps if you think they're better suited for certain asset classes versus others?

Yes, I'll start, and then I'll pass it to Sean to talk a little bit about what he's seeing in the equities place -- equity space in particular. As I mentioned on the earnings call, we average about 1 million contracts per day in 2020, and that's up about 50% compared to full year 2019. So very strong growth in the Active Trader segment of our business. Obviously, the biggest gains we saw were in the equity side of our business and the micros, in particular, were a tremendous success. But we also saw year-on-year gains in metals and in ags and FX. So all of those contracts, we saw good participation from the Active Trader segment. I think that really speaks to the diverse set of products that we have. So if you are an active trader and you come to our markets, we've got all of the products that you would be interested in trading, whether it's commodities or financial products. You can come to our market, and you can trade that 24 hours a day, which is very attractive. And one of the things that we've been very focused on is building that liquidity 24 hours a day. Our digital outreach has been very successful. We're reaching more participants than ever before. And we continue to invest in education and events with our broker partners. Couple of points around the Active Trader. They tend to have a very high rate per contract. They don't tend to be members of the exchange. So they -- so there tends to be a high rate for contract. So they contribute more to revenue than they do to volume because of that. And this is an area that we're going to continue to look at and develop. We think that there is a lot of opportunity for us to expand in the Active Trader segment. I don't know, Sean, do you want to talk a little bit about what you're seeing in the equity side?

Sure. Thanks very much, John. A couple of things I'll mention. We're obviously very excited about the success of our Micro E-minis, now launched a couple of years ago. So recently, averaging about 2 million contracts a day. And on a risk-adjusted basis, priced at a significant premium to the e-minis. In fact, also, as we sit on the on other calls, on February 1, we did increase the rate card. So the fees that we charge for non-members for those products as well. If you look at the micros for non-members in particular, they were priced at $0.20. They're now going to price at $0.25 on an e-mini equivalent, that's either $2 or $2.50. So a significant increase there and also a significant premium over our other products. So very excited about the 2 million contracts a day. Obviously, in a new product, single most successful launch in CME Group history. In terms of the Active Trader segment, we did add about 200,000 new Tag 50s. This is the way we track new customers. It's about 200 -- 200,000 -- excuse me, new customers last year. In CME Group history, that is a phenomenal number. You can go back to more than a decade ago, and I would strongly believe that there were fewer than 200,000 Tag 50s across the entire exchange. So this is obviously enormous growth. So we're continuously looking at innovating. We're continuously looking at adding new customers. On the innovation side, we are very proud. On the earnings call we did show, as we do every year, innovative new products launched. And last year, for the financials and OTC unit, more than 3.2 million contracts a day in new products launched since 2010 and $365 million in revenues last year. And so even in an extremely difficult year, in particular, for extremely low volatility environment, we made $50 million more from new products in 2020 than we did in 2019. So a result we're very proud of. Obviously, then, as I said earlier, when you start to see an increase in volatility, even small increase in volatility, that product innovation and the reach of new clients shows up in much higher volumes as we're seeing in the latest week. In terms of attracting new customers, the things that we do to attract new customers. So the new products, I've talked a bit about that. I talked earlier about the SOFR futures, recently record open interest, record large open interest holders, record volume, Ultra 10-Year futures, record open interest, record volume in the last week. So we continue to get great traction in those new products. I can talk about the Bitcoin futures where we recently are having all-time record volumes and Ether futures we launched fairly recently, doing more than 1,000 contracts a day. So also in crypto space. And we've got a long pipeline of new products that are still in front of us, but the recently launched products doing very, very well. In terms of adding new clients, nothing that we're very active in is building new analytics and new tools, using the unique set of data that we have that no one else has access to in order to add value to the world, right, in terms of better managing their risk. But also, obviously, as we offer these new tools and these new analytics, that attracts new business, right, and new participants to our markets. So in my unit, for example, last year, we launched 4 significant new tools in the last several months. We added the new TreasuryWatch Tool, which allows you to see through our unique set of data as well as the data we have public access to across the Fed and the treasury and others. Everything from the overnight rates and what's going on in the overnight market all the way out to 30 years across both the cash and the derivatives market. Then in addition to that, we launched the new FX Swap Rate Monitor, which for the first time ever, shows the greatest transparency I've ever seen a central limit order book in FX swaps, which you can access to our FX-linked product. So clear standardized lower total cost alternative to OTC FX swaps. We also launched our new FX Options Val Converter tool, which for the first time ever, shows all of CME's listed FX options in OTC equivalent terms. And then last, we also launched on our FX Market Profile tool, which, for the first time ever synchronizes the spot foreign exchange data available on EBS with the FX futures data available at CME and shows side-by-side, minute by minute, the liquidity in each of those 2 separate liquidity pools. But we show them in a synchronized way and in a uniform way, so the clients can see, depending upon what the type of trade they want to do is, whether they should be using the very deep liquidity in the spot foreign exchange market or in the futures market. And it's very clear from the different nature of these liquidity pools from the data we are now showing clients for the first time that you need to use both of those liquidity pools in order to minimize your execution costs and to maximize our customers' returns in their own businesses. So I'm bringing that up in part because we have 15,000 unique registrants to those 4 new tools. And those obviously then are converted into sales opportunities for our product. So another way. So we innovate on the tool side showing more value, but that also gives us many more sales opportunities.

Yes. No, I'm going to hit on a lot of these points that you mentioned. Very interesting. And just going back to your numbers, it's a huge number, 250,000 ads that you have there. And just to clarify, that's Active Traders that you see on the platform that you added. And are they primarily using equities? Is that their main focus? Or is it across the board utilization?