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

Sorry about that. Anyways, it looks like we're getting started a little bit early. Good morning, everyone, and thanks for joining day 2 of the UBS Financial's Conference. I'm Alex Kramm, Senior Research Analyst at UBS, covering the U.S. exchanges, rating agencies, information services and commercial real estate brokers. Kicking the day off here with one of the, I guess, longer-standing public exchanges and certainly largest in terms of market cap in my coverage, CME Group. Delighted to have with us today, Julie Winkler, Derek Sammann and Sean Tully to give us a little bit of an update on what's going on, on their side. We're going to do this fairly informally and go through a few questions that I have prepared. [Operator Instructions] But I think we should have plenty of topics to touch on here anyways. So I'll address the whole group, and hopefully you'll figure out who the best person is to answer. So first of all, thanks again for coming on. But since there's no presentation, why don't we start off really big picture? Forget the current environment or the last 15 months of COVID. When we look out medium or longer term, what gets you guys excited about CME's position in the industry? And why do you think there's still some structural growth ahead?

Sean, do you want to jump in on the rate side?

Sure, I'll jump in. We're very excited about innovation, right, and the ability to continue to deliver new efficiencies to our clients. Over the last decade, we've delivered enormous efficiencies to our clients. We're constantly looking at the total cost to trade and making sure that we are the single most attractive place for any of our customers to manage any risks. On that front, obviously, you know about a lot of the innovation we did over the last decade, how did that do in the first half? In the first half of this year, in financials alone, 4.3 million contracts a day came from new products launched since 2010. In addition to that, they delivered to investors $273 million in revenues. So the product innovation continues to be an extremely exciting area. And if you look at innovation, it's coming across every asset class. If you look at this year, I started talking about crypto very differently than I have in the past. Crypto has been exciting this year and I think will continue to be exciting, with not just our Bitcoin futures doing almost 12,000 contracts a day and our Micro Bitcoin futures stood at almost 25,000 contracts a day, each of them with high RPCs. So $5.45 RPC in the Bitcoin futures in the second quarter. And the micros at $1.57. So the micro story, a very strong one, between the micro and minis and the Micro Bitcoin. And obviously, we've got further asset classes that are doing very well there. We've also seen enormous growth in things like our Total Return and AIR Total Return futures in equity space, where we are providing standardized, clear lower total cost alternative to OTC equity total return swaps. And we're seeing great growth there. We now have between our Total Return futures and our AIR Total Return, or adjustable interest rate total return futures, more than $57 billion worth of notional equivalent in open interest. So this is providing huge efficiencies to the equity total return swap market as the next phase of uncleared margin rules his participants in September. So continuing to innovate across the asset classes, continuing to drive efficiencies. Obviously, we now also have the cash mortgage businesses. And for the first time, we were able to synchronize data and synchronize analytics across the 2 different liquidity pools, whether it is treasury futures and cash treasuries or in foreign exchange, the spot foreign exchange market and foreign exchange futures. This data, being able to synchronize it to be able to provide analytics, seeing how these are each of each their own unique liquidity pools, what that means is it allows participants to decide with the analytics and with the data will be able to decide exactly where and how to execute their transactions depending upon the size and the type of transaction in the single lowest cost, most efficient way. We're innovating on BrokerTec. Very excited about the beginnings of the innovation there, reducing the minimum pricing point on the 3-year notes. Shortly after we migrated BrokerTec over to Globex, if you look at the 3-year notes on the platform, the average daily volume went from $10 billion a day to $16 billion a day with that small change adding efficiency. So added 60%, 60% growth in that product with that small adjustment. $6 billion in additional volume, a very exciting result. RV trading, another area, which I'm excited about on BrokerTec and innovation using Globex technology. So it allows you to do curve trading spreads, such as 2-year, 5-year note spreads, 2s, 10s, 10s bonds, et cetera. So all of the different spreads possible across the different maturity spectrum of the benchmark on the run bonds. And notes, very excited about the efficiencies we're providing there with lower minimum price increment, eliminating legging risk to transacting and improving liquidity through implied functionality. With that recent launch, we got 26 participants trading. We've got last week about 330 million a day. We had a recent market day of 1.1 billion. And that's with primarily and actually essentially only manual users. So the automation, so the ISVs are only just starting to provide automation tools, right, so APIs and bridges to APIs for that new functionality. So very excited about the potential growth there. Maybe I'll just move very briefly, and then I'll hand it over to Derek, who's got very exciting news, especially on the micro WTI side. On the rate side, if you look at the LIBOR transition, I think where we are and where we're going to be is very good. So today, we have a very strong and robust SOFR market. We have a very strong and robust Eurodollar futures market. And we are planning on launching. We are going to launch, pending regulatory review, the new Bloomberg short bank yield index futures. And we have been endorsed by the ARRC of the Federal Reserve with our term SOFR rate. That term SOFR rate, to the extent that it gets uptake from the cash market -- the -- all of the financial transactions that we'll reference term SOFR will be based on CME's SOFR futures. Putting that into perspective, New York State this year passed legislation that created a safe harbor for tough legacy contracts in LIBOR that -- because that safe harbor says that if you use the ARRC-endorsed term SOFR rate plus the ISDA spread, which is the ARRC-recommended methodology, then you are safe from any lawsuits. There was a lot of concern years ago about potential lawsuits with the transition of LIBOR. Well, guess what? It is estimated that post June 30, 2023, there's going to be $4 trillion assets tied to that new rate under New York State law. And it will be based upon CME's SOFR futures. So I think in terms of our innovation, in terms of our solving problems for the industry, in terms of our providing new efficiencies, I'm very excited about the growth that we will continue to have by continuing to do that. And maybe, I'll hand it over to Derek.

I think maybe just a bigger picture, to answer your question, Alex. I think we're really excited about our position across asset class. I mean if you look at the year, we had record first half in 2020, really difficult comps. You look at the success that we're having in agriculture, for example, the agricultural market, it's a $0.5 billion business to us. We're on track to set record revenues this year. This business is our 1 business that's up year-on-year against brutal comps of last year. We've got record levels of non-U.S. business. We've got record levels of retail participation. We've got record levels of open interest. This is an asset class that shows that the strength and the power of the model, the diversity across asset classes where you've got, in some cases, relatively low or middling levels of volatility across asset class, we're positioned to take advantage of a lift in any asset class when they take place because we are the benchmark liquidity provider. So a really good story on a diversified basis. And Sean mentioned obviously, the addition of the cash markets business on top. I'm happy to talk about the micros, that might be a subject of a different question you wanted to raise, but the micro conversation is one of our continued progress that Julie and her team have put into place to be able to more deeply penetrate and more deeply effectively serve a global self-directed retail client trading base. We've had micro contracts in gold since 2010, silver since 2014 and really took off with equities in 2018. And that progress of continuing to serve customer needs with products that are specifically focused to their risk profile, that fit better needs, using a distribution model at the network level, CME Group out into our global distribution partners, has proven to be a playbook that has been incredibly successful, most recently indicated by our Micro WTI launch that launched just on July 12. In the first 20 trading days, we already surpassed 1 million contracts total. So we're already beyond that 50,000 ADV level the last couple of -- the last 2 weeks, we've averaged 75,000 contracts. And this is a contract that's 1/10 of the size, it's cash settled. 29% of our volumes at our micro WTI is coming from outside the U.S. versus 20% for our main contracts, so we know we're adding more global non-U.S. customers. And what the most important fact is, and Alex we've shared the deck with you on Slide 27 of the materials that we sent you guys, there was a little call out for Micro WTI. The most salient statistic in there shows how successful these products are in bringing new customers into CME Group products. The last bullet point indicates that over 4,000 customers are customers in our WTI micro contract that have never traded a CME crude or energy contract before. So when Julie builds distribution networks and brings customers to us through our distribution partners globally, whether they come because they want to try to micro equities or micro gold or micro Bitcoin, they can now trade all the micro products that we've rolled out. So 4,000 net new customers to the exchange in energy that have never traded an energy product before, that is the very definition of a successful cross-sell. So really happy about that. And the playbook we've built there and the success that we're having has built north of $100 million revenue for us that didn't exist 2, 3 years ago. So those are some exciting offshoots of the things in which we're continuing to fine-tune the business. That's really a function of Julie's team being able to leverage the client relationships and distribution networks they have access to, and micros are just a great example of that. We have many to speak of. That's the most recent example that really shows the power of the model.

Thank you. Yes, that was a lot to unpack already. Hopefully, we can go deeper in some of those areas you already highlighted. So hopefully I won't be repeating too much. But maybe since you just mentioned Julie at the distribution side, maybe we'll go there next for a minute because I think people generally -- a lot of investors look at the trading business just as a big cyclical bed. But as I was trying to ask my first question, like what is the longer-term growth? Is there still longer-term growth? And I guess, for you, Julie, what are you doing to grow that base of business? Like how are you driving engagement both from a sales perspective? And then I know we talked about some of the new products already, but any new innovative tools, any new ways to engage with clients, new analytical tools maybe to get -- to build that greater ecosystem? Julie, if you have anything to add, that will be fantastic.

Sure. No, thanks for having us, Alex, and great question. I think it all starts as with really our client centricity. And so whether it's the 41 new products we've introduced this year or the innovations that Sean and Derek both spoke to, it really has to be is what is the customer need that we're solving for. And so we have a global sales team in place to really help us understand what those needs are. We have a very campaign-based sales approach so that as the business priorities get identified, SOFR's a great example, we can actually start building out who among our customer base is going to be most interested in learning more about that product, engaging with it, understanding what the liquidity profile is in that contract. And so it's a whole process and a lot of this is just discipline that we put within our sales process. and continuing to harvest net new customers. We've had a huge amount of engagement over the last 5 years on identifying who are those people out there that should be using futures and options on futures but aren't and how do we go find them? And that's really where the data side of the business comes into play where we use a team of data scientists to help us figure that out. And we've overhauled all of our digital properties so that we can create a much more customized and personalized experience for our customers and we can anticipate where it is that they are looking next, so that our leads, our salespeople can call, reach out to them and use all these other means to get the information to them at the right point in time and make the sale. And obviously, a big part of this is working with partners, working with our bank FCMs, our other clearing members as well as our retail broker partners. They are all an extension of the sales team that we have, and that is a key part of how we ultimately are successful together of how we partner, how we're doing joint events with them. And this last year has really, I think, allowed us to do even more than we could do before because we're still so much in this virtual setting. We've had our sales activity up about 6% over where we were last year. But in Q2, we saw a 56% increase in the amount of in-person events that we were able to do. So customers are interested in getting back and meeting with us, which is certainly rewarding from our team's perspective as well. And I think the companies that have been successful throughout the pandemic are those that had client relationships built on trust and that they knew people. And they had deep-seated relationships and that transition to a virtual environment was relatively easy in that sense. And that's where we're going to bring the hustle, to go out there and bring more customers into that. Derek mentioned internationalization, a huge part of what I see as a growth opportunity as well. We have about 60% of our sales team outside the U.S. London is our biggest office. Lots of new resources plowing into Asia as well. And that's really a lot of new client acquisition and more educational opportunities than we probably have in North America. So we're really deploying the model and the country-specific focus there, I would say, more acutely than even what we're doing in the Americas. So that is exciting on the horizon. And then the last part of your question just on data and analytics, this is obviously a huge growing part of the industry and customers are consuming data in more ways than they ever have before. CME is in a great position of that we provide more market depth than any other exchange or any other entity to over 40 benchmark products. And this is really a sign of the strength of our data business as well, where we're up year-on-year, almost 9% on revenue. And what we're seeing is people need our real-time data, they're consuming data in new ways and how we've addressed that with our nondisplay policies, and they're using tools and analytics that Sean referenced earlier to make their trading experience at CME even better. So you'll continue to see more from us, but this is all just part of that ecosystem. So we can introduce SOFR futures. We can use that information to then create the SOFR term rate. And so it's really the business kind of redeploying its own capabilities to ultimately bring value to the customers, which is what we're all about.

Great. And you just mentioned the excitement around international. So can you just be a little bit more specific? I think your non-U.S. volumes continue to grow faster than the U.S. A large portion now is international. So I guess the question is, how much room is there? Where is the most white space? And who are the incremental users that are picking up CME contracts around or trading CME products around the world?

Sure. I'll start with that and then maybe hand it over to Derek. Yes, I mean, Q2, we had the second best on record really with our international volumes. So the volume was up 6% year-on-year, 5.2 million contracts. We continue to see APAC growing as a region faster. I think the segments that were most active there was definitely on the hedge fund side and on the retail side has also been very strong for us there. But we had 3 out of 6 of our asset classes internationally showing double-digit growth. And really, it was just energy and equities that were down a little bit in Q2, largely just because the comparable in Q2 2020, we all know what's going on then. So I'd say EMEA and LatAm are also, really, we're seeing a lot of great growth there. I think our product introductions have had a lot to do with that as well as our teams there. So those regions are both up 5%. And very similarly, lots of strong growth in rates, ags and FX. The one of the bright spots that I'm seeing is that -- and kind of a newer trend is the new product adoption among our international client base. SOFR in particular was one where we saw more people trading, international clients trading SOFR futures that we have. The other bright spot, and I know we'll spend some time on that later, is just ESG products. The demand out of Europe, followed closely by the U.S. and also APAC, for this solution set is really off the charts. I would say it's coming up in probably 85% of our client conversations. Our sales campaigns there have been highly successful. There's a lot of educational efforts to do, but corporations are really looking for what they're going to need to be able to get to these net 0 commitments that they've made. And in a lot of cases, Alex, these are customers that maybe traditionally have not traded futures with us actively before. And so we see that as a really great opportunity to bring them in. And I think maybe with that, I'll turn it over to Derek if he has any additional comments. Obviously, ags were a bright spot, too. So he may want to start there.

Yes. And Alex, on Slide 10 is the information you've seen from us before and just the continued growth and strength of our non-U.S. business lived in Europe and Asia, and you can see by asset class, this particular quarter, kind of what percent of our business is done outside the U.S. And you can see some healthy growth in certain areas, and Julie just touched on it. As I mentioned at the top of the call, our agricultural products markets, which is the global benchmark ag markets, again, $0.5 billion business to CME Group. Our non-U.S. business in the second quarter was up 42%. And what's exciting about that is, and this actually ties back to retail, a lot of our retail growth incrementally is coming out of Europe and Asia. We've seen that in the Micro WTI launch. We see that in our distribution partnerships in places like Korea, for example, where when you run benchmark, global benchmark markets, where customers know they can be in lit markets during their time zone, on screen, and they may get in and get out no matter what time of day it is and what time zone than there is, that then allows you to extend your franchise. So to the extent that our globalization story is as good as our technology growth story and we continue to invest in our Globex distribution technology, we continue to invest in our front-end strategy, in things like CME Direct, which is our own front end, which saw a record utilization in the first half of this year. Our enhanced analytics using QuikStrike for our options business continue to be the means by which we're capturing electronic regional traders in Europe and Asia that want to interact with our markets. That's why we're setting records in our businesses. And that's why ag has been such an outstanding success story for us over the course of this year. So just a good overall story there in terms of global penetration. And I think Julie mentioned it before, we now have more U.S. salespeople outside the U.S. than inside the U.S. Why? Because that's where our marginal business is coming from. And the last add on ags, which kind of ties this together is not only are we seeing record levels of non-U.S. participation in primarily our corn and bean business, given the global trends of demand and supply right now, but also record retail participation outside the U.S. And by any cap that continues to be one of the strongest performers. Add to that, the commercial participation, which is also at record levels for ags and select products and energy as well, it just tells us the story of a globalizing entity with global benchmarks that leverages our technology platform and distribution that we're continuing to enhance to bring more customers on board, to give them the best overall experience, the broadest asset class with, to the point Sean made before, the best capital efficiency story they can get in any market.

Great. I was going to ask about retail more, but I think we touched upon it. Maybe just -- just to finalize on the retail side. I mean, where do you think you are on retail in terms of how much more participation that could come. But then also, are there any risks associated with that customer base? I know there's no direct risk, but in terms of just risk in general, just have a lot of retail in the market. And I'm asking because also historically, you've always positioned yourself as being the market for the real -- the real commercial users or the real hedgers. And now there seems to be this chase of retail. So the question naturally becomes is the core customer base tapped out? And why are you focused on retail so much. So if there's anything else to add, I'd be interested.

Yes, I mean retail isn't new for us. This has been a business we've been focused on growing for the last 10 years. So this isn't something that we're pursuing because other alternatives are tapped out. We have a separate team that manages our retail customer base, and it is run very uniquely from the other sales model that we talked about because we function as a direct outreach to those 100 broker partners that we have around the globe. And so their ability and our -- to attract the customer with our help and educate that active trader is something that is a journey that we've been on with them again for over 10 years. What has made the difference and why you hear us talking about it more is really that product innovation that Sean mentioned earlier. And with the introduction of a larger micro suite, this is something that they've been telling us that we needed to do to continue to grow this business and kind of take things to the next level. And so that was an investment we made in digital marketing and advertising and joint education work with them to really kind of take it up a notch. And that's really what we've done. We are on pace to bring in about 200,000 new retail customers this year. And that's done at the expense of our institutional customers. Again, that's a separate coverage team and a separate model there. So I don't worry about that at all. What I will say is -- and you mentioned it, there are alternatives there for retail traders and we all see it all the time. I think the difference is that the traders that are coming to CME, that are sophisticated enough to be able to trade derivatives contracts are not the same people that are actively trading Bitcoin on said other exchange. This is a different profile of people. There is more money funded in their accounts. We are far more profitable on those accounts than what some of those other alternative marketplaces are offering. It's not to say that there isn't competition though. And I think we are highly attuned to saying what else do we need to be doing? I still think there's going to be tremendous growth in options on our micros that we're starting to see attract a good percentage of retail traders, but we're still very early days there. Sean is introducing a treasury yield futures complex on the micro front shortly. And we're just 20-some days into even the WTI. And so what we know about retail is, they want to be trading things that they know and they need to be educated. The influencers, all of this is a big part of it. And so a lot of it is just how we continue to invest in that business. How we also diversify those suite of broker partners, so we're seeing a lot of great engagement from those Tier 2 broker partners that are perhaps even a little bit hungrier than some of the top guys. And so we're spending a lot of time globally with those partners to understand how they're positioning the business. And I think we still have some runway for sure.

So why don't we turn the conversation a little bit more to the near term. And I guess this is for Sean. People are clearly always very focused on your interest rate business. So maybe we can just talk a little bit about the near-term trends. What are you seeing in terms of indicators that you think are important in terms of open interest, large OI holders? What are they telling you? And then I know there's a load of question, but what client segments are more active than others? How do you think trading is going to play out as the expectations for the interest rate environment change over the next 12 months? I know it's difficult to predict, but I know you have an economics team, so you have a house view. So where do we think we sit today? And what does this mean for the next 12, 24 months?

Sure, Alex. Thanks very much for that, and a really good question. I think one of the really exciting things about our business is, if you look at the second quarter, year-over-year growth for the total exchange in terms of average daily volume was about 5%. Year-over-year growth for the financials are about 8%. And yet, especially in the financials, this was an extraordinarily difficult environment. And I think that's something that we probably tend to forget. If you look at the foreign exchange market, for example, one of the things I look at is percentile rankings of volatility. Obviously, if volatility was 0, there's no risk to manage, right? So when volatility goes up, we tend to see higher volumes. But if you look at the second quarter, which was a very good quarter and very good year-over-year growth quarter, it was extraordinarily suppressed from a volatility standpoint. If you look at, again, dollar euro, for example, at the 15th percentile ranking going back to 2007, that means 85% of the time, going back to 2007, volatility was higher. If you look at dollar yen, we were at the tenth percentile ranking. So 90% of the time since 2007, volatility was higher. If you go over to, let's say, the 2-year note futures, it was at its eighth percentile. 92% of the time, volatilities have been higher than they were in the second quarter. Go out to the 10-year notes, 12 percentile ranking, 88% of the time, volatilities have been higher. Even if you look at equities, equities in the fourth quarter -- in the first quarter had decent volatility, slightly above their long-term mean, but fell dramatically in the second quarter. So if you look at the second quarter, E-mini S&P realized volatility was at the 29th percentile. So 71% of the time, volatilities have been higher. So look at what we achieved. We -- in June, we achieved a new all-time record number of large open interest holders across our financial products. And yet it was one of the lowest volatility environments in history. So I think the fact that we were able to have such a high level of activity, to see growing activity, to see massive adoption of new products in what is an extremely volatility suppressed environment is an extremely good time. Why is that volatility suppressed? I think we all know. It's the Federal Reserve. It's the Federal Reserve's extraordinary policy of holding at 0 interest rates overnight. And it is -- in addition to that, they're continuing purchase of $120 billion worth of securities mortgages and treasuries per month, extraordinary intervention in the market that reduces the volatility and reduces interest rate risk. And so the fact that you've got massively suppressed volatility with good growth in our products, I think, is an extremely good sign. I see the economic environment as a number of enormously coiled springs. If you look at a 5.4% inflation rate year-over-year, if you had ever told me, I was a trader, a rate's trader, a manager of treasury for 23 years before I joined CME Group now almost exactly 10 years ago, if you told me you could have a 5.4% inflation rate and a 5.4% unemployment rate and a 0% overnight rate, I would never have believed you. Yet that is what we have today. And at the same time, the Federal Reserve are purchasing the securities that they're purchasing. So you've got very good growth in the economy. You've got roaring inflation in the economy. And you've got a Federal Reserve that is extraordinarily stimulative. At the same time, you've got the highest debt to GDP level in our nation's history, right? We're reaching those peaks, last reached only during World War II. And if you look at the underlying fundamentals, I think they're completely different this time than they were during the global financial crisis. And I think that's one of the things that many people are missing. If you look at Bridgewater, Bridgewater came out with a study -- with a study this week that's very similar to a coiled springs analysis that I do internally at CME, basically saying that we think that this is -- this time is very different than it was during the global financial crisis. And we've been saying that now for at least a year in different respects. But one thing I would point out in particular relative to the inflation rate, is if you look during the global financial crisis, if you look at household net worth in the United States, it peaked in the third quarter 2007 and they never reached that peak again until the third quarter of 2012. And that was obviously in part because of the equity market, but in addition to that, a very big driver of household net worth in the United States is the value of your home. And the value of your home and the stability of your balance sheet, where you are with debt service levels, are hugely important to how you're feeling and how much money you can spend. If you look at household net worth today, we're 22% higher than we were a year ago. We've seen, in the last 12 months, the fastest growth in household net worth in U.S. history. And if you look -- and it's not just the folks on the call and the folks who are in technology. If you look at the Bridgewater report, if you look at the bottom 60% of households in the United States from an income level perspective, they've got the highest level of household net worth as a percentage of GDP in our lifetimes. So I think that we've got a lot of coiled springs, you've got an equity market where if you -- let's say, the Case-Shiller ratio, we have never seen levels of this other than, let's say, 1999. If you look at the real 10-year yield on a look-back basis, there are only other 2 times you've ever seen this, from 1976 and 1980, and we know what happened with interest rates with Paul Volcker having to stop inflation in 1980. So I think, again, overall, I think there are a lot of coiled springs. I think the volatility is extremely suppressed by the Federal Reserve relative to the actions that they've taken as well as the fiscal stimulus. And for me, again, with the incredibly suppressed volatility, to see that we had a record number of large open interest holders in June, is a very positive result, but also a very -- created a very positive outlook.