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

All right. Good morning. We'll go ahead and get started with the next session. I'm Patrick O'Shaughnessy, capital markets analyst here at Raymond James, and thank you, everybody, for joining us this morning. Up next, we have CME Group. And on their behalf, we have Derek Sammann, Global Head of Commodities and Options and International Markets. Derek is going to go through a brief presentation, and then we'll open up to Q&A after that. So Derek, welcome.

Super. Thank you. Great to be back. This is my first conference in person for quite a while, probably for some of you guys as well, and it's just nice to be back, back on planes and traveling and seeing customers. We have our folks all over the world. So we've got a team in Malaysia today. Haven't been down there in 2 years. So it's nice to get back on the road. Patrick graciously gave me a couple of minutes to spend time just doing a quick overview of the business, where we are. Suffice it to say, good time to be in the volatility business. There's a lot of that around right now. As I think you are aware, we are the largest multi-asset class exchange in the world. We own and run benchmarks across all of the biggest markets between equities, foreign exchange, fixed income, agricultural products, metals and energy. As you can see, long-term sustainable growth and differentiation, high barriers to entry, high-margin business. We have a lot of competitive differentiators in our market model that we talk about. And you'll see the significant growth that is a result of what we're seeing and certainly volatility tailwinds across asset classes, not the least of which in the last 1.5 weeks have been unleashed in the energy and agricultural markets as well. So long-term success across asset classes, we'll talk a little bit about what's going on and what we're seeing in the immediate environment here as well. One thing to note, we did come off of a record year in 2021. So having come off a record year, we're stepping into a significant increase in a volatility environment, whether it's fixed income, whether it's ags, whether it's -- or what we're seeing in the energy markets and equities, up and down. It has been a great start for us this year. Year-to-date, our business is up 21%. Month-to-date in March, we're up even higher than that, led by our agricultural products business, up 64%. Our energy business, up 42%; and our rates business, up 30%. And one of the reasons that we love this business and what we've built is we're diversified across a number of different areas. You've seen this slide from us before. You can see a very well diversified set of product revenues. So if you think about how we're diversified across asset class, you can see very, very strong leverage across not just financial products in fixed income, equities and FX, but across our commodities portfolio of businesses in energy, agricultural products and metals, in addition to the recurring revenue streams that we generate in our market data business as well as what we're generating off of our equity investment in S&P Index JV that generates about $215 million or so a year in recurring revenue. So when you look at this, you'll see diversification across asset classes. We also have diversification across product types. Within this, we've got our futures and options business. We have our cash businesses in the NEX transaction from a couple of years ago. That's the market-leading EBS FX cash business and the BrokerTec cash business. We also run a swaps business that clears in the same clearinghouse as our futures that unlock market-leading margin efficiencies and capital efficiencies for our customers. We also are diversified across revenue source. We make about $3.5 billion on the revenue side of our transactional business. We make an aggregate of about $800-ish or so million when you think about recurring revenue, whether in the form of $515 million of our market data business or the $215 million or so that we generate from our S&P Index JV and some other recurring revenues here as well. So it's a well-diversified business and one that is responding very, very well to market dynamics today. This is a more granular look of how the market has evolved over the last 2 years and what we're seeing sort of on a monthly basis here, gives you a sense for where we finished our record 2021, where we're coming into 2022. And as I said, if you look at the March numbers here, you'll actually see that the largest gains, as I said at the top of my comments, were in our energy business and in our agricultural products businesses. Our ag business makes almost $500 million a year. Our energy business is about a $600 million a year business. So when our ags business is up 64% in March, that's good for the bottom line. It's also a high rate per contract, i.e., a high-margin business for us, as is energy. Our energy rate per contract is about $1.10. That compares to $0.65 for the exchange as a whole. Ags is about $1.25. So when these businesses do well, this is good for the RPC overall, good for the bottom line and the exchange. Very quickly, we spent a lot of time continuing to globalize our business. We spent a fair bit of time globalizing our sales force. As you can see, and this surprises a lot of people, we're called the Chicago Mercantile Exchange Group, but we're actually not Chicago-centric. We were up until about 5 years ago. If you actually look, this very small stack, lower left-hand corner, 64% of our sales staff is now located outside the U.S. That shocks most people. If you look at Singapore and Hong Kong, they represent larger concentrations of sales staff than in Singapore. And actually, our European operation based hub and spoke out of London is our single biggest sales center outside of all of our global locations. So this investment in our non-U.S. sales and client acquisition structure is what's driving the graph on the right, which is our outsized growth outside of the U.S. New client acquisition strategies. This yields product innovation opportunities. This is yielding higher rate per contract customers for us. For every customer we bring in outside the U.S., they typically tend to be a higher rate per contract for us. So this is good because not only does it add net customers to us, it adds net high rate per contract customers to us, high-margin business to us. That tends to be sticky as well. At the top, you'll see some comments about what we're seeing in terms of each of the asset classes and 1 -- what percent of each of these asset classes trades outside the U.S. Shouldn't be surprising that FX and metals are the 2 most global asset classes that we have. They are global markets that trade literally from the Auckland open all the way through to the New York close. What's really interesting is our agriculture products business at 32%. This is a business that set an all-time record for revenues and participation outside the U.S. last year. And we're seeing that continue today, certainly in light of what we're seeing in some of the stresses in the markets. This gives you a very detailed -- not as detailed as the following slide, but gives you a good sense for what it is that we do and how we innovate within our markets on the product side. We spend a great deal of time working with our global customers, asking them, "What can we do in our markets? What unhedgeable risk do you have in your portfolio? How can we help you manage risk across your asset classes and exposures in a way that you can't right now?" So we do a lot of work on the product innovation side. And this really serves 2 functions. Not only does this yield new revenue opportunities for us, as you can see, significant additions to both volume and revenue. More importantly, this makes CME Group even stickier to a customer base. As we are building out products like Mid-Curve options or Weekly options or micro versions of our existing contracts, that makes it a stickier set of overall products inside our portfolio base. So that means the dis-synergies that customers would look at if a customer -- if a competitor tried to compete against us on any one of these products, it makes it a very, very tough value prop to try to compete with us to say, "Well, I'd like to launch small versions of an asset class product." Well, you're looking at an exchange that has done that in every asset class with global liquidity, screen-based, actionable, lit markets. That's hard to do if your value prop is, "I'm cheaper in one asset class." So this generates net revenues. It connects us more deeply to our customer base, and it makes it harder to compete against us over time. This is a slide, a lot of detail on here. The takeaway here is we have a significant sized options business. We closed -- make close to $600 million in our options business globally. This is a part of our business that's been the fastest-growing part of our business alongside our non-U.S. business over the last 5 years. We continue to accelerate the growth of our options business. It's been outgrowing our futures business for a number of years now. And the reasons are we do this because, yes, this generates more revenue for us in options and it's a significant competitive differentiator because we run liquid electronic markets in every asset class different from anybody else out there. But more importantly, every time we bring an options product into our market, that tends to breed some amount of futures hedging on the back of that. So it end up reinforcing volumes in our futures business. So the $600 million we make in our options business actually is a conservative estimate for what that value is to the firm because of the associated amount of hedging that comes alongside. And that hedging only happens in our futures because customer will trade the option and they'll hedge with the underlying future on our exchange. So the value prop for us is, yes, to continue to grow our options business and attract new customers, here's all the ways that we're doing that. And our -- this is -- we've given you a graph of our customer count for some functionality analytics that we've built to make it stickier to our platform, and that generates increasing volume and revenue for us as a firm. Very quickly, I'll get to those last 2 because, Patrick, I don't want to run through a couple of questions here. You can see strong continued growth. You'll see on the left-hand side here, strong commitment to expense discipline. As we continue to accelerate growth on the revenue side, you'll see that expense discipline kick in. Everything that we develop, all the effort and time that we put into our research and development, all the technology we've added, we've been able to use that -- use our resource in a way to generate income and top line revenue, but also do that with expense discipline that I think is second to none in the industry. So that's a hallmark of what we do and how we do it. And then the other key there is our capital return policy, our variable dividend. Typically, we look to -- you'll see that increasing variable over time, but you've also seen the quarterly dividend go up as well. We just announced an increase in our quarterly dividend to -- Jack, to $1? Up to $1 a quarter. So we've -- as -- our goal has typically been to generate roughly 50-ish -- 50% to 60% of our free cash flow at the end of the year in the form of a variable dividend, and that's allowed us, as we continue to throw off more cash, we've been raising that quarterly dividend up as well. So continued focus on increasing the dividend on a quarterly basis, so you've got the regular recurring revenue there, and then knowing that we're going to get that big dividend at the back of this. So as we do well and do better, we share more of that with our shareholders. Lastly, this is our value prop. I'll leave it up here, lots and lots of detail. I'll let it sit as Patrick and I talk through stuff. But at the end of the day, this is how we think about the business, and this is how our customers and our investors look at us. We have a strong competitive position. We have high barriers to entry. We are the most diversified derivatives exchange in the world across asset classes. No better time to see that on -- display them in the markets that we're facing right now. Our growth orientation continues to be focusing with our customers and building our global customer base, finding unique ways to grow. Sometimes that means us owning all of businesses like the acquisition of the NEX businesses for our cash platforms in EBS and BrokerTec for cash FX and cash treasure -- cash bonds, respectively, or in doing our OSTTRA JV and selling a portion of that, realizing that there's better synergy there for us by working with partners. And then finally, our compelling investment. We just talked about our long-term CAGR growth and significant orientation towards growth and the environment that we're facing right now. There is no shortage of risk in the market route right now. So when volatility is high and at a premium, this is a market where we do particularly well. But even in the absence of volatility, volatility is a lovely tailwind for us, but we continue to find ways to grow and innovate our way through low volatility environments as well. That's how you see that continued CAGR growth over the years. And our capital return policy as we just talked about. So I'll leave this up here, but I wanted to make sure to get back to Patrick to talk through a couple of questions, and we'll go from there.

All right. Terrific. Thank you very much, Derek. Covered a lot of ground, and I have some questions that kind of dive deeper into some of those topics.

So to maybe start the Q&A, I think energy is probably where we should lead off, given what's going on in the global macro events. Energy price is very much the news, crude oil $130 a barrel. How is CME's franchise positioned to benefit from what's going on in the global macro and help market participants manage their risk?

Yes. I think we're in a terrific position. You look at our energy business. This is $600 million to $700 million business. About $400 million -- $450 million or so is from the crude oil market. This is a market that's certainly in light of what we're seeing in the conflict in Ukraine right now. CME Group owns 90-plus percent of the U.S. crude oil market in the form of West Texas Intermediate, the WTI contract. The U.S. has been the swing producer in the global crude oil market for years now, really since the U.S. lifted the export ban back in 2014, 2015 under Obama. And that has actually meant that U.S. crude has been able to be pumped at the lowest possible level and then shipped and exported. Pre-pandemic, we were, I think, at peak production. I want to say in 2020, we were pumping about 11 -- close to 13 million barrels a day and exporting close to 3 million. We saw that pull back through the collapse in global demand. We've seen that return now. So we are just back globally to peak global demand for oil at about 100 million to 105 million barrels a day, and the U.S. is back pumping about 11 million and change right now. And I think we're exported about 2.5 million. So when you look at other oil coming off the market, whether it's Russian oil -- let's be clear, Russian oil is between 5 million and 6 million barrels a day. So it's not nothing, but it's around 5% of the market. Now 5% of the market no longer being available means it's got to be sourced from someplace else. Well, the U.S. is the swing producer, and that's likely where we're going to see that increased demand for hedging come from. So we're already seeing that happen. You've seen the spread between WTI and Brent be relatively stable. In previous years, when you saw big dislocations, you saw that spread move way out. So the market is looking at the differential. That Stability in that differential is an indication the market is saying that, "Well, WTI is going to be that source for global increased production. So that's where my exposure is." So I think we're extremely well positioned there. And we're seeing that in our markets right now. We're seeing open interest up. We're seeing participation up. And it came at a good time. But just last July, we launched a Micro WTI contract, and we're trading -- I think we set a record last week of 300,000 contracts in the contract that's less than 7 months old. So we're -- we feel well positioned there. And that's before we even start to talk about nat gas. So if you're talking about the energy transition and what that means, what does it mean for natural gas, fossil fuels, generally, natural gas has already been deemed by the EU to be a green product along with nuclear. And that's a rational decision. That's a good thing because it is clean. U.S. natural gas is the cleanest burning natural gas in the world. It's also the cheapest. If you look at Henry Hub in the U.S., which is a market we own 82% of, it's trading at $5 an MMBtu. Asia is trading -- Europe is trading -- I think it spiked up to $100. Why? Because everyone is purely dependent on Russian gas coming through Nord Stream 1 right now. So as the market evolves with current circumstances and Russian natural gas coming off the market, the U.S. is now the swing producer in the global natural gas market as well. That comes in the form of liquefied natural gas, which is U.S. pumped Henry Hub, liquefied, sent off the ships and exported to Europe and Asia. So the position that we are in, in natural gas is very similar to the position that we're in, in the global crude oil market, whereas the U.S. is the market for global crude and natural gas, and we're best positioned in ownership share of both those markets.

It's a good point. And I'm just kind of curious, kind of digging into that topic a little bit more. How globally relevant are these products, WTI, Henry Hub? Like theoretically, they're U.S. products, but they seem to have a lot of global relevance and it's a global commodity market.

Yes. Totally. And our history has been, one, born out of the physical commodities markets and ags back 170 years ago. And we feel that benchmarks are best served when they are the underlying physical benchmarks. So what you just mentioned there is critically important. You're talking about physical crude oil, physical natural gas pumped in the U.S. and physically exported to a country. So where is your point of risk in that price? It's the value of that physical asset itself. These are markets that we know how to run, how to physically deliver for 170 years, and we do that flawlessly. So the -- this is not a regional benchmark or a financially settled asset. This is, "I have physical gas. I'm importing it. I'm a refiner in Europe. I've got to import that. So the source of my price risk is actually physical crude oil in the U.S." Or, "I'm an LNG regasifier in Europe. The source of my price risk is actually Henry Hub-priced LNG coming out of the U.S." So the physical benchmarks that we run become global benchmarks when they are exportable. So that's how we think about it, and that's how our customers are interacting. And that's why we're seeing such significant increase in demand from Europe and Asia, particularly in our ag -- that's always been true in agricultural markets, but our energy markets now as well. So we're seeing that flow through on the customer side.

Got it. You touched on clean energy and the clean energy transition. Can you speak to CME's positioning or clean energy as a theme, whether it's natural gas, whether it's carbon offsets, kind of what are you guys developing in that area?

Yes. A couple of things. So on the earnings call, if you were able to listen, and I talked about our environmental products portfolio in both prepared comments, and I think I had -- 2 of the 3 questions I answered were about environment. You might have asked me one of those actually. But the way we think about the energy transition is this is going to be potentially a generational or multi-decade shift. There's just no way and you saw this in the freezing spring in Texas last year when you saw significant switching to renewable energies, and then days when markets under stress, everything had to revert back to either -- the worst-case scenario, coal-fired electricity, but even the wellheads for natural gas had frozen over because they weren't intended to be used. So now that gas is understood to be as clean as it is. Natural gas isn't just a transition fuel. It's the fuel of the future as well. So we feel strongly about that. So we're continuing to invest in the growth in our natural gas business, number one. Number two, when you look at what we're doing on the carbon side, we've taken the lead in the voluntary carbon market. We're working with the largest spot platform in an exclusive relationship with them, where we are the singular provider of the futures and the list of derivatives versions of the spot market in this company called CBL Xpansiv. So the voluntary carbon markets, we have 3 different underlying products. They're known as GEO, Global Emissions Offset contracts. These are -- we've got 3 different versions of that. We've got our GEO contract. We've got a nature-based GEO contract that are linked to underlying natural resources that create the offsets themselves. And we just launched what we call the C-GEO, or Core-GEO, which is a set of emissions offset contracts that are compliant with some of the new regulations coming out of the UN right now. So we think it's critically important that, for the carbon markets to evolve globally: number one, they need to be freely traded markets; number two, they have to be global; and three, they've got to be able to transition across regions. So there are cap and trade programs that have been in place in Europe and the U.S. for years, but they will only ever be focused on those small regions, and those products are not fungible and tradable globally. So our belief is that the market right now and the explosion of the spot market on CBL Xpansiv is now reflected in the futures growth that we're seeing in those contracts. And we see this as an absolutely critical part of the future of the market. But those will continue to exist alongside fossil fuels for a long, long time. If anybody thinks we can flip a switch and everybody buy EVs and go electric straight away, then I think that there's a different world view out there. And secondarily, that electricity has to be powered by something, and that's going to be powered by things like natural gas. And every one of those industries out there that have made carbon neutral pledges need a way to manage that risk effectively and globally in the liquid market. So that's what we're focused on. Not to mention the leadership position we have in cobalt and lithium as well, which are small and emerging but incredibly important. I mean look at the price of those commodities markets, not to mention, nickel has exploded as well. Why? It's component to EVs.

So you touched on international growth in your presentation. How much faster are international volumes growing relative to U.S. volumes? And then I think based off your commentary on those are higher RPC contracts typically or customer pricing levels. Probably more importantly, how much faster is your non-U.S. revenue growing versus your U.S.?

Yes. So historically, our non-U.S. revenue has outpaced our revenue growth coming from a lower base. That shouldn't necessarily surprise. And Asia is coming from the lowest base. So the growth rates look a little funny because they're outsized relative to what they were even just a couple of years ago. We did see that slowdown over the last 2 years. And I would say primarily because where we saw significant growth leading up to 2019 is we saw huge explosion in energy and huge explosion in metals. Gold really in sort of head-scratching way has not really participated in this run-up in inflation and really hasn't participated in the overall price increase. Yes, we're knocking on the door of $2,000, but the gold market has largely been sideways for the last 18 months or so. We think that probably catches up over time. But we've actually seen our -- that significant outpace growth start to moderate over the last 2 years. And so what have we done about that? Well, we've increased our sales folks outside the U.S., as I indicated there. And a lot of our ADV growth, and we had an all-time record, not just in Q4 of last year, but a full year ADV of volume record outside the U.S. A lot of that uptake was actually in the lower rate per contract, that is the micros or the micro equities, for example. So that's all new kinds of acquisition stuff for us. So to a degree where we're seeing significant volume growth, we're seeing new retail participation in the micro-sized contracts, which is to a degree by design. We want to attract that flow into our business, but it does come at some lower RPC rates, particularly in equities. And so that's the reason why we actually priced our WTI contract at such a significant premium relative to our main contract, we saw the success in equity. So we're trying to make sure that we're growing and learning from that and adding that. So we certainly think that there's more room to grow. We think that the language we tend to use with our penetration of Europe and Asia is we're probably in middle innings of client penetration in Europe and probably early innings with Asia. And we see that even in a deeper way in our options business as well. We're coming from even a lower base, but the trajectory is that much more significant. And that's another part of the business that really outperformed last year.

You spoke to the high barriers to entry that CME Group enjoys. In the past, you guys have faced the NASDAQ NFX in the energy and commodity space. There's an interdealer broker who has talked about introducing a new interest rate futures complex. Can you speak to why CME still feels really confident in its competitive position?

Sure. I've been at the CME Group 16 years now. I spent the first 16 years of my career trading OTC swaps and FX option structure products for a French investment bank. I came to CME in 2006. So I still think of myself as an OTC guy even though I've been here 16 years. I've also run every asset class, every business inside CME with the exception of equity. So I've been attacked in every one of those asset classes over time. The biggest one was actually NYSE Liffe U.S, which if you go back in time, you look at -- that was a direct frontal assault on our fixed income franchise. And the idea was that ICE after purchasing NYSE and LIFFE, they brought that together, they were going to provide a Eurodollar contract to offset against the DTCC-cleared government bonds. And that was -- on paper, that was a scary looking thing. So we've learned over time, and I have personally been attacked in every asset class with some competitive threat on the exchange side somewhere along the way. And what we have learned is a number of things. Number one, to be able to have high barriers to entry and defend your franchises, you have to continue to offer the most compelling operational and capital efficiencies as possible. One of the best ways that we push back and we overcame the challenge for NYSE Liffe U.S. on fixed income side is we simply quantify for people to say, listen, if you look at the range of -- because we bought -- CME and combined that with CBOT back in 2008, we had the entire yield curve from overnight fed funds to 30-year. When we quantified for folks the amount of margin offsets and curve trading, it was in the billions of dollars of dis-synergies, if you removed the Eurodollar portion of that, and that couldn't be offset by any amount of fee waivers or premiums paid to people or stipends paid to people to move that business. So I mentioned that earlier, the dis-synergies that you can create to customers by creating as much operational and capital efficiency and synergies inside your franchise is the best way to raise that barrier to entry. Secondarily, competing on price is not a business model. Saying, "I'm cheaper" isn't a business model. You've got to innovate the business. You've got to provide solutions for customers that have an unhedgeable risk. You need to be attacking a broken market, not a market that runs well. So what do we do? We focus on creating the most capital efficiencies and operational efficiencies. That's why we have swaps platforms connected to our cash markets that clear in the same clearinghouse, while we built options and futures in the same clearinghouse for all the offsets. So being able to take it, remove and compete away in one particular asset class is an economically unviable solution. So I can go more on to that, but it's been a journey for sure, and we've learned a lot. But there's -- for us to be able to offer the best solutions for our customers makes it really difficult to compete with us.

Got it. Your presentation also mentioned options. And options volume was substantially faster -- or grew substantially faster than your futures growth in 2021, particularly in some of the company's financial contracts. What were some of the drivers behind that?

Yes. I noted a couple of things. If you look at the steps we took in 2013 to actually say we were individually running the biggest options markets in each of these individual asset classes, in aggregate, we were running the largest options exchange across asset classes in the world. Yet, we weren't investing in our business as if we were an options exchange. So we developed an option solutions team that did exactly that. We started to define ourselves and invest in ourselves and track ourselves against what's the best demand out there, what's the best of breed out there. Whether it's technology, whether it's analytics, whether it's product innovation, whether it's capital efficiencies, where and how are we positioned to serve our global customer base. So in a short list of things, to be successful in how we built our options business, best technology, whether that's our front-end capability. I mentioned our QuikStrike user account. That's a functionality analytical tool-based account that we built out in 2016/'17 that we continue to grow. That brings people to our front end. That brings people into our market. Matching capability, spread capability, having electronically executable options 24/7. We've closed all of our options trading floors with the exception of Eurodollar options. So we've electronified our options market so that it's available and lit 23.5/5.5 days a week. That's critically important. If you're going to pick yourself out there as a global risk management center, you better have lit markets every hour of every trading day. So that's what we focus on. Couple of other points there. Sales, we spent a lot of time investing in training our sales force. We've also invested in analytics and our distribution capabilities. So that's an area of the business that continues to outside -- generate outsized growth in revenue and is a huge differentiator and competitive differentiator with our customers.

Terrific. Why don't I pause and see if there's any questions out in the audience? I'm not seeing any hands. One here.

So yes. There's also discussion about decentralized finance [indiscernible].

Yes. Great question. Decentralized finance was the question. I think that takes a lot of different forms. I think when you think about the blockchain and distributed ledger technology, I think a lot of the focus unnecessarily swings to crypto. And I think that's just a flawed understanding of what that is. Decentralized finance and distributed ledger technology opens up an enormous amount of opportunity. That is a market shift, that is a market adoption story as opposed to an individual, one kind of competitive differentiator capability. So we are actually actively involved in kind of all the big industry consortia, trying to figure out how distributed ledger technology and blockchain can benefit the market. We're seeing that mostly in the clearinghouse side and the kind of the operational and capital efficiency side of this. Imagine a world that leverages the distributed ledger technology or blockchain to enable real-time clearing settlements and processing, for example. That is literally a game changer for the amount of risk that could ever get piled up in the system. Already, we're the most prudent risk manager in [ planning ] our clearinghouse because we run variation margins twice a day, 1 [ center ] a day at least and twice a day. In markets like these, we're running more intraday cycles as well. Imagine doing that in real time. But that's an industry adoption piece. For us to be able to do that, that means every clearinghouse and every bank and every payment processor also needs to adopt that. So I think we're seeing that move forward. Everybody is looking for the golden use case for that. We think that's an industry use case. So we're involved in the consortiums and the industry bodies working on that. But I think that is going to be something that yields significant benefits over time, but that will be an industry adoption piece as opposed to, I think, anybody individually saying this is a competitive differentiator for us.

All right. Well, with that, we are out of time. But thank you, everybody, for joining us this morning. Thank you, Derek.

Good to see you. Nice beard, by the way.