Hong Kong Exchanges and Clearing Limited (0388.HK) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. Welcome to 2020 first half result analyst presentation by HKEX. Today, we are pleased to have our Chief Executive, Charles Li; our co-President, Romi Lamba; our Group CFO, Vanessa Lau. Without further ado, Charles, please.

Thank you. Thank you for attending this web call. I really wish that we could be able to see each other in person. Hopefully, this is the last one we have to do. I'm not sure that it's a wish that is going to get realized. So once again, thank you. Today, I'm very pleased to be here reporting yet another record result. The financial performance quickly first. We are now announcing record half year revenue and profit despite the massive challenges around us, and with our core business revenue up by 13%, total revenue up by 2% and PAT up by 1%. Vanessa will go through the details on the breakdowns. We are also recording a record half year Stock Connect revenue and that's a 46% increase over last year. Net investment income fell and Vanessa is going to give you a breakdown. That really is the one area that changed between the core business and the total revenue. In terms of our overall business and strategy, we had a very strong IPO market, #2 globally in numbers and #3 in terms of funds raised. We are only half year there. Most of the IPOs, at least historically in our market, have generally come in the second half. Obviously, this year is slightly different. We had some real big ones on the first half as well. So strong performance in Connect scheme and that also include Bond Connect, all achieved half year record high ADTs. And we secured a major licensing agreement from MSCI Asia, an emerging market, to offer a suite of 37 new contracts, that further expanding our product footprint and ecosystem in our market. We continue to work on many of the market macro structure enhancement and technology capability enhancements. And hopefully, this is the year that we will really begin to make a tangible difference in those areas that ultimately result in actual financial contribution. Finally in focus, we're really seeing a new era of liquidity in Hong Kong. Later on, Romi is here and if anybody wants to ask any questions on that, I think he is prepared to run you through some of the slides. So essentially, we are now becoming a real premier global fundraising venue for new economy and jumbo IPOs, and those IPOs are contributing to increasing dynamic trading activities. And the holistic product ecosystem encompassing Hong Kong, international, onshore, online really make us a very unique market. And I would now turn to Vanessa to go over the financials quickly and then I will pick up from there. Vanessa?

Thank you, Charles. Good afternoon, everyone. Thank you for joining us. I'm Vanessa Lau. I would now like to share with you our first half 2020 financial results. We're very pleased to report record half yearly revenue and profit. Total revenue and other income comprises 2 elements, the core business revenue and the net investment income. In the first half of this year, our core business revenue was up 13% year-on-year, driven by the 20% increase in headline ADT. However, with the significant fall in global portfolio valuations, especially in March, net investment income fell by 45% versus the record investment income in the first half last year. With strong core business revenue offsetting a lower investment income, overall, our total revenue and other income was up 2% year-on-year to $8.8 billion. EBITDA margin was strong at 76%. Profit after tax was $5.2 billion, up 1%, and earnings per share was $4.15, roughly the same level as first half last year. We will continue with our 90% dividend payout ratio amounting to $3.71 per share for the 2020 first interim dividend payable in cash without a scrip alternative. It is worth reminding ourselves that 2019 was a record financial year, with the first half 2019 being the stronger half of that year, so we are pleased to have been able to build upon that to reach record first half 2020 performance. Turning to the next page in our detailed financials. Our core business shows strong growth versus first half 2019 on both revenue and profit. OpEx was up 6%, reflecting good cost discipline, resulting in a solid EBITDA margin of 76%. With the recent market volatility, it may be helpful to look at consecutive quarters as well as the year-on-year figures. So moving on to the next page where we look at Q2 results versus Q1, you can see the rebound of the external investment income portfolio and the seasonally higher depository, custody and nominee fees contributing to the positive result in Q2. OpEx is roughly stable across the quarters. Moving on to look at the trend line. We have been generally trending up over the last 5 years on both revenue and profit. Q2 this year has been significantly above this historical trend line. This reflects both the resiliency of our core business and the foundations laid in the business to capitalize on the opportunities ahead of us. Our cost discipline over the years has been strong and helped us maintain an attractive EBITDA margin. Next, we take a look at the year-on-year performance of our operating segments. You can see that with a significant increase in trading volumes, all our business segments achieved higher revenue year-on-year. Stock Connect revenue continued to achieve new records with Northbound and Southbound ADT reaching half yearly highs. Stock Connect revenue reached $743 million, contributing to 8% of our group's total revenue and other income in the first half. Similarly with Bond Connect, as we celebrated the third anniversary in July, we recorded record half yearly high volumes, tripling that of first half last year. Listing fees was up 10% with 64 new company listings in the first half and newly listed CBBCs reached a half yearly record high. The Commodities segment was up 8% on revenue, mainly from slightly higher chargeable volumes on the LME and the fee increment that we implemented from January this year. Post-trade revenue was up 11%, driven by the ADT increase. Our technology business saw a 19% increase in revenue as we experienced more demand by both new and existing exchange participants for our facilities, which in turn increases our network and total usage fees. Corporate items was down because of net investment income, which I'll share with you more details on the next slide. Net investment income was $838 million versus $1.5 billion in first half 2019. Net investment income comprises of internally managed corporate funds, margin and clearinghouse funds and a noncore actively managed external portfolio. The internally managed funds were broadly flat, down $8 million year-on-year as the fund sizes were bigger but we increased our margin rebates to clearing participants from September last year. The external portfolio saw a loss of $138 million, which when compared with the record gain in first half 2019 of $535 million, meant that year-on-year, the portfolio had a delta of over $670 million. On the following page, I would like to recap on how our externally managed portfolio has performed over the years. The portfolio is highly diversified across asset classes with over 20 fund managers, which helps to mitigate the portfolio volatility and the asset class concentration risk. On the left-hand side of this page, you can see that we started our portfolio in December 2016 and have had multiple cash injections and asset class rebalancings since then. In March and April this year, we made 2 cash redemptions totaling $3.3 billion, so the portfolio is now reduced by about 30% in size, and after the rebound in Q2, stands at around $6.7 billion. As expected, investment income does fluctuate from year-to-year and is primarily driven by the macro investment environment. However, you can see from the chart on the right-hand side that over the 3.5 years since the inception of this portfolio, despite the loss in Q1 this year resulting from the global market selloff, this portfolio has generated a cumulative gain of $1.2 billion, representing a 5.1% annualized return, so a solid longer-term performance. Moving on to EBITDA by segment. EBITDA largely tracks revenue performance and increased year-on-year for all our operating segments, except Derivatives, which was roughly flat due to lower volumes in DWs and CBBCs. Lastly, let's look at our operating expenses. OpEx was up 6%, reflecting our investments in talent and technology, including our acquisition of Bay Connect in June last year. Professional fees increased mainly because of strategic projects and a review of our HKATS Derivatives Trading System. So reflecting on our first half results, we're very pleased that our core business continues to show resilience against a volatile and uncertain macroeconomic backdrop. Our external portfolio rebounded in Q2 and we believe the derisking actions taken should increase downside protection. We are well placed to capture future growth opportunities and we'll continue to focus on managing our costs and risks. With that, I will hand back to Charles for our business and strategic update.

Thank you, Vanessa. I wanted to quickly just flip through the remaining pages of these slides, which are there for you to use. I do not plan to go over them in greater detail unless you have questions later. I think on Page 17, essentially or trying to answer the question, where are you on your strategic plan, I think, is on track. We are making a whole range of improvement and progress, both in market infrastructures and new products and technology evolution. Other than MSCI announcement, which was obviously a very strong win that we are very proud of that took a huge effort, other than that, it's really a quiet first half of executing on many important initiatives, none of which are individually blockbuster announcement, but together, they are very important to continue to push our strategic plan and program forward. In the next few slides, I think it's all about -- for people who follow us actively, I think some of the slides are new. This is really all about trying to explain to you the significant changes that have taken place in our market -- in the secondary market, in the market volume, volatility, ecosystem, product mix and how IPO market, reinforcing the trading activities and how the overall ecosystem are collectively contributing structured uplifting in ADTs and in market activities. And I think some of the slides are quite telling. And if you have any specific questions, Romi will be very happy to answer them and go through some of the slides selectively. But do pay attention to those new additions because they do provide good interesting insight into our trading activities, which indeed is structurally uplifted to heightened levels that most likely are irreversible. Just quickly before I turn to Q&A, looking ahead, this is still going to be a very difficult year. Looking around on macro geopolitical and economic issues, we will continue to see a lot of challenges, new things, new reports, sanctions and this and that. And I think resiliency, adaptability, sustainability, which are all qualities that we are very happy that we have exhibited over those difficult periods, will continue to bring us out of these challenges. And the COVID-19, obviously, and also the China-U.S. tension are things that will continue to shape headlines and affecting daily trading up and down. But I think directional-wise, I think we may not have seen the worst, but people seems to be well prepared for the worst, and the market seems to be pricing almost anything that we've been talking about into this market. So we think we will continue to be highly relevant and highly significant in -- as a leader of connecting China and the world. So our core businesses will remain well placed and robust and resiliency has been key. We will continue to see reports of big jumbo IPOs and listings. And those are not only important business transactions for the market as a whole, but importantly, they are likely going to continue to accelerate this new and dynamic composition of our market. So we will continue to build on our market's diversity and attractiveness and continue to manage and enhance the resiliency. We're going to see the second half with the election, with everything else, I think the more interesting things are yet to come. And -- but I have no reason to doubt that we will continue to come out of it well because we are prepared. And we think we have all the key ingredients that will continue to help us to succeed. With that, I will be very happy to see whether there's anything else that you wanted to discuss. Thank you.

Thank you, Charles and Vanessa. So let's move on to the Q&A session.

We have already got the first 2 question from our webcast, both from Jesse Zhu from China Securities. So first question is, the investment income fluctuate greatly in the first and second quarters. So does the management team consider reducing the equity investment exposure in the future? Second, it's great to see many U.S.-listed companies are now secondary listing in Hong Kong. When should we be expecting these companies to be included in the Southbound Connect?

Thank you. I'll address the first question. So our external portfolio has gone through a series of derisking actions because we do realize that the portfolio income could lead to fluctuations in our total revenue. So we're very comfortable with the derisking actions that have taken place. And as I mentioned before, the portfolio is now 30% smaller in size, and the equity component is much less than, say, a year ago. So at the moment, very comfortable with where we are, and we'll keep this under review and currently have no intention of injecting more cash into this external portfolio.

Yes. On the secondary listing inclusion into Southbound, we obviously wanted to do this as much as you all do and the question is not about us, the question is about the domestic changes. They continue to see -- early inclusion could have the effect of discouraging them from otherwise considering the domestic market. It is not a logic that we think makes sense but it is nonetheless a key driver in that discussion. So we continue to work our way through the system to articulate why this is something that is good for China, good for Chinese investors, good for these companies. And hopefully, the revenue sharing and everything else will make them feel that anything listed here even with the Southbound inclusion, they are part of the success. And so it's not easy. Like everything else, Stock Connect, as successful as it is, is also sometimes become reasons for people to see maybe they shouldn't be that successful. So in any event, it is something that we continue to work. To the extent that you guys have any influence or any opportunity for people to say that this is good for everybody and by all means, chip in, it is something that should happen. And I believe that anything that should happen ultimately happens. It's just, I don't have a timetable for you, unfortunately because it's not up to me.

Thank you, Charles and Vanessa. So next question coming from Shujin from Jefferies. The question is, derivative trading fee declined y-o-y in second quarter mainly due to 30% decline in the number of trades of SI futures and options. What's your expectation of the second half derivatives trading turnover? Will more products be helpful?

I ask Romi to comment on that.

Sure. I think we, generally speaking, derivatives fall into 2 buckets, as you know, futures and options. And the price per contract for futures is higher than for options. And we also see when there's greater volatility in the market, the futures products tend to do better. When the market is performing well, the single stock or the options tend to do better. So we do -- in fact, it's a little bit of a reverse correlation, if you will, that when cash ADT is down, the more profitable part of our derivatives business is up. So in terms of our existing product suite, the performance will very much depend on how the market performs. In terms of new products, yes, we do have the MSCI suite of 37 contracts. However, it's still early days. Some of those contracts are going to have fee discounts and fee holidays and so on. So in terms of revenue contribution, I think the new product suite will probably not be a major contributor in the second half of this year. However, we will get investment income as the open interest builds up. And that's probably all I can say in terms of looking forward.

Thank you, Romi. So now we'll take more questions from you directly. Moderator, please.

[Operator Instructions] Your next question comes from the line of Livy Lyu of HSBC.

I have 3 questions. First of all, we see that the Stock Connect revenue has already reached $700 million and around $500 million of that is from trading currently. So what about the other $165 million revenue? What's the breakdown and where are they from? And second question is about the fee mechanisms for Bond Connect. Because we've already seen that trading volumes through Bond Connect has already increased a lot during the 3 years. So how is the fee mechanism for this? And how do you share the revenue with CFETS and also HANA? And the third question is about STAGE. So could you elaborate more about the newly launched STAGE? As a central hub for certain data on sustainable and green finance, what is the potential business model for STAGE? And are we going to monetize these data?

Okay. I will have Vanessa answer all 3 questions and then see whether there's any supplemental comments by Romi later.

Thank you, Charles. So the first question on Stock Connect, why the total revenue is $743 million and only $500 million or so is fees, the rest of it is actually investment income, market data fees, throttle and usage fees. So that adds up to the total. On Bond Connect, we account for it in our accounts. You can see the line coming in as share of profits less losses of joint ventures. So if you look at that line, you can get a rough sense of the magnitude of our actual revenue. But as I said earlier, Bond Connect is a great story for us, tripling volumes versus last year. And although the absolute revenue may be small compared to the rest of our business, it's definitely a growing platform. And then on the third question regarding STAGE, very excited to launch our sustainable finance platform. It's still at a very early stage and we will continue to build on it. But it's already great to see good reception from our issuers on the initiative. And again, HKEX is very committed to being a leader in the ESG space. So I would say watch this space.

Your next question comes from the line of Gurpreet Sahi of Goldman Sachs.

If I can have 2, please. First is on the MSCI derivative contracts recently announced and very recently launched. Can Charles or Romi talk about the efforts to build liquidity into the contract, especially on the MSCI Taiwan contract, which I think Singapore can no longer have after February? So as of now, I see volumes not so great. So do we expect volumes to quickly ramp up as we move towards that time line of February? And then can we expect the similar volume, if not higher, that MSCI Taiwan traded in Singapore roughly 100,000 contracts a day? And then second one for Vanessa, please. Two parts to it, mostly housekeeping. First is the scrip dividend, the scrip option for dividend not being offered to shareholders. Is that a permanent thing or is it only temporary for this half? And then on the mix for the portfolio, the collective investment schemes portfolio. Can we assume that the mix remains the same? In other words, I'm more interested in the public equities, this $1.5 billion of managed money. Will it remain there?

Romi, why don't you talk about the MSCI...

On the MSCI and specifically the Taiwan contract, there are not a lot of precedents when you see the same contract move from one exchange to another. There have been a couple and one very relevant example was probably a decade ago when MSCI moved some of its licensing from CME to ICE. And what we saw then and what we expect to see here is probably a lot of the activity doesn't move until the rollover dates. The next rollover for the Singapore -- or for the SGX Taiwan contract is in September and then there was another one in December. And then finally, they'll expire in February. So we do expect to see volumes pick up as the open interest migrates. We have put incentives and structural programs in place, particularly around block trades and other market-making activity. I cannot obviously tell you whether we're going to hit 10,000 or 50,000 or 100,000 contracts, but we are optimistic that this is the contract that the market wants and is keen to invest in. And we're obviously doing whatever we can to make sure that happens. Vanessa?

Sure. Gurpreet, thanks for your question. On the scrip alternative that was removed on this dividend, I would say it's all part and parcel of how we manage our capital structure. We have a strong balance sheet with surplus cash, which is very positive, especially in this period of uncertainty. We regularly review our corporate fund position, our CapEx and OpEx needs, our projected cash flow and funding for our strategic projects. So at this stage, taking into account all of the above factors, we believe it is most appropriate to pay this interim dividend in cash, which will avoid dilution to our earnings per share and also our dividend per share. And of course, without the scrip alternative, we can even pay the dividend at about a couple of weeks earlier. So we will continue to monitor and review this as our business needs evolve.

Thank you. So next question coming from Yafei from Citi.

One is, can you update on us the MSCI Asia futures contract, where we are with the mainland regulators? What is their main pushback on this particular contract? The second one is that we see an escalation between U.S. and China in terms of conflict in the financial space. There is potential sanction risk coming on to any financial institutions. So is there any risk for Hong Kong Ex specifically? And recently, there's also a news article saying that U.S. might force its institutional investors not to invest in Mainland China equities. And if that happens, what will be the impact to Hong Kong Ex?

Yes. I don't have anything tangible to report on the Asia futures. We continue to discuss. There is a positive momentum in terms of attitude and that allows Hong Kong to launch. But we are not yet at a point where we can announce whether or not we are going to do it. And if we do, what sort of a contract that we might be using. But the general principle has already been approved almost over a year ago but we just need to ultimately execute on that. And at this point, unfortunately, I do not have the most definitive update that I can give it to you. In terms of all the stuff that is happening, I already lose track because every day you wake up, something happens, somebody says something, some tweet comes in. And I don't really know how to make sense out of it because some of this, at least you can -- trying to find a way to say, okay, this is about that, okay? This is about this and they want to do that. But I don't really know some of them -- for example, the university endowment are the smartest money in the United States. They made all this investment not at the direction or they are not like public pension or public employees, federal employee pension funds where the government at least has some say as to what you should be investing. This is smartest money, long-term money. The money is coming to them with nothing to do with the government, and they never really consulted anybody making those investments. And I'm not sure what the government is going to be able to tell them how they need to get rid of it, on what basis. And if they don't, what is going to be the consequence. So they have more questions to answer than we do. Obviously, I think the primary focus right now is really about U.S.-listed Chinese companies that may have some accounting issues that they have to deal with the regulator, and because of this ongoing conflict or unresolved dispute over the audit papers -- working papers, that you could see some of those company got delisted. If the statement is made about, you better really divest because they could be delisted, I'm sure they are able to understand those risks without anybody mentioning and reminding them now. But if the directive is to say that you shouldn't be investing in Chinese companies, I find it very hard in the U.S. as to why anybody would be listening to it and why anybody would think they have the right to. So I don't really know how to handicap all of this, and I'm not going to lose any sleep because if I'm trying to really be overly analytical about any of this, I probably don't have time to do anything else because much of this development to the crap that is happening every day is so out of your ordinary sense of expectations that I finally just say, "Okay, if there's something real comes, I deal with it. If it's otherwise, I'm going to move on." So I'm sorry, I don't have an answer to you because some of them eventually find themselves, work itself -- themselves out.

Thank you, Charles. So next question, we have Harsh from JPMorgan.

I had 3 questions. First is on Asia derivatives. Any time line? Is it procedural in terms of how much time it takes to appropriate the vision of regulators, then that can be approved? That's one. Second on the MSCI suite of products. How should we think about the EBITDA margin? Broadly, you have pretty high, 80% of all EBITDA margin in the F&O product. Should we expect similar EBITDA margin, not really but, let's say, on 2022 once things become normalized and we do get a big way of critical mass, is it a fair expectation or will it be lower? And third one, with so much of disruption all over, is there any very interesting M&A opportunity or strategy gap, which you think you can fill inorganically?

Okay. I will address the first and third quickly and then Romi will talk about the margins of the MSCI contracts. Again, as I said earlier, I don't have any time line. Conversation is continuing. Very substantive conversations that are taking place. Sometimes you think progress is made. And -- but sometimes, then you're realizing that you're back in the drawing board. I think the general principle is that it's approved as a concept, we should be able to do it. The regulators are ready to have a consultation process working between them. But ultimately, they need to pull the trigger. They need to not only pull the trigger but they need to pull the trigger on the right contracts that we think makes sense for us to do. And both need to happen and we'll continue to trying to push for both to happen. On M&A, we obviously have an active strategy department that are looking at all sorts of opportunities. But with COVID, with the election, with Sino China, I think this is most definitely not the time to go around shopping with a big wallet.

In terms of the steady state or normalized MSCI EBITDA margin, it's probably going to be lower than our existing product suite, which has an 80% margin. But I can't be specific. There will be, as you pointed out, a period between now and, say, late 2021, '22, where the ramp-up will help the profitability. So all I could say is if we manage to achieve similar volumes to what SGX has had in the past, our margins should be quite similar to theirs. No reason why they would be lower or higher.

Thank you, Charles and Romi. Next question from Sharnie from Bloomberg Intelligence.

Bloomberg Intelligence. I have 2. First would be on the IPOs. Just want to see in your discussions with a lot of these Chinese unicorn companies that are seeking listing, what are you hearing in terms of what they think about the sliding between Hong Kong and Shanghai or a combination of both? And say, for dual listings, what would be the thought process in terms of the allocation between Hong Kong and Shanghai? And while I appreciate that it's different from company to company, just generally speaking, what would be the key considerations? And secondly, while I appreciate that there's COVID right now so now might not be the time to spend all that type of cash that you have, but say, in the medium term, what kind of areas would you be looking at for acquisitions?

Thank you. I think on the IPO front, if we are talking about Hong Kong or China, I think if you're talking about IPOs who are just the companies in China, I think the preferences continue to be like the last 20 years. Anybody who have any international aspirations tend to want it to be, anybody who wanted to have a tremendous valuation and is able to somehow secure a position on the queue sometimes choose to be in China. But we have always been, I believe, the more competitive market because we just have a lot more to offer. But if you're talking about companies that are listed in the U.S. that are considering returning, whether or not they're going to be choosing Hong Kong to return to or choose China onshore market to return to, I personally would think that the overwhelming majority will choose to be back to Hong Kong rather than to onshore, simply because they made the journey international. They have always wanted to be international. And I think coming home probably is fine as long as it does not change fundamentally their business profile, operating structure and many of the shareholder structure. So I think Hong Kong makes the most sense for the returnees, but there might be exception to that general rule. But there's another situation that people need to be aware of, that there is -- there are a large -- reasonably large number of companies listed in the U.S. today that are not automatically eligible to be listed in Hong Kong unless we continue to make certain changes on our VIE rules, our grandfather, WVR grandfather rules on corporate WVRs. A lot of those incremental but still -- potentially still important incremental listing changes that we probably needed to do, without which, some of those companies may find it difficult to actually come to Hong Kong and if they really need to make a decision to return and we are not yet ready for them, maybe going back to China is the only option for them. We hope that we are able to resolve some of those issues, but we need to do so with the collaboration and partnership with SFC and we can't do it internationally. And I have to share that we do not always see eye to eye on many of those issues. And so the work remains to be done if we really truly wanted to get all the big good companies that we wanted to actually be back here. In terms of medium-term M&A, I think medium-term usually means that you already have some pretty good concept or idea. As you may have noticed that there will be a leadership change, so important decisions on M&A, the chief executive has a lot to do with those decisions. And I certainly will not be making important M&A decisions for my successor. And I think it is therefore pretty safe to assume that M&A of any meaningful size should not be in the cards before the leadership transition.

Thank you, Charles. So next and probably our last question is from Irene from Morgan Stanley. So the question is around net investment income for the Post Trade segment. If we compare the average fund size in Q2 versus Q1, it increased by 3%, and your investment income actually increased 7% quarter-on-quarter. So just wonder how HKEX managed to keep their returns stable while we've seen a significant drop in 1-month HIBOR in Q2? Shall the analysts look at other benchmark rate for future reference?

Thank you, Irene, for the question. It is right to observe that actually, there are a number of factors moving in opposite directions that's resulted in this outcome. So generally speaking, our fund sizes have gone up because of the higher trading volumes. The interest rates have gone down on our deposits. And also some of our rebates to participants have gone down because they're tied to certain benchmark interest rates. And then also on top of that, we have some deposits, which were locked up earlier, and therefore, at higher interest rates, which haven't rolled off yet. So a number of different factors in different directions, but that's basically what drove the post-trade income there.

Thank you, Vanessa. So everyone, please raise your hand to press to button if you still have further questions or we'll call it the end. Good. So thank you, everyone, for your attendance. Thank you.

Thank you very much. Hope to see you next time in person.

Ladies and gentlemen, this concludes our conference for today. Thank you for participating. You may now all disconnect.