Interactive Brokers Group, Inc. (IBKR) Earnings Call Transcript & Summary

Welcome, everybody, to Piper Sandler's Global Exchange and FinTech Conference. This is the 18th year that we've been having this conference. It's great to be back after a 2-year hiatus, and it's great to see New York City back and alive and rebounding. So we have a great lineup. I'm excited about our speakers today. We have 17 speaking sessions today. Overall, there's 22 company sessions, 19 of 22 are the CEOs representing their companies, including Thomas, which will give a more formal introduction here in one second. We also have 4 panels. And of course, I think a lot of you've heard right now about our keynote speakers, Chair Gensler of the SEC; Bob Greifeld, formerly of Nasdaq and the Chairman of Virtu; and finally, Glenn Hutchins of North Island will be the keynote speaker tomorrow. So with that, we'll get started. And again, it's great to be back. I want to introduce our first speaker, Thomas Peterffy. He founded Interactive Brokers. I mean, well, first, you went public in 2007, and it was founded many years ago. But Thomas is really known for being the pioneer of electronic trading. He brought -- we still talk about the computer that he had, a box that he brought to the CBOE floor that was -- he was able to calculate the price of options. And I don't know how they calculate it.

'83.

1983. Okay. So he passed over the CEO reins in June of 2019, but he's still very involved with the leadership of Interactive Brokers so Thomas first, great to see you again and to be back live.

Thank you.

So first question is, well, we have our fire back too. So that made it have to -- still going after -- so the big thing I think I'm going to ask every CEO is this current environment. There's uncertainty about inflation, interest rates, the geopolitical risks. And I guess the question is, you're an experienced market veteran. Is there anything that compares to this and how is Interactive performing with -- given this macro environment, this unique macro environment we're in today?

So maybe it's somewhat similar to the 70s, the Carter years in many ways. But here, I'm talking to a sophisticated audience, so you probably know better than I do. Bottom line is I expect the market to go down to the 3,500, 3,600 range because I do not believe that the Fed will be able to raise interest rates above the inflation rate, so they will be stuck under the inflation rate, so I expect inflation to continue at 5% to 6% and the Fed funds rate the part at 4%. That's my view, but it's just a guess.

It's going to be interesting to see how things turn out here. I know internally, the Piper Sandler people feel that are a little bit gloomy on the future here -- the near-term future of the market. But besides the macro uncertainty, we've seen big upticks overall. Since the time we sat physically together in '19, we've seen big upticks in retail activity. And just wanted to get your view, there has been a pullback with tech valuations here more recently and a semi pullback, but if you still compare the levels we're at today to 2019, we're elevated. So I guess, what do you feel like is the driver because your clients -- it's not about zero commissions with the majority of your clients. So what do you believe is the retail -- driving the retail activity? And then sort of what's the outlook given this uncertainty we have in the markets overall?

Well, the activity is much higher, especially in options. It has a great deal to do with investor education. And here I have to pay a compliment to the likes of Robinhood who brought in millions of young people who are not familiar with the market. And so that's a huge thing that they've done in that way. As far as our customer activity is concerned -- the softening began in the Far East, around the end of the year, then starting at the end of February in Europe, the account openings have slowed down and trading volume and in anything from Europe also slowed down. But the U.S. and Americas were not affected up until May when the tech stocks kind of collapsed and that has impacted those folks. But if the market really comes down to the level where I think it will come down to retail activity certainly will decrease. We will not suffer as much as many of our peers because many of our customers are professionals who will continue trading during those times. But whatever goes on here, the rising interest rates will make up for the diminution of trading volumes. So I don't expect a real hit from that. I would expect that the smaller, newer brokers who have many, many small accounts with the interest income is negligible will have hard times.

It appears there's some segmentation going on where it's the newer, smaller retail investors that might be getting shaken out of the market given the valuation. Your traders are more driven by volatility, which is still elevated. But you grew your accounts by 56% year-over-year in the first quarter, a very strong number. And I guess given the reset that you just talked about in not only in Asia but in Europe as well, is your outlook still that you can grow accounts? How do you feel about account growth going forward given?

So for the last 12 months, our accounts are up 36%. I don't know about the 56%, but maybe you're right, per quarter, right? But over the last 12 months, it's up 36%. So our most affluent source of new accounts are word of mouth. We continuously have to come up with new products and new features to keep our clients engaged and to entice them to go and talk to other potential clients, and that's been working for us. But we have to bicycle very hard -- have to peddle our bicycle all the time. I can't let up. And it is true that the new accounts are not as profitable as the old ones because as I said earlier, we started with recruiting market makers from the floors. And so they were our customers. And to the extent they are still alive. We like our customers and they trade all day long because that's what they do. And so the new customers are different. They are retail. Basically most of them are retail customers who don't trade so often so while our accounts have been up 36% for the last 12 months, our trading volume. And here, I would correct for the first 3 months of last year, which was crazy. But correcting for that, our trading volume is still up only 15%. So which meaning that the new clients don't trade as often as the old ones.

You talked about, again -- well, first, I hope Milan is actually pedaling the bike like you. You can give the bicycle to him a little bit.

Milan is our CEO.

Yes. And so you talked about how growth has slowed in certain segments of the world, namely Asia. We've gotten a lot of questions because you were getting accounts and activity from Eastern Europe. So the impact of the Russia-Ukraine, both on accounts and I guess -- but it also increased volatility as well so a double-edged sword.

So, not really. I mean the fact is that the impact on new accounts and trading volume from Europe is huge, namely there are much fewer new accounts and the trading volume is much, much less. And so I think the war will sooner or later settle out or if it doesn't, we'll get used to it and the trading will be back, but the sanctions will remain. And the sanctions, they cause very, very high energy prices and the energy prices suck away resources from the people that otherwise would go into savings and investments that will not. So as a result, I think that this is not going to have a positive impact on our business or generally the financial sector.

So we started the talk discussing the macro environment, the uncertainty and you have a trading model, but still higher rates with the strong likelihood of multiple, whether it be 7 or 8 rate hikes, Interactive Brokers is still positively impacted.

Overall, yes.

I guess whereas some of the firms that are concerned about people, they call it cash sorting and moving cash out. That's not really the case within Interactive programs.

So what we do is we pay interest to our customers on cash over the first $10,000, 1% to -- I mean, 0.5% under the Fed funds rate. So say, Fed funds goes to 2.5% we'll pay them 2% on all the cash in the account, except the first $10,000. And this goes for all accounts that have a volume of $100,000 or more when the volume of a total volume when account liquidating volume when account is only, say, $50,000, then we pay half as much. If it's $75,000 we pay 3 quarters as much. But over $100,000, we pay everybody 0.5% on the Fed fund rate for whatever, even if they just have a $2.50 in the account, it doesn't matter.

You've made a point I think Interactive has made it a point to be the most competitive, not only on commissions, but also on the interest rates on the margin loan rates as well and that.

Margin, margin loans, we -- our margin loan rates go from 0.5% above Fed funds rate to 1.5%. For very large loans, we charge 0.5%; for very small loans, 1.5% over and in between, we charge in between.

Your advertising shows that your offering is highly competitive and put it that way. The one thing you've been -- I think Interactive Brokers is conservative overall, but one area that, that comes out is in your investment strategy with the cash. You've been short-term treasuries. And I asked you on the last call, was there any contemplation of change in that strategy?

And there isn't -- I have made one mistake. I made an investment 2 years forward. I bought a treasury bond when it went up to -- suddenly it went up to 70 basis points. And I would -- that 2-year note and I shouldn't have, of course, because -- but -- so I will just stick to very, very short term within 3 months maturities.

And at some point, well, I know you reevaluate constantly. But is there some likelihood a year from now when the interest rate outlook is more stable, but you would consider something different in the investment strategy.

So no because, look, the way I feel about it is that I don't think we'll be able to tackle inflation, that we'll not be able to tackle inflation, and the inflation will continue to be rising, why, because as the Fed raise interest rates, the refinancing of the debt, the $30-plus-trillion of debt is going to become very expensive. So say if interest rate is 6.5%, the refinancing of the debt would cost $2 trillion a year, and that is extra deficit. And in my view, inflation comes from deficit spending, namely more money in circulation creates inflation. It's an old Austro-Hungarian view of money tree system. But it works.

You've proven your conservatism pays out in the long run, and is well capitalized as Interactive Brokers and the other strategies as well. So one thing, and I started off introducing you about it, but you've been -- the pioneer who brought automation to the options market, a market that -- I don't know, again, I said this, how you calculate a price of an option without a computer or something automated. So I guess the question is and I know you're still enthusiastic about the potential for options continually expanding even above this elevated level. And just so options right now are -- overall volumes are 2x-plus of what they were pre-pandemic. But you still feel bullish about the proliferation of options.

Yes. So I think that -- which -- and it's not I think, I know that options volumes have been gradually increasing since the first trade I done on the floor of the American Stock Exchange 45 years ago, first option trade, right? Over the last 45 years, the volumes have been gradually increasing. Now we are facing a situation where there is more and more education about options and that gets more and more people interested in the product. And we have 9% of the -- our customers have 9% of the U.S. options volume. And due to our special way of executing our option trades, I think we are going to have more and more of that market share. And I will explain how we execute our options, and it's a little bit complicated, so please pay attention.

It's a sophisticated audience here.

Yes, sophisticated audience but for you to understand this, I first have to explain to you what the market maker does. So Timber Hill we used to be called that was our predecessor company, who is the largest global automated market maker from 1984 to 2015, 31 years. So this is the one topic that I really understand what I'm talking about. Otherwise, I don't really. So what does the market maker do? A market maker makes a biding offer, right? And the highest bid and the lowest offer on prevailing on all the exchanges constitutes the national best bid and the national best offer or the NBBO, it's called, right? So market makers make a bidding offer and the highest bidder and the lowest offer generally gets to trade on the exchanges. And now what they do is they buy -- some of the market makers buy order flow from the retail firms and they execute them out or slightly better than the NBBO. So in other words, they buy their bid, which is lower than the offer, which they make where they sell. So they trade back and forth and that's how they make their money, and that sounds very easy, but it is not. What happens is that as they buy and sell, they get into a huge position. While we were market makers, our position was usually equal to 7% more or less of the open interest. Keeping such a big position hedged is a very difficult task. So you need sophisticated algorithms that evaluates for each option, whether one more of that -- if you had one more of that option, would that reduce the risk in your position or would it increase the risk in your position? And accordingly, you decide whether you would like to buy this option or you would sell this option. But you don't want to do both. But while they buy this order flow, they have to do both because they are not in control of which side they do. They get the order, they have to execute it, right? So now we take advantage of the situation for our executions. And the way we do that is that we have made agreements with the 16 top market makers and liquidity providers. And the agreement says that when we get an option order, we show you how many of these options we have to buy or sell. We don't tell you which side we are on. And they give us a bid or an offer or both. And we take the best bidder offer depending upon which side we are on. And they also tell us at what exchange they would like to cross the trade. And if you take the best one, and we put up that contract for an exchange option and on the exchange option, the market maker that we agreed with will, again, make the same bidder offer that he made us for our internal option. And if there is no interference in the exchange option auction, he gets the trade. If there is interference and the customer gets a better execution. So in other words, we have 2 auctions. We have a private auction first with the 16 liquidity providers, and then we have a public auction of the exchanges. Now this sounds like it takes a long time, but all this gets done in about 300 milliseconds, the whole thing, right? So this enables us to give a much better execution than other people get. I think, although I cannot prove it, but it would stand to reason, right?

But your active customers continue to pay you a commission.

That's right. That's right. So -- but of course, for options, everybody charge at the same commission because we all charge $0.65 and then at least I don't know what others do, but we go down with volume. So the more options you create, the lower the commission becomes. But as far as stock executions are concerned, we do the same -- not exactly the same, but similar. We also pledge the orders and see who is bidding their offering for the stock.

I joked and said our audience was sophisticated. I hope they absorbed that because a lot of the rest of the day is going to be talking about auctions. So Thomas just previewed what goes on in the options market in these mini auctions. It sounds like it takes a long time.

I think we're the only ones who do this. I'm not sure, but I believe that we are the only ones. And the reason we know we came up with this idea is because having been an automated market maker, we know how it works. But I don't think other brokers do. So I believe that we may be the only ones doing this. That's why other brokers sell their orders. And if there is any truth to what the rumors are about prohibiting payment for order flow. The fact is that maybe they will not get paid, but they still have to send their orders to liquidity providers because they don't know what else to do. They don't have the software.

I mean, there's obviously -- you're doing something right, again, have customers continue to pay. And I know options are a little bit different. But the idea that you attract these active traders and it's known throughout the industry that you have the best execution in options. So 2 last things I want to cover is probably -- I mean, this is a highlight of my day, right, but another highlight will be Chair Gensler's speech at noon. And he's going to talk about options. And we suspect he'll talk about options. You gave a preview of what goes on in the options market, which has historically been an options market. Again, this has happened in milliseconds. This isn't a thing where you get the option collar or anything like that. But I guess my point is, what are your thoughts, just quick initial thoughts on applying an option type model to equities?

So since the exchanges have the -- all the exchanges, I believe have -- there are 16 of them, I think. The option auction, all the options exchanges have them and all the stock exchanges basically are options exchanges because they will have options, right? So that means that they all have the options out there. So running the same software for stock is no different than running it for options. So I don't think the exchanges would have to do any programming other than configuration work. I have something that I don't understand about this entire proposal, namely that -- look at a firm like UBS or Citibank or J.P. Morgan, what do they do? They have a sales department and they have a trading department. Now, the sales department gets the orders, they send it over to the trading department, the trading department executes it, sends it back to the sales department. It is exactly the same as [ Schwab ] trade gets an order, sends it to Citadel, Citadel executes it, internalizing it, sends it back to Schwab and the trade is done. So I do not understand what goes on in the minds of the people who do this at the SEC, how they could make this discrimination that Schwab together with Citadel cannot internalize, while UBS or Goldman Sachs or any of the large investment banks can do it. And whilst it basically has worked that way forever, internalization has been the rule certainly before the exchanges started, but even after exchanges, the exchanges only get the refused -- the part where, as I said, they have to hedge themselves somehow every now and then.

It's a great question. And I think you're going to join us for lunch till -- hopefully, we'll maybe get some clarity at lunchtime. I want to wrap up last question and to see how fast Milan Galik can ride that bicycle is when we first met, you had a goal of being the largest broker in the world. You've certainly have had the fastest growth, the most growth, but being the largest broker in the world and obtaining 80 million accounts over time. And I know you truly believe it that you have the competitive pricing, the product, the technology, etcetera. So I guess is the goal -- given that all the growth you've seen is that goal still in sight?

Absolutely. Absolutely. So we have tremendous advantages relative to our competitors, right? Because firstly, we charge interest rates on margin loans much, much lower than the other, as I said, we charge 0.5% to 1.5% over Fed funds, other folks charge 3%, 4%, 5% over. So it's a huge difference if you're a serious player. And [ Traube Ameritrade ] still has $80 billion, over $80 billion of margin loans, and we only have $41 billion or $42 billion. So there is still a lot of accounts to get from there. Our executions are better because as I just explained, how we execute options, it's very different and we don't sell our order flow. And our stock executions are very similar to our options executions. We do not charge custody fees. Now we hear more and more that more and more online brokers -- I think by now, everybody charges custody fees. I don't -- they range anywhere from 5 basis points to 25 basis points. It's a lot of money. We don't charge any of that. We lend out your fully paid stock and we share the interest that we get 50-50 and we guarantee you against any losses. We show our stock lending availability online, along with the lending rates. So you can make a decision immediately whether you're going to a short stock or not. Other places you have to call the broker and then you have to negotiate the rate. We have 150 trading venues in 33 countries in 27 different currencies, and we keep on working on that, and we will have more and more and more in the years to come because we want to be all over the globe. And we offer hundreds of research analytics and trading tools, including [ Agos ] and Interactive tools and the platform is entirely free for any of our customers even if you -- they only have $1 in the account. How can you beat that?

Thomas, you've created a great firm. Thank you for being with us. What -- your vision back of automating options, whether 30 to 40 years ago, is still play -- the acceleration is still happening. The vision is still looking forward. And so it will be interesting to watch. So thank you.

Thank you very much, Rich. Thank you.