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

All right. Welcome back to the 20th Annual Global Exchange and Fintech Conference. We're going to turn the sales here to the e-brokers. And it's my pleasure to introduce Thomas Peterffy, Chairman and Founder of Interactive Brokers. He's also going to speak today at [indiscernible] as one of the keynote speakers along with [indiscernible] and as we talked about pioneers the last [indiscernible]. I'll try to keep sort of that. All the stories that we're going to talk about. Talk more about the Interactive Brokers. But Thomas brought Interactive Brokers and we just talked about this in 2007 in public. We didn't know each other then.

So anyway, I guess first question Thomas I guess the environment for electronic trading. I mean I am there for retail training, the environment for Options rate you've been a big proponent. We'll talk about how you automate it and there will be great story about how you automated the Options markets. But what's the general environment that you see out there today in auctions trading and then retail trading?

So in Options trading just like in stock trading, the attention is focused on the indices and very few of those big tech stocks, and it's a very narrow leadership I don't think that in the long run, it's going to be a good thing. Options trading has been gaining prevalence for over 50 years now. And it has really picked up in the last several months because of the daily listing of the weekly options, which give us daily expiration, same-day expirations, it's basically -- it's simple bet ,you make a better 2 p.m., and we get paid at 4 p.m. And if you -- or you get lost, you lose at 4 p.m. It's just gambling.

Would you have thought that the Zero base exploration contracts with [indiscernible].

Sure. I mean, yes, I mean it's gambling and your odds are much better than any other gambling situation because markets are very efficient. Commissions are very low. So it's -- I think that the winners must be at least 40% of the players, right? So it's a great odd.

And on the -- of the retail, like you cater to the semiprofessional, highly active trader, that's becoming the technology and can you talk about, I guess, of that, who is trading? Is it the most active players?

Well, on the one hand, we have the gamblers. On the other hand, we have the professional people who are trying to be on both sides of the market. And ending up with a few dollars by the end of the day, right?

So we have rates going up. We got the 0 BT contract. What happens if we have a turn in the market. I am not smart enough to predict that. Suppose we get rates that at some point, turn around to coming down. Do you see that as a -- as a positive that the retail trade would stay active because there will be volatility in the market? Or what do you see, I guess, is the outlook?

So I don't think that rates will come down by much because I think that inflation is at the resistant trend and having to do with the globalization on the one hand and increasing deficit spending on the other, which is driven by inflation, which is driven by deficit spending, which is driven by higher interest rates, which is -- higher interest rates make the debt service more expensive, which adds to deficit spending, which adds to inflation, and we can go in the circle [indiscernible]. So although in the near future, maybe in '24 or '25 rates could come down a bit. But on the long run, I don't think that they will. But so as far as Interactive Brokers is concerned, lower rates would not be positive on the other hand, maybe to the extent. So the way Interactive Brokers is positioned currently, any drop in interest rates by 1% would hit the company by $200 million a year returning by 2% -- so it's not that much. And the same way, a 1% interest rate rise would at $200 million to the positive way. And so unlike other firms, we are paying our customers on their cash holdings half percent under the fed fund rates and we pay and we charge 0.5% over Fed funds for margin for larger quantities. So we are not as sensitive to interest rate changes as other firms are, although you would have thought that rise in interest rates would be good for them. But given the fact that they have lent out their customers' cash for 10 to 15 years, it's exactly the opposite.

Thomas made a point to e-mail me to again emphasize that he does share so much of the upside with his better clients, a good part of your clients that there wasn't a cash sorting going on that happened at other brokers. So one thing -- first, I just want to make sure you see that I think Thomas was one of the first ones that talked about the fire side, my fireplace that I didn't have the fire burning.

Because I'm always so cold in the morning.

I spent a 15-year burn on this fire. So what makes Interactive Brokers special, unique ? Is its international account growth -- accounts coming from all -- not just the U.S., which most of the other brokers are U.S.-centric, but you get a big portion, not only from -- was Asia-Pac, but also -- but now the Middle East and Europe. So can you just talk about -- and you are still growing faster, even though it's maybe a bit slower than the COVID area time frame. But can you talk about this sort of geographic account growth and what you see the resilience of it or...

Right. So between 20% and 21% of our clients are U.S. But as far as activity and the rest of the America -- Americas is concerned, it's about 60% and 80% of the trades are done in the United States. So even though we have many of our customers are in Asia and in Europe and then Middle East, they are all trading in America, basically. So they are also buying the leading 7 companies, just like anybody else in the world. So that's where all the action is concentrated. And so our growth in number of customers is -- goes along with word of mouth recommendations. It's roughly around 20%. And then to the extent that we are trying to market to introducing brokers that is an additional and that we have 2 large introducing brokers that are coming on toward -- in the second half of the year. The first one of them is -- first one is coming in -- starting to onboard in July. And so we expect a total rate of growth in customers at roughly 30% annualized.

So these 2 -- if you're growing at 20%, these 2 introducing brokers can add an additional 10% and I know that's sort of a bit of frustration to see how these big financial institutions sort of how quickly they move or how -- not quick?

They take a long time to figure out what to do and how to do it and then the lawyers step in and they want to change the agreement and everybody wants to have an input.

So you're growing the fastest. You have most active traders, your margins are strong. They're bumping up right around the 70% range.

70-plus.

70-plus. I try not to say too much.

Low 70s.

So how do you think about margins? Is that some -- we know you're also -- you continue to invest.

Of course. So we are basically the most efficient platform. And our earnings are accumulating on the bottom line very, very quickly. So we are not at a stage where we have to look at either introducing some sort of new product or customer type or taking on some less efficient firms in the business and trying to incorporate that onto our platform. And so if that happens, then for limited period of time, the margins would dip below 70% while we assimilate that operation. But then once that's done, we'll be back well above 70%.

That's pretty strong industry-leading margins. Just to step back on a question because you talked about marketing, and I know how proud you are of the platform. And initially, and you can correct me if this is wrong, but initially, you didn't market -- you thought and I think it did, it didn't spread by word of mouth. But I know you had a view that people would go to the platform because it was technology.

It was a big mistake. I was wrong. I admit.

You weren't too wrong at 70% margins in the long run. But I guess the question is what changed your mind that you would benefit Interactive Brokers to advertise it and market.

Yes. So advertising right now is extremely important because -- but even with advertising, I don't think that people believe what we say because -- I mean it stuns me that the big banks are paying less than [indiscernible] 1% in interest. And the big brokers are -- e-brokers are paying 0.5% or roughly and we are paying 4.58% and by my logic everybody should come on to our platform, but they don't. So either they are just inertia or they don't believe it.

Or maybe not aware until you advertise.

Yes. But we're advertising it and it is not happening. I mean right now if you go watch television or see banner ads all over digital advertising, still it's not happening. They are not coming. I mean they are coming to the extent of 20%, but they should be coming a 200% right?

Thomas, you have high standards -- high targets. But we know at least haven't -- at least my opinion, I haven't followed the industry. There's a lot of uneducated -- I wouldn't say I mean uninformed.

Uninformed, yes.

Uninformed, people enter and open up accounts. But I think your advertising that certainly points out some of the differences in your offering. So now you are advertising. You got a great platform. Options are becoming more popular. What else can -- and I know you continue to invest and you're optimistic on growth. But what are the new things or new products or new areas that you could see interact?

Well, we are -- we always are working on new products. But as we experienced in the past, whenever we start something new, everybody copies it. So we don't want to announce it until we're ready to introduce it, right? So I'm sorry.

I thought you'd give me some insight, I understand. I guess one thing when we talked ,you also stepped back and do all the Investor Relations. You certainly still guide the firm. But you also have a full-time CEO. Could you talk about...

So Milan Galik, our CEO, took over 3 to 4 years ago, something like that, and his performance is better than I ever expected and that is evident in the numbers. And so it's really -- it was a very good move. And he's still in his early 50s. So it's going to be around for quite a long time.

So would you foresee -- so you do have a structure that appears to be working quite effectively. I know you're -- placed a lot of emphasis on not distracting him and allowing him to run the company.

That's why he is not here talking to you.

We'd rather talk to you anyway.

Yes. But anyway, if you want to hear him, he is always on the earnings call. So please come on to our earnings announcement, and then you can hear him.

One thing you have stayed involved with. And we certainly -- we see how regulation is impacting not only crypto but equities as well. We -- [indiscernible] will be presenting tomorrow afternoon. Any comments on -- he does have 4 rule proposals the comment period has ended and we'll certainly discuss that in detail as much as he'll talk. But any thoughts on the things that he's proposed or market structure in general in equities?

Right. So the 4 proposals, the first one has to do with disclosure of execution statistics and that's -- there is not much argument about those. They are probably positive, although we would prefer if they look at the quality of overall execution rather than relative to the NBBO, which you can basically move the NBBO very easily. So I think that comparison to the VWAP for the day for each stock would be much more informative. And we have been disclosing that for every -- at the end of each month for several years now. Secondly, is the tick sizes. I think the tick sizes, they are proposing are too small. It will fragment the volume and the NBBO will become somewhat less significant because it will -- you will see very, very small amount of stock on the NBBO relative to what you see today. Thirdly, the best execution rules. They are -- I mean, they are -- to tell you, frankly, they are difficult to grasp the proposed rules on best execution. And I'm still awaiting our lawyers to explain to me what they are. And fourthly, the idea of Options that is going to be a very big change to accept by the industry because most brokers are, as you know, they are geared to executing via their liquidity providers. And so -- and I understand that they are preparing for a big legal fight if the SEC is pushing forward with that from the point of view of Interactive Brokers. What we do is we get liquidity providers and institution order flow that we try to match our retail flow with. So we already have our kind of an option, and it would be a big change for us, what the SEC is proposing. But we like the fact that currently, we are the only ones who are doing that. So our ability to provide best execution is very unique, which if this would become the law, then it would no longer be so unique. So from the point of view of Interactive Brokers, we are not in favor of the euro, although we believe that, that rule would be generally positive for the public.

So thank you for the comments rule by rule. And I think they -- not all, but echo a lot of the comment letters and feedback that especially the tick size I know most aren't in favor. The real small tick size. One last question on that and then sort of go to the wrap-up. But 4 separate rule proposal, and I know the [indiscernible] believes that they are separate. But any views, Thomas, on when you have 4 changes, would you prefer to see it more on a phased-in approach? Or do you think that they stand alone enough that the way they've been proposed, it might be worse?

Well, I think that the disclosure rules are relatively simple to follow and the tick sizes -- I think the exchanges will also be opposed to the tick sizes. So I think the tick sizes, if they go forward, I think they will get modified and they will become larger than currently proposed. And if they do, I don't think there would be too much opposition to that. So I see the first 2 rules are easily implemented and the second 2 is as I said, the third one, I don't really understand yet. And the fourth one, I would bet against them. I don't think that they will be implemented.

Understood the exchanges actually do not as you say, they would rather -- they want to see smaller tick sizes, but not...

Not that tiny -- not so tiny, right?

So I guess. We've been talking here for 15 years. We've seen HFT come into the marketplace. We've seen you make changes to Interactive Brokers and if you do come at lunch, you'll hear where the name Interactive Brokers came from. But anyway, the changes over these 15 close the market maker, 0 commissions, 0 [ DTE ] options. So I guess, Thomas, you are the visionary or you have been the visionary, what do you see going forward for Interactive Brokers or for I guess, auction, retail auction trading in general. Any big views or changes or...

Big views. So around 2,000, we had over 200 seat -- exchange seats that we were leasing, and we had market making members on the floors of the 5 options exchanges and they were holding hand held devices which we were communicating by radio waves. And so that was the height of our market-making operation. And than as after the 208, 209 crash, high-frequency trading came along and they -- going after made of, made of use to cross trades on the sense we used to buy order flow from retail brokers and cross it against himself on the Cincinnati Stock Exchange. I thought that we we'll see real business in retrospect. It was just a facade. So -- but the HFTs basically got the idea from made up of buying order flow and we were trading as market makers, we were trading on all the exchanges and basically, our bread and butter came from the retail order flow and after the 208, 209 crash, we saw that order flow drying up. And so we had to eventually decide if we would take the other side of Interactive Brokers' orders or get out of the market making business. And I regret the decision that we made at the time, which was to get out of market making and we saw the market maker to [ Sigma ] on an earnout basis. And we basically got nothing for it. But -- so here we are today, right? So it's basically you see the HFTs, they are providing an extremely efficient markets as far as I can see from -- relative to the bid and offer. I am not so sure that if you look at -- I mean, they say that Citadel made $7 billion last year on the market-making side. So they must be -- they are doing something that's very well done from their point of view. And where do we go from here? Well, if you look at Apple's goggles, I think that -- there will be some technology that maybe we will work with that. I mean, I've been trying to figure out how to think about that. And there are -- there is certainly potential for that to visualize 3 dimensional services like from Options trader's point of view, the probability surface going out in time is -- and... So you -- currently if you come to Interactive Brokers, we have something called Probability Lab, where you can see the probability distribution function derived from the exchange courts and then you are able to adjust the distribution and get Option volumes from your adjusted distribution and you come from there, create orders that would take advantage of the difference between the actual implied distribution by current prices and what the prices would be if they went after -- if you derive them from your distribution function. So you could change that for a 3 dimensional situation, which would be really quite -- shaking.

This just proves to me why you're the founder of the company and why you keep the vision that we talked about, the vision doesn't stop. And I think I have a glimpse of it, but that would be fascinating stuff. It's been a great time following Interactive Brokers. We definitely want you to -- the audience that is to come and hear Thomas' full story at lunch and more about the story of bringing automation to trading, which you are what are the pioneers. So thank you.

Thank you very much.