MarketAxess Holdings Inc. (MKTX) Earnings Call Transcript & Summary

And then I guess just taking a step back and looking at the big picture holistically, right? As the market gets more and more electronic, you get the rise of algos and automated trading. You're opening up markets, you have more streaming/live markets type initiative here. How do we think about the velocity of just the overall market activity, especially in the credit world on a go-forward basis? And how is MarketAxess kind of positioned to kind of stand to benefit from that?

Well I mean one of the things you've seen, and history has proven this out, when you automate, when you convert to electronic solutions, turnover goes up, and in some asset classes, more dramatic than others. But the turnover rate in the credit market, if you look at the convergence of what's happening, ETF growth in the space, that those ETFs trade more. The underlines can trade as a result of the activity in the ETF. You're just having this convergence of things that tend to turn over higher, putting aside before you even get to the automation of the bond market. So electronic trading, new products, new types of products tends to impact turnover. The other interesting thing is we've just had an explosion of the overall asset class with the new issue market across the board. So any increase in turnover is quite dramatic in what it can do for the secondary market. So our goal is to deliver the tools that allow that turnover to go higher because I do think when you look at the spread of the market we sit in and the workflow to find upon and trade upon, it's still not terribly efficient for what the market can really bear and do. And that will -- and if you look at some of the new participants coming in, they tend to drive turnover higher, the systematic fund complexes tend to drive turnover higher. So there's a lot of evidence that suggests the turnover should go up. It certainly doesn't suggest that it's going to go yet.

And Jeremy, you see, Chris doesn't like talking about numbers, so then I have to fill in where he has gaps. So for all the reasons Chris mentioned, we -- given the question around velocity or turnover. For the first time really-post credit crisis, the market was turning over. Investment-grade market was turning over about 1x per year. So if there was 2.5 trillion outstanding, [ trading ] volumes were 2.5 trillion, rough numbers. Crisis hits and that turnover rate and velocity went down dramatically to around, say, 0.6 of a turn per year. It's only in the last 18 months or so where you've seen velocity pick up. And to Chris's point, with all of the outstanding debt today, I'm not saying it's back up to 1. It may have gone from 0.6 to 0.65 or 0.7. Still, you look at where U.S. investment-grade market volumes have been pretty healthy in the past couple of years. With what Chris was talking about on the ETF impact and automation and deeper liquidity and smaller trade sizes because more comfort streaming prices, all of that thrown to the mix. And we're not saying, hey, listen, build your models next year for a onetime turnover on an 8 trillion market. We're not telling you to do that. But there's a better case...

[ indiscernible ] now , Tony

There's definitely a better case today for improving velocity and turnover in the marketplace.

And I think looking back historically, any market that has moved from analog to electronic has inherently had higher velocity over that time frame, right? And then I guess, Chris, you kind of mentioned live markets a little bit. Let's just unpack that, a little bit more detail. For those maybe newer to the story, can you just kind of recap what the initiative is there? And then obviously we've been getting a little bit more kind of questions around kind of some of the nonpublic peers, so your Trumids, your Liquidnets to the world. And I think some of those capabilities are some of the stuff that you're looking to explore within this initiative itself as well.

Sure. So live markets was something we were pushing earlier in the year, first quarter. Our timing coming up against March was not ideal because it does require dealers or traditional dealers or dealer partners to stream price into what is a fully live order book. We kind of, during the crisis, pulled back, worked with dealers and clients to come back. We thought September time frame is the right time. The dealers are in. We're pretty comfortable with how Live Markets order book looks. And we're still -- now we're out marketing it to clients. So they can see a streaming live order book in credit that's quick to trade. You can also join and place an order. So we're allowing your clients to make spread instead of crossing spread, and that's been a mantra here for some time. Live markets obviously has some dealer relationships that help the order book get full, and it streams live orders. And so it's a new market protocol that is only new this year. And we're pretty excited about the early days of having a live order book in corporate credit.

And what's the competitive landscape, I guess, in that market? Who are you competing against in line markets?

It's really -- it stands out by itself because it's an institutional-size live market. That's unique. There's obviously live order books in retail-size markets with quite wide spreads, as we've heard. This one is a true institutional live order book, so there's minimum size requirements. So if you're an institution looking to click to trade in the more liquid end of the market, it's available to trade and available to click. And so once you have that live order book, more automation can be built around it. You can join the book with automation, you can peg to the inside. You can have auto-execution solutions, either an algo or small orders that trade against the live markets. And there's a lot of things you can build around that foundation of a live order book.

And then I think as we look ahead going forward, you guys obviously have the dominant market share, especially in corporate credit itself. We've heard -- and Tony, I remember a couple of years ago, we talked a lot about ICE and corporate credit. But with Tradeweb being a public peer, as I mentioned before, we're getting questions on Trumid, on Liquidnet. What kind of initiatives are you continuing to evolve? So we're talking about what you already have in place, but how are you either going to improve them or further evolve the company to kind of protect that moat, protect that liquidity pool from other entrants?

Yes. You want me take it, Chris?

Yes, why don't you take it? Since you have all the numbers, Tony.

Jeremy, we've -- every conversation with you or investors, typically competition comes up. And we faced competition from day 1. So this is -- at no point in our 20-year -- 20 years in business have we been competition-free. If today that competition arguably may have concentrated in some way, we've always competed against Tradeweb and Bloomberg and big companies, well managed, well funded. Lots of interest in the space, relevant, lots of connectivity. So that's not going to change. And some of the newer entrants around Trumid and maybe Liquidnet, they may have some unique things going for them. For us, we believe competition is healthy. We believe that it fosters innovation. We believe we have to continue to stay ahead of the competition. And if you look at our investment agenda today, Chris mentioned Live Markets one of the big investment areas. We've got other investments in the private bank space and with private wealth managers. We continue to innovate around new functionality and protocol. So we're not standing still. And yes, we hear a lot about Trumid. They've been successful raising money. They have a lot of success in the new issue market and the gray market. And that's a lot of what we're doing around Live Markets might be coming out from a different angle. But we're very focused on that space. And quite frankly, and not to pick on this one item around new issues, our market share is typically lower in new issues. It's not 0. And if anything, what's -- part of what's driving our market share forward the last couple of quarters has been doing better in newly issued bonds. It's a bigger piece of the market. And also, we're doing better in newly issued bonds where we can demonstrate more clearly the cost savings through Open Trading, for example, and when bid-ask is wide or even new issues. We're doing better. So we've got a bunch of different ways of attacking and driving adoption forward. And the fact that there's competition, it shouldn't -- nobody should be afraid of that. And we're going to live with it going forward. So we have to continue to innovate, create value for our clients, deliver unique liquidity. That's -- it's all part about -- part of our revenue growth plan and our adoption plans.

And then...

Sorry, Jeremy, I just thought I'd add because I honestly didn't hear many numbers in that. And Tony is right, like we are responding to the competitive environment. I think we're responding quite quickly. Actually if you look at our LiquidityEdge acquisition, that's really both a defensive and offensive transaction. We're -- on defense, we're enhancing our treasury functionality for our corporate bond traders, things like auto hedge, net hedging, which we just rolled out this week, is now going to be available. That was something that we heard from Tradeweb, and I credit them with being innovative around the arrayed solution to get into the corporate market. So we responded there with quickly doing a transaction and integrating it to offer a net hedging solution. Trumid is interesting and, their model is a little bit of a dealer-to-client streaming model. It's similar to our Live Markets. Our Live Markets is more live, I would call it, than their dealer streams. But in answering Trumid, we actually think some of their models are innovative. And we just recently launched this summer our direct dealer product where a dealer can stream to a client of their choice, price information and then respond -- have that client respond and engage. So we're trying to offer solutions both for the dealer and to the client that we're seeing in demand in the market space.

And then I think you mentioned LiquidityEdge. Obviously, the deal is closed. I think one of the things that to be on offense in that business was trying to connect what had been more of a dealer-to-dealer-type platform into your massive kind of client network. How is that going so far? I assume with everything on your plate in the macro backdrop this year, it might be a little bit challenging, but what does that outlook like -- look like?

So the outlook looks good. And the reason why is in May, we launched our first dealer-to-client solution. So it's probably a more targeted solution, it's a click to trade solution where clients who are MarketAxess clients can sign up for a new front-end that is designed for click to trade. It clears and settles through MarketAxess, so it's favorably seamless to the MarketAxess relationship. Phase 2 of the integration of our dealer-to-client solution is really in the fourth quarter where we're off of the MarketAxess GUI. We're looking to deliver a full suite of product so you don't have to go to a separate trading terminal. You can launch it within your own MarketAxess GUI, which is distributed across the planet at this point and just phenomenal distribution. The eventual end state of all of this is having not only click to trade solution where LiquidityEdge, what's great about that product that we acquired is its customized liquidity. So we can match certain market makers, certain dealers, certain banks with certain clients and make sure they have kind of a curated liquidity pool. And -- but if they need an RFQ, [ end state ] has RFQ solution as well. So the integration is ongoing. It's throughout the 2020. Honestly, work from home ironically helps our development time frame. So while it's difficult to onboard new clients and have a lot of work done by dealers and dealer onboarding, from a rollout of functionality, it certainly has helped us.

And then Tony, if I recall, I think in the 8-K you guys had released back in August, I think I read it correctly in that self-clearing is up and running as of early August. When -- did I catch that right? And can you just remind us what the big picture lateral is from an operating leverage and a potential margin expansion story here, the self-clearing initiative going forward?

Yes, sure. And you did read it correctly. So we did go live on August 10 at self-clearing in the U.S. And it was a little bit delayed. And this is one of the ones that the pandemic probably didn't help and didn't help with -- on the vendor side. We are live with self-clearing. We're a better part of a month into our self-clearing journey. From a cost standpoint, and we've talked about this a couple of times on various earnings calls. If you look at our credit side of our business where we're -- our clearing costs for matched principal trading, it had been running -- clearing costs are running, rough numbers, 11% or 12% of our Open Trading revenue. So last year, 2019, Open Trading revenue was $100 million in credit. Clearing costs were $11 million or $12 million. If we look at where we are in self-clearing, we think going forward, we will drive that rate. If we're looking at it as a percentage of Open Trading revenue, we'll drive that rate into the single digits. So this year, the run rate for Open Trading revenue, take the first 6 months, I'm not saying that's what it will be for the full year. We take the first 6 months, it's something like $175 million in revenue. So if we're -- the savings are 2 percentage points or 3 percentage points or 4 percentage points, you can do the math around that, and that's the savings for going self-clearing. But beyond the cost savings, we did this for more than just cost reasons. This was also to take control of the selling process and to improve our client service. So it's beyond the cost side of it. Again, we're 35 days into it right now. We -- the transition, I'm sure with any big firm transitioning to clearing, there were -- early on there were things that we had to deal with early on in terms of our relationship with DTC and the pipe that's available to settle trades around client instructions that had to be updated. We have 2,000 Open Trading clients with 40,000 sub accounts, things that we had to work through as part of that migration to self-clearing. But we feel good about where we are right now. It's something we've been talking about for a number of years. I'm glad it's finally here. And we'll see those cost savings coming through as the quarters move on.

And we're almost on time here, but I just wanted to get maybe a position, more of an open-end, big-picture manner, and let you guys talk to whatever you want to talk about. But you guys have an unlevered balance sheet at this point. And then I know, Chris, when you first came over, you were taking a really hard look at that data business. But as we look ahead, you've got so many irons in the fire on an organic basis right now and new initiatives. But maybe let's look intermediate term. If we look out 3 years from now, what do you think are some of the interesting new potential adds could be for the MarketAxess platform, whether it's something in-house or tapping into the balance sheet of Tony DeLise and adding something inorganically?

Well look, the great thing about MarketAxess is the lane it sits in is pretty rich and pretty open-ended. When you really add up the credit market globally, the opportunities are enormous. We've just entered the rates business. We plan on being a hefty competitor in the rates business to fill out really the offering, right? We're a bond market, and we were missing one of the biggest bonds that are traded. So the rates really is complementary of the overall offering we have today. I just think the passion that I see in the client's eyes and from our own employees is around changing how the bond buyer and seller conducts its daily business and changing traditional market across these spreads, joining spread. And those are the things that have been untapped for years. And if we tap them, it's true returns to the investors, the clients of those big fund complexes. It's a meaningful benefit to the P&L of the fund to -- if you're, 10% to 20% of the time, passive in bonds that you can take your time in, that's a meaningful return to the investor. So it also has the collateral effect of narrowing the spreads even further. So the more automation that we deliver, the more tools that we deliver to our clients, the better they trade and the better outcome they have for investors. The last piece I'll say is something that I discovered since I've been at MarketAxess, I came from a world of single CUSIP symbol, single futures product. The CUSIPs are millions, and people don't invest in just a single CUSIP. The portfolios want to invest in a view, in an exposure. And you can create that exposure with a variety of different CUSIPs. And so the analytic opportunity in the bond market is untapped, completely untapped that we can help a portfolio manager. If they want a 10-year AAA, we can select a bond that's more appropriate for them even by sector because it's trading better, it's more liquid or they can join part of the time being passive. So there's trading behavioral changes based on the analytical data that we see inside our market that should change the outcome for the end investor that's invested in these funds.

Perfect. Well I think we're out of time. But Chris, Tony, thank you so much for being here again.

Thanks.

Thanks, Jeremy.

Take care.