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

All right. Good afternoon, everyone. I'm Ari Ghosh, and I cover the U.S. exchanges here at Crédit Suisse. [indiscernible], we are hosting a virtual side chat with MarketAxess to discuss strategic priorities and the outlook for 2021 as the company enters this year with tremendous momentum and rapid market share. It's my pleasure to welcome President and CEO, Chris Concannon; and CFO, Tony DeLise, this afternoon. Gentlemen, wish we could do this in person in Florida but still, really appreciate you being here and doing this with us virtually. So thanks so much.

Well, thanks for having us, Ari. Really appreciate it.

Absolutely. So why don't we just jump right in? So 2020 was a disruptive year for global markets to say the very least, but it was one of opportunity for you, which highlighted the value proposition of your platform as you expanded your global network. Let's start with sort of your thoughts on the evolution of client behavior over the past 12 months and the implications sort of for the page of fixed income market automation in the coming years.

Well, that's a great question and a topic that I think when I look and talk to the industry, they're all having the same discussion as we did see an acceleration in electronic trading in the credit markets globally. And that's exciting for us because we live and breathe in that universe where the primary market for the -- certainly, the U.S. credit markets. And so it was an important change in client behavior, or I'd say, an acceleration in client behavior certainly across all our products. A lot of people seem to assume it was related to the work-from-home transition that we all went through. And the real consensus, just from talking to clients is that was probably a component of it, but the bigger component of it was the -- what happened in March and the blowout of spreads in our market, and the ability to achieve savings on our platform. We were able to deliver $1.1 billion in savings to our clients on $687 million of revenue. Like there's not many companies that can actually deliver more savings than they charge a client. So that -- I think the important part of our growth was the need for alternative liquidity, certainly in the time of the crisis, but also the savings that, that alternative liquidity gets. But it's clearly a behavioral change, a need and a product that people desire more and more. We continue to see that trend line going forward. So it's not like it reverses when everyone comes back into the office, it suddenly reverses and have a question mark on whether everyone comes back into the office ever. But the predictions around what does electronic trading look like into the future, I think everyone -- even folks that would prefer it not to go too fast are predicting very high numbers of electronic adoption across the U.S. credit industry.

Yes. And before we drill down by product, I just want to take a couple of minutes and just take with open trading. This continues to resonate with a growing user base, and that happened even after sort of, to your point, market conditions normalized, spreads and volatility came in, you still saw this acceleration in usage on your platform. So maybe let's talk about some of the factors that are driving the games over here. Are you seeing an uptick from new client segments, either dealers, bonds, regions? Is APAC a little more active? It's probably a little bit of all of that. But what's the most powerful driver of over the last 12 months that perhaps you didn't see the same magnitude in the years prior?

It's a good question because, obviously, when you look at the numbers, open trading has been a clear driver of our growth, and it's across every product. We have very high open trading penetration numbers in high yield, obviously, in high grade. But even in EM, even in munis, we're seeing wonderful results from open trading. And I think the driver is there have been changes in behavior, both from clients but there has also been new entry into the market. And when you think about open trading, I think about it as more of a network, putting clients together with clients, alternative dealers together with other dealers and alternative dealers together with clients. And then ultimately, what we're seeing and we saw this in 2020, dealers are now becoming clients. They are launching RFQs, using open trading. It's really become a dealer-to-dealer solution as well. So we've seen high-growth in open trading as a result of dealers liquidating positions and using request for quote to exit those positions or unwanted positions. So aside from the savings that you get in open trading because that's where that alternative liquidity is driving, we do see new entry as a key component of that driver. Think of -- I look at all these market makers in the ETF space that I grew up with on the equity side, many of them don't trade fixed income. And for the first time, we're seeing those alternative ETF-market makers step into the fixed income market. And open trading is an outlet. It's where they put their arm from the ETF on, and it becomes a key driver. So when I look at the ETF market and the growth and higher velocity of ETFs, I see open trading success down the road.

Got it. Maybe moving to some of the key focus areas on products and starting with credit. Again, you continue to see strong market share gains in U.S. credit across both high grade and high yield driven by open trading and some of the benefits of unique liquidity, cost saves that you just talked about, and that was really magnified last year. So maybe just starting with a little more high level, given that we're coming off this record year for issuance, elevated sort of spreads and volatilities moderated since early last year, what's the outlook for credit markets over the next 12 months? And are there any factors that may continue to drive industry volumes and activity levels at an elevated clip in 2021 as you look at it?

Well, I'm a glass half full guy, so I'd like to save mine and turn it over to Tony and have the glass half empty guy talk first.

This is why I love -- in the last 2 years have been so thrilling to work with Chris. Ari, it's an interesting question because the credit markets are still healthy. There's still healthy new issuance. This is going to be tough to replicate the new issue activity that you saw, particularly in U.S. credit last year. It's just that, in all likelihood, that's not going to happen. This is probably the -- thinking from a short-term budgeting standpoint. This is probably the first year that I can recall in the 15 years here that what we're looking at and what we're sort of forecasting for market volumes, particularly in U.S. credit this year would look more flattish over the course of the full year. And you've got a couple of tough comparable months coming up. But we still think -- we still think it's pretty healthy in terms of new issuance. The thing that gets us maybe more excited today is that for the first time, postcredit crisis, we're talking about the first time in 12 years, what we can see is a pickup in turnover and a pickup in market velocity. And it's really -- that's really in the past 18 months or so. Maybe it's more focused in the 1,000 most active bonds, but you're definitely seeing a pickup in market turnover. And that's something -- I don't think that any of us really have baked in to our models would be, hey, what happens if this trend we're seeing in market turnover continues, pickup in market turnover continues, what could that mean for overall market volumes? So just to put it in perspective, we're talking about U.S. investment-grade market turnover, rough numbers, has gone from [ 0.65 ], say, a year ago to about [ 0.70 ]. Precrisis, the market was turning over 1 time per year. So that's another 50% increase in volume. I'm not suggesting we should do our model in that way. But I think that's the most exciting thing we're seeing right now. Is there a case to be made and maybe today we can make a stronger case that we'll see a pickup in turnover and market velocity. Now glass half empty. We still have central banks, which are very active in the markets. In Europe, they're consuming 40% of every new issue that comes out the ECB is purchasing. So that dampens activity. And we don't know how long it's going to last, but that is not supportive today, at least outside the U.S. that's not supported.

And Ari, I would just add the glass half full. When you look at the adoption of electronic trading in our market and compare it to all other markets that went through an evolutionary change of adopting electronic trading, the one fact that is always exists in a conversion to electronic as turnover goes up. In many instances, it goes up fast, and it goes up high, like multiples of its normal turnover. And so you can't have adoption of electronic trading, and you can't have spread tightening as a result of that electronic trading because that's really what's happening without an increase in turnover. So the pie, when you think about 2020, right, the new issue was $1.8 trillion. And now we're looking at an $11 trillion pie, just in U.S. corporates. You add some turnover to that, and Tony and I can actually take -- play golf. Well, the impact of electronic adoption clearly increases the turn. The other piece that we're seeing that's exciting about 2021 is, the market is now -- has enough attributes both data, electronic training and data is a key element and then spread tightening that systematic hedge funds have entered the credit market. They have historically been out. Their strategies don't work. They have a [ base ] to be passive. They -- those strategies don't work when you're trading with a dealer crossing the spread. So systematic hedge funds are here, and they're just starting. And so -- and the data is ripe and it's really good data for them to use. So I think that's an exciting part of the 2021 strategy. And the other piece is, ETFs have crossed the $1 trillion mark, fixed income ETFs crossed over $1 trillion. We're going to see $2 trillion in 2022, no doubt, if you look at the pace of how fast they're growing. And that's putting aside any macro market events that force that pace to increase because of desperation for yield.

Yes. I think that's a good segue into the next point. And you kind of -- often you touched on the structural changes, new participants in the space and things like that. So when I think about the high-yield segment, that seems to be going through a bit of a structural shift as well. You added 400 basis points sort of market share just last year, and it seems like there were a lot of these factors driving it. You talked about ETF, the high-quality names from Fallen Angels. And then even your participants, like some of your credit hedge funds that maybe weren't as active in the markets in previous years. So when you look at the addressable high-yield market now and you've kind of put all of this together, has that gone through like a shift? Like should we think about the addressable market being larger as a result of it? When we think about the addressable market and creating velocity as a result of some of these new players in the space over like 2020, some kind of one-off event where you found some of these players being a little more opportunistic, and they might not come back at the same piece that they did?

Well, what's interesting is, obviously, we see in the high-yield space, there's definitely new money chasing those higher yields. So there's just macro demands happening that we're seeing. We're also, in 2020, we obviously saw higher volatility in high yield. So that tends to drive turnover. And that -- we obviously had a great 2020 with closing our market share somewhere around 17% of the overall market. I do think the open trading solution and high yield is more meaningful ironically than and high grade because that savings is important. And it's also the connection to the very active ETF sector. When you think of HYG and JNK, these are super active ETFs and all they hold is high yield. So it's definitely having impact on the turnover in the underlying market, and that we're seeing more entry coming into those ETFs. I do think the activity of some of the hedge funds that I mentioned, they are looking at the high-yield space as well. Because, again, the ability to enter that market and be passive mean not cross the spread and it becomes meaningful to the cost of that trade. If you can avoid that spread and actually make the spread, there's transactions that couldn't occur before. So I do think the high-yield market, and if things do shake up a little bit, look at the leverage that corporations have taken on, and we are not really sure when the market is going to sustain this kind of bull run. If things do turn in the economy, you're going to have a lot of Fallen Angels falling into that high-yield space pretty quickly. So it has certainly a right feel to it in 2021.

Right. And I'd also add that when you talk about addressing the market, we were having this conversation 5 years ago, definitely 10 years ago, we would have -- we've had a different view on the addressable market. When you -- and particularly around larger trade sizes. In high yield, around 80% of the market volume is in block trades. High yield that designation is greater than $1 million in trade size. If you look back 5 years ago, our market share was close to 0, 5 years ago. So it was -- we discounted it in terms of our addressable market. If you look at it today, we are -- we're very focused on high yield, very focused on open trading the value proposition there, what it's doing for our high-yield business. If you look at it today, our market share in the fourth quarter hit double digits. It was 11% in block trading. Again, 5 years ago, it was 0. So we feel much better about the addressable market and where the high-yield market overall can go in terms of electronic penetration. I don't know, we're at 17% today, maybe the market overall is 20% electronic. We still think that the market, that's going to be 65%, 70%, 75% electronics. So huge runway and feel much better about -- like the whole market is addressable today, and that wasn't the case 5 years ago.

Right. And I guess, greater customer comfort around processes, around the trades and things like that, that's driving some of the larger trades as well, which is helping there. So it's a kind of fee support itself, which is the overall ecosystem there. Moving to EM. This is another area where you've seen tremendous growth over the last 3 years as well. You've been adding resources in APAC. I think there's also open trading that sort of solving for some of the transparency issues in that market. So maybe can you talk about the market opportunity here and your strategic vision in that region as maybe some of the local players change the way they behave as well.

Well, I'll start, and obviously, Tony has some thoughts on EM as well. I mean I think they're being kind calling it opaque, right? It is dark. The transparency of the EM market is quite difficult to navigate. The EM dollar-based is -- obviously, you can see it on trade, it's a little bit more transparent, but EM local is a true challenge to trade. It's a brokered market. It's a phone-based market. There's not really a trade report anywhere in those -- some of those local markets. So it makes it very important to be on a platform like ours where you can actually see price and navigate pricing. The EM market actually struggled in 2020 with what happened in the overall market. So the overall market did struggle. We're seeing that market return now. So the overall market turnover in EM is quite attractive. Our position in that EM market is quite attractive. What I love about EM is, we are a true network in the EM market. We are connecting local dealers who can produce some of the better prices in that local corporate bond to the global investor base. So they are -- we're putting those people together. It's a true network. In fact, in EM, open trading is a very sizable part of our EM growth, and the clients are benefiting from just better pricing and that better network effect or connectivity. Things like Chinese bonds are obviously a big factor for us in long-term growth. So when we think about 2021, accessing the Chinese bond market is an important part of our growth strategy. And obviously, we're working to seek all the necessary approvals there. But that's a giant market that doesn't even sit in our EM today. So we're pretty excited about all the markets that we can unlock in all directions. So we've made substantial investments in Asia. We have investments in South America as well. Mexico has been a great market for us more recently. So we're super excited about EM. And the best part about EM is, we are literally competing with the phone and a fully brokered market. And while that's behavioral changes, those are behavioral changes that we know and we have tackled and it makes exciting. And there's no one else marching through that world. We're just literally competing against the phone.

Got it. I'm going to touch on the China bond opportunity shortly. But I think I want to stick with some of the less transparent segments and that's perhaps ripe for destruction. And I know this is the best topic of yours, Chris. So the muni market, again, early stages of electronic trading there. Again, similar to what we were talking about basis challenges around noncontinuous trade data, robust financial sort of reporting. So maybe, can you talk about ways that you're looking to help sort of digitize this space and, thereby, potentially magnifying trading velocity? And then again, like if you think about your acquisition of muni brokers, like how does that fit into the overall strategy here of digitizing this market, which there seems to be a tremendous potential?

Yes. And you're right, I do love the muni market and largely because it's a diverse market. Its diversity of product is amazing, right? There's millions of CUSIPs in that market, very complex to locate actual bonds and putting aside trading the bond. The other part is, it's -- which is -- really plays well with our platform is, it's a small ticket market, right? You're not doing big blocks of munis. It's a very small ticket market. And so you need automation when you're facing those diversity of product and small ticket markets. It is a fully brokered market. It's all phone-based, people calling up people to locate liquidity. But there's a lot of technology solutions, but you kind of nailed it. The lack of data for munis, even though we have muni reporting, the ability to know where to price a bond, not where it traded, is hugely important. So we think our data strategy in the muni market and data analytics, more importantly, being able to locate a bond is an important component of what the muni market does today mechanically and manually. With regard to MuniBrokers, we haven't closed that transaction. We're still working on closing it and tying up [ blue sense ]. It's just really reflective of we want to invest in that muni market. We think it's right for automated trading. We have some of the largest investment firms looking to automate their muni areas. And so exciting change can happen there. And the data part of the muni is what's exciting for me because being able to tell people where they can find a bond and how they -- and how to price that bond. That's -- those are some of the pieces of the puzzle that we can put together on a platform in real time.

Got it. Go ahead, Tony.

Ari, just we do joke around that Chris is really excited about munis, but it's for good reason. This is a -- it's a big market in the institutional space. 99% of what happens is not electronic. And for us, just to put it in perspective, every point of market share for us is about $10 million in revenue. We crossed the 1% market share level. And this -- on the muni side, the opportunity here is as big as what we're seeing in the high-yield space. So if we dream that we can get to 10% or 20% market share, that's $100 million or $200 million in revenue, very high incremental margins. So Chris is right to be excited. And hopefully, we're doing all the right things and making all the right investments. And we know it takes time to move markets, which have largely been phone-based in the past, but that's why we're staying focused on it.

And Ari, I think it's important that we're recording this because Tony just said, I was right [indiscernible] that's not.