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

Right. Thanks, everyone for joining our virtual fireside chat. Apologies, we're not able to get the video cameras working for this particular chat. But we do have everyone on the phone line. So I'm Brian Bedell. I cover the Brokers, Asset Managers and Exchanges here at Deutsche Bank. And so we are very excited to have both Chris Concannon and Tony DeLise from MarketAxess with us again this year. I know you get -- most now Chris and Tony, but I'm going to give you just a quick intro here. So Chris is the President and Chief Operating Officer of MarketAxess. And joined the firm in 2019 after a very long history in electronic market trading structure, spanning about 25 years on the equities side, culminating at Cboe Global Markets and with previous leadership roles at Bats, Virtu, Nasdaq and way back when, Island ECN and even the SEC. And Tony is a 15-year veteran of MarketAxess, joining in 2006 as Head of Finance and Accounting and becoming CFO in 2010. After 15 years of CFO and accounting experience at PublicCard and Arthur Andersen previously. But although, that sounds like the purely financial background. Tony is much more than a CFO, having been involved with the firm's strategy for most of its time as a public company. So thanks to both of you for being with us today, and apologies for the video issues on our end.

Well, Brian, thanks for having us. And I just want to point out, Tony and I, despite the years that we've been in the industry, we are really good looking and young. The video, it's okay.

I'll let -- ask for that. Maybe we'll try to get some pictures at some point.

But anyway, yes. So no, I'll start out with some questions. I know we're starting a little bit late here. But if I think the web portal is working. So if people have questions, they can shoot them in on that portal or you can e-mail me at brian.bedell@db.com. But I'd like to focus a good portion of our time today on sort of the typical, most interesting thing is getting into the drivers of that case of electronification of corporate bond trading. And this is really -- it's the heart of the debate around the magnitude of earnings growth we can potentially see for MarketAxess over the next several years. And just to frame that growth in the share of electronification of corporate bonds over the past couple of years, at least the way we're measuring it we combine MarketAxess and Tradeweb volumes, what we see in investment grade. It was nearly 33% in April, electronified, up from 25% a year ago and a high yield, it's nearly 20%, up from 14% a year ago. So a lot of progress has happened, obviously. A lot of that came in the back half of the year. And so far this year, the shares have backtracked a bit. I know there's a lot of seasonality involved in that. And we should really be looking on a year-over-year basis, of course. But maybe to start, Chris, with you, kind of a big picture question. But what do you see as the major structural differences of how the corporate bond market is electronifying versus how cash equities and options markets electronified back in the 1990s and early parts of the 2000s.

Sure. And there's some sizable differences that I think both markets will experience and certainly what the equity markets have experienced. Obviously, in the U.S. and European equity markets where you have a very high retail participation, government intervention was a key attribute to some of the accelerants of electronic change. But where there are similarities, I do see new entry of participants have been a big driver in both, whether it's futures, electronification, cash equities globally, FX, and in particular, we're seeing that play out in the fixed income market. So yes, very large bank traditional dealers and then we've seen new entries into the market, particularly the ETF market makers, particularly the corporate bond and treasury ETF market makers have played a major role in the adoption of electronic trading because they don't -- they didn't have the traditional distribution. And so folks like MarketAxess can help facilitate that distribution, and it's meaningful for the end users, which is -- it's a very different price that is achieved when a dealer is trading in or between an ETF and the underlying corporate bond versus a dealer who's trading traditional spread in the corporate bond market. So we've seen, if you look at last year, one of the big drivers of electronic adoption was the benefits of price savings. Effectively, the spread in the electronic platform was more attractive than the phone and chat that was available dealer-to-dealer -- client-to-dealer chat or client-to-dealer phone-based markets. So we're seeing that all-to-all market that MarketAxess has, where both investors and dealers face off to one another and can respond to price requests being a critical part of the growth rates and the adoption rates that we saw in 2020. Obviously, spreads were exceptionally large. So the savings was quite sizable. And certainly was attracting more and more players into the electronic space. I think over the long run, you have to take a long-run view here or not a quarter-by-quarter market share gain. And the long run, when you really look at this market and the complexity of the market, and the complexity for the investors, particularly the professional institutional investors, electronic trading is still early days. And that 33%, as I see, it is really just the beginning of a much larger march to electronic trading, where people are predicting 40% in just a few years. My prediction is 90% of the market will be electronic. How price is formed can be different, right? A traditional RFQ can be done over chat, over the phone. It's much easier done electronically, and it gets a boost in terms of price response when you have an all-to-all market embedded in that RFQ. So electronic adoption, early days. It will be different growth rates across different asset classes. Obviously, the U.S. and European corporate bond market is moving quickly and adopting electronic trading, both the end user, the institutional investors as well as the dealer is now fully incented to adopt electronic trading.

Yes. Very interesting. I'm going to maybe put you on the spot a little bit with the 90% comment, if you could give us a -- I know it's probably tough to answer, of course, but a timeframe of when you think we might get pretty close to that. So that would be on the...

I was hoping I could just throw out the 90% without any timeframe.

I was going to think next quarter or a couple of quarters. But...

No. Look, it's a multiyear development. And what I mean, if you look at other markets, they have achieved electronic trading is close to 90% and some higher. But the forming of price can be very different. And so when people think about electronic trading, they think about a big club where things are traded in a dark pool or trading on a club. That's not what the the bond market and the fixed income market more broadly will look like. It will be a variety of different protocols, but to reach those protocols, most orders will end up being electronically delivered. And that's a different thought process than what we have today and certainly what people think about electronic trading in the market.

Yes. And actually, that's a good segue into this next question. Of course, realizing, I know -- reckon if they say this, I mean there's so many different bond CUSIPs, for example, and so many different liquidity points. So it's a tougher slog to get this market electronified naturally. But what do you see right now as the biggest friction points to advancing that if we think about what the dealers are doing, obviously, new issuance allocation is very important for the buy side that the dealers typically facilitate researches involved in that. And maybe comment on fear of information leakage, how you sort of answered those friction points as you talk to people that are trading on your platform or you want to trade.

I think the friction that I would point out is largely, it's a dealer-based market. So the providers of service across the market, globally, are largely dealers and not agents. And as markets form, agency models are born. And agency models breed innovation. If you're a traditional dealer, it's very hard to run an agency brokerage model side-by-side with your dealer model. We've seen that attempted in FX, and it's very difficult to deliver. So I would argue as the market fragments, and we're seeing fragmentation start to develop. Obviously, we're a major player in the market where prices form. But as that market becomes more complicated and as that complicated is enhanced by the number of products that the average institutional investor has to trade across electronic solutions and what I would argue, agency electronic solutions become an important solution for the end client, solving both where to find the bond, how to trade the bond and what time of data traded in and what sizes to trade it and become a typical point for the buy side to slowly adopt and solve. Today, it's largely a list of bonds that we're requesting price on. And over time, that behavioral change will develop. One of the most kind of -- one of the eye openers for me walking into the bond market from both an equity and derivatives background is that the development of limit orders and use of limit orders is quite well. The traditional trader on the largest, most sophisticated institutions don't really use limit orders. It's a full price request market. So you're, by definition, crossing the spread every time you're trading in that type of market. And our vision of the future world of the bond market is that investors will, in fact, and we're seeing slow adoption, but we are seeing adoption of use of priced orders in the market where you set the price or you respond to someone else's request. And only an all-to-all market and an all-to-all solution can allow you to do that. It's very hard to face off to a dealer on a fully disclosed basis and say, well, my limit price is x, what's your limit price? So there are the use -- the adoption of limit orders in the fixed income market, and I include the government bond market because we see it as definitely a dominant price request market. The adoption of limit orders will ultimately change what this market looks like. It will compress the spread. And by definition, if you have a limit order or priced order, it is going to be electronic. And I think the use of limit orders and the avoidance of spread in the bond market will fundamentally change the return of investors' funds. And that will have a competitive dynamic among the institutional investor community. And we're seeing that play out where some large institutions are sort of slowly getting interested as other institutions are developing the use of technology and the use of more sophisticated ways to respond to other price requests.

That's super interesting. Maybe just on that topic real quick. What percentage of the trade is coming through your platform, if you know, are using limit orders now. Just to get a sense of how low that is and how much upside there could be?

It's below 1%. That we see institutions using -- there are some sophisticated hedge funds entering the market that are obviously responding to price requests. But among the large institutional asset managers, it's quite a small percentage of the overall volume of the market. And so when I think about electronic adoption, even though we're at 33% overall in the U.S. corporate bond market, the percent of price enhancement technology, which would involve the use of limit orders is tiny. And that will dramatically change what -- how this market looks in the next 5 years.

Interesting. Okay. Maybe to go deeper into some of the protocols and workflow enhancements that you're working on, right now, that you think will accelerate the adoption? And maybe we can go deeper also into composite pricing. I know that's a big part of the story for both dealers and buy-side participation. So to what extent do you think those can use some of the friction points? And how is progress on those protocols coming along?

So the protocols, there's a variety of different protocols that MarketAxess has innovated and so there's a different approaches depending on -- as I think about the liquidity of the underlying bond. So then the more liquid end protocols like an order-based protocol, like live markets, would be effective in that new issue market that order-based protocol would be very effective. And we're seeing early days still as more and more dealers come on to our platform, have truly live order-based market-making across the platform. RFQ will continue to be the dominant approach to this market, requesting price from both dealers and other clients will continue to be a dominant form. And then we are seeing, obviously, solutions like portfolio trading solutions become a little bit more prevalent where there are times when portfolio managers see the need for doing a large block trade across a major list in finding solutions for how to put that into a price competition among dealers and then effect that trade because these are sizable trades and then process that trade. So there's a number of components to the portfolio trading protocol and one that we see more and more demand for among our institutional investors.

Very interesting. Maybe just moving back to some of the near-term strategies. There has been some shift in corporate bond market share in recent months between you and your main competitor. What do you think is driving that? And what specific protocols are you working on to reaccelerate your market share there in the near term? I know it's in some different areas. I guess, both -- mostly in investment grade, but also high yields?

As I mentioned, I think the portfolio trading protocol has probably been an area that we certainly have invested in and some of our competitors have invested in. And that does move share because they are sizable trades. And they're solving a processing need by the client and the dealer, but they're also solving a pricing need. So there will be a movement of portfolios across the platforms. And we think we have an offering that's quite compelling. And obviously, putting those large portfolios in competition, price competition is an important component as we see that workflow going forward. But obviously, processing a long list of both buys and sells is an important friction if you're doing it manually. And the processing value of portfolio processing, I think, is important to end clients as well. So I think that's probably where we've seen a share move is around those portfolio trades, typically single dealer-to-dealer, dealer-to-client portfolio trades is where we've seen some movement in share.

Interesting. Okay. I've got a question that's coming -- yes, go ahead, Tony.

Yes. And just -- first, I want to make sure my phone was still working.