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

Good morning, everyone, and welcome back to Morgan Stanley's Financials Conference. I'm Mike Cyprys, equity analyst covering brokers, asset managers and exchanges from Morgan Stanley Research. And welcome to our fireside chat with MarketAxess. We're excited to have with us today, Tony DeLise, the Chief Financial Officer of Market Access. As many of you know, MarketAxess is an electronic fixed income trading venue, but the primary emphasis on credit markets and recently extending into rates. Tony, thank you so much for joining us today.

No, Mike. Thanks for having us. Thanks to Morgan Stanley. We had a good lineup yesterday and today, looking forward to this chat as well.

That's great. Great. So I'll kick off with some questions. We'll see if we have any time towards the end for any investor questions that can be submitted via the web portal. When we think about MarketAxess, you guys were founded over 20 years ago. There were many firms back then attempting to electronify fixed income markets yet. MarketAxess is just one of a few firms that is still here today. Can you talk about what you got right where others faltered? And when you think about the competitive backdrop today and the new entrants that are popping up today, how does that stack up versus what others have tried to do over the years?

Yes. Sure, Mike. And really 2 things in there. And what do we get right and some comments on the competitive landscape. And listen, hopefully, we've got a lot right over the years. We've delivered for a long period of time. We've built a wonderful network and been able to attract both liquidity providers and order flow onto the platform. And that -- we did that by listening to clients, providing value to both dealer clients and investor clients. And we've also been innovative around protocols. One of the things that that we recognized early on is that not all bonds trade the same way. And trade size matters, liquidity matters, and we've been innovative around protocols. And when you look at what differentiates us today, there was one really critical decision that we made during the credit crisis that's really set us apart and set our liquidity apart and that's opening up the platform and and launching all-to-all trading and allowing any participant on the platform to act as a liquidity taker to act as a liquidity provider. That was a critical decision. And that's hopefully, one of the things I think everybody would recognize that we got right over the years. But sort of the second part of your question around competition today and we faced competition from day 1. And I've heard Rick many times talk about what it was -- what he was faced with when he launched the company 20 years ago, and there were dozens of new initiatives in this space at that time. And even -- I've been here, I'm coming up on 15 years at the end of July and I've seen more than a dozen new start-ups and even established companies to try to make a go of it in our space. And I'd tell you, the competition -- it's narrowed over time, and it's narrowed over the years and there's differences by region, there's differences by product. But when you really narrow it down, electronic venue competition, it's MarketAxess, Bloomberg, Tradeweb would be in the in that mix, again, depending on the product or the region. But I tell you 1 thing and still, we can talk about electronic competition. But in credit, this is the biggest competition we face is the traditional way the bonds trade and still the vast majority of the market doesn't trade electronically. So it's still -- there's still an enormous opportunity ahead of us and competition is not going away. And nobody said, us included, was that it was going to be a sole source to one venue. Competition is healthy. We need to continue to innovate. We need to continue to add value and deliver value to clients.

And as firms have tried to chip away at your lead, you've maintained a dominant market share. What would you say are the top contributors to your moat? And how do you maintain or even improve that moat as you look out over the next couple of years?

Yes. And I'm sure in this conversation, as in most conversations with investors, open Trading comes up a lot in our conversations. And it's hard not to pick at that as one of our real differentiators. And you look at it today, it's more than 1/3 or 1/3 of our trading volume happens between 2 parties that don't have a relationship. And without accessing our platform and accessing our liquidity pool, they wouldn't have found each other. And just the price improvement that we're delivering when those 2 parties find each other, it's demonstrable. It's -- and listen, it's big numbers. For 2020, it was more than $1 billion in price improvements. So that's a big differentiator. That is part of the moat. But I'd tell you, even before getting to that, a big part of the moat is a network that we've created and the way that we're connected to clients, and we've got more than 1,800 clients actively trading. There's a breadth of engagement across products with all of those clients. There's a deep integration with those clients and direct connectivity into that order management system. Stuff that's difficult to replicate. I think it's one of the reasons you see the competitive landscape so narrow is that -- and to create that network effect, it takes years to do that. It's a lot of work and effort for both us and for clients to get to that level of connectivity. But you might -- the second part of what you were asking was how do we maintain that moat? And really, how do we grow from this point forward? And you've heard from us, and you see that we've got a lot going on right now. We've got an enormous investment agenda. And that's reflective of the opportunity in front of us. We've got a big investment agenda on protocols. So we -- and we talk about live markets and Mid-X and portfolio trading we're doing with automation, fit that under sort of the portfolio. The protocol theme, we've got new client segments and geographic expansion that we're investing in. New client segments like a client-to-dealer rate space and even the dealer-to-dealer municipal bond space and what we're doing across the globe to advance geographically. We've got a couple of acquisitions we're in the middle of integrating. So we've got a big investment agenda. We think all of that will be additive to our business, will help us maintain and deepen that moat and it provides opportunity to grow going forward.

So I want to dive into a number of those different things that you mentioned. But before we do, just maybe keeping a little bit higher level. Over the past 12 to 18 months, we've seen a big uptick in electronification of credit markets. It's still well below other asset classes. So what challenges do you see that remain at this point for digitizing the trading of corporate bonds?

We spend a lot of time talking about competition. And what I mentioned before is that still the biggest opportunity is trying to move all of that flow that does not happen on an electronic venue that's happening by e-mail, voice, instant messaging is moving that electronics. So that's still the biggest opportunity and has the biggest hurdles in it. So and you think about it today, in U.S. investment grade, maybe 35% of the market is electronic. In U.S. high yield, maybe it's 20% or 25% of the market's electronics. So still there's a big swap of trading that is not happening electronic, and there's resistance points. And it's funny because, again, having done this for a long time with MarketAxess is some of those resistance points haven't changed. Trade size is a resistance point. New issues and actively traded bonds, there's some resistance on trading that electronically. Concerns over information leakage. Those are hurdles that exist. And we've got a series of protocols and initiatives to address those resistance points. But yes, it's hard work. If this was easy, the markets wouldn't be sitting at 35% electronic in IG and 20% or 25% in high yield. It is hard work. We've got protocols that are directed at those resistance points where those protocols are leveraging off of like with Mid-X and with automation, it's leveraging off of content and data that's unique to us, to help clients make trading decisions, help clients become price makers. It's things like live markets, which are directed at new issues and more actively traded bonds. So we're trying to invest to change those dynamics and address those challenges that remain in terms of moving that flow electronic.

And if you look out 5 years, how different would you say the credit markets could look in 5 years versus today? What new protocols could we see emerge? And how might the trading workflow evolve?

5 years a long time, right? It's -- I -- listen, this is me talking, and I -- If I said it was a house view, I think way more of the market is going to be traded in electronic. I think the debate today is not are these markets going to go electronic. It's -- the debate today is over the pace of adoption. And I think in 5 years -- and in 5 years, more than 50% of of credit markets, more than 50% could be trading electronic. And the themes that will play out there, I think one of the big themes is around automation and how that continues to evolve. And for us, if you look out over a number of years, where can we really change this equation on market share and adoption, it's how do we take a client order, how do we execute in a variety of protocols, how do we maximize price improvement and execution with minimal manual effort. That's a lot -- that's doing a lot, but that's -- how do we take that order and direct it to where there's the most liquidity or time of day. It's -- how do we do that and do that in an automated way. I think that's -- that will be -- it will look different 5 years from now. And just like it looked different 5 years ago, it's going to look different 5 years now. But I do think that automation theme is going to continue to evolve, and that will be one of the big drivers on how these markets evolve and how they electronics fly over time.

So you mentioned in IG, maybe around 30-ish, 35% high yields, around 20%, 25% electronic today, and that's up substantially from 5 years ago. But yet turnover in markets has not really increased much. But I know that there are some debates and views out there that perhaps over the next 5 years, we could see a meaningful pickup in turnover. What catalyst do you see on the horizon that you think could serve is that inflection or catalyst around increasing turnover?

Yes, yes. No, it's a good question, and it's -- it's one like if you let your modeling mind expand. And you said if we're -- if we got back to pre-credit crisis turnover, how big would the markets be today? And just to size it up. Think about it, pre-credit crisis, the U.S. investment-grade market was turning over somewhere around 1x a year. All right. So we're turning over on time. Market is much bigger today. The U.S. high-yield market was turning over maybe 2 times a year. You fast forward and you say, what's going to look like 2 years ago. And the IG market was turning over maybe 0.6x down for 1 and the high-yield market was turning over 1x, down from 2. Those are big changes. Those are big changes in velocity. We've seen a pickup in the last 24 months or so and a pickup in velocity. If you look at the numbers, you're going to say, it's not appreciable, but going from, say, 0.6 turnover to 0.7 turnover, you've seen an increase in investment-grade velocity and investment-grade average daily volume. And similarly, in high yield, it's gone, we'd say, 1 to 1.2x. So Those are just some numbers just to show that there has been some movement more recently. But when you look at can we get back to those historical levels? Can we start getting enthusiastic about building models that have a more aggressive assumption around market bonds? What has to be there. And are the signs there for that? I think that's the bigger question. And we think, again, this is going to -- may sound a little bit like a broken record. But on the automation side, as more and more trading takes place in a low-touch or no-touch environment, that's going to be helpful for turnover. We think as liquidity deepens and you have more price responses back and just a depth of liquidity that will help with turnover. We think even what's happening around us in the fixed income ecosystem around ETF share trading and the velocity around the ETF market, we think that will be additive. And you could point to other markets. And I don't have the chart in front of me, but you could point to other markets that have electronified over time and look to see what's happened around velocity. And it's almost -- it's an empirical evidence that once markets electronified, typically the things that happen as bid-ask spread tightens, trade size is smaller, velocity picks up. So that's what typically happens over time. Although let's -- in our space, we haven't seen that in a large way. But I think some of those early signs are there, again, around automation and depth of liquidity, and I think all of those will be helpful. And I do think you'll -- we've seen this pick up in velocity in the last couple of years. It's going to continue as well.

Is there anything that stands out in your view as to maybe why we have seen that decrease in turnover and why it hasn't picked up and any perspectives? And maybe what people were thinking 5 years ago on that front? And relative to expectations, how that played out and why?

Well, I think it was -- it would be probably easier to answer that question on why did it decline when the credit crisis hit back in sort of mid 2007 into 2008, 2009, why did it decline? And that was -- it was a 100% dealer-centric model. And at that time, when the credit crisis hit, there was still tremendous order flow in the marketplace, dealers backed away from market making .You [indiscernible] overcome down. And listen, the other thing today, I'd tell you is that these market conditions aren't necessarily right for velocity. And we -- we've seen a set of market conditions like we've seen in the last couple of months. We've seen that over time. Typically, they're shortened duration, but when they happen, when you have conditions where it's pretty benign, where there's very low credit spreads and almost no volatility, that's not great for turnover. And I do think if you see more volatility in the marketplace, an increase in credit spreads, we're at all-time low credit spreads in high yield. We were looking at, on the investment-grade side, credit spreads haven't moved in weeks, like literally. They haven't moved in weeks. And that's just not right for velocity. But we do think over time that, that's going to change. And these sort of short-term pockets like this, they've happened before. And we saw this in the middle of 2014, in the middle of 2017, towards the end of 2019, market recovers. And we're definitely in the camp of bringing on more volatility and spreads here.

Open Trading. That's one of the areas that you were alluding to earlier that distinguishes MarketAxess. That's your all-to-all trading protocol that you have, it's gained a lot of momentum there. How do you think about enhancing that protocol from here in increasing penetration as you look forward? What actions could you take to facilitate that? And then separately, as you think about buy side to buy side connectivity on the all-to-all that's pretty low today. How do you think about supporting an increase in that?

Yes. No, I'm going to go off here and talk about Open Trading and all the wonderful things there. And it's easy to talk about. It -- today, about 1/3 of our trading takes place where the 2 parties don't know each other. And the beauty of that is any participant can be a liquidity taker, a liquidity provider. So it could be a loan-only money manager, insurance company, pension fund, ETF market maker, credit hedge fund, it could be a dealer seeking liquidity and then any party can respond. So that's an all-to-all environment. And think about what we're doing at any given day, we've got $19 billion or $20 billion in order flow. Over 30,000 orders a day that are exposed into that community. That's all-to-all. So that's how we define all-to-all anyway. But those -- I talked about the cost savings earlier on. I think also, in Open Trading in one of those items that we've talked about historically, we've allowed other market participants or entrants to engage with the order flow. So 5 years ago, we weren't talking about the ETF market-making community because they didn't really have a way of participating in the marketplace. But today, they're a big part of the growth story and a big part of what happens in Open Trading. The other thing in Open Trading, and this -- we absolutely did not talk about this 5 years ago because we didn't have engagement with the dealers as liquidity takers. And today, we've got about $1 billion in volume per day that is dealer-initiated orders, only happens in Open Trading. It is all-to-all. Dealers are exposing those orders to our entire trading universe. And Mike, your question on sort of the buy side to buy side, that's not -- that does happen, but that's not what we're focused on like buy side to buy side, it's how do we get more order flow into the platform? How do we allow clients to engage and even the buy side act as price makers. What content and data do we have to -- and tools that we provide to them to help engage with that order flow? So I -- we don't segment it that way, buy side to buy side. Yes, it does happen, but it's how do we give clients the tools and data to help them respond to orders? I mean that's what we're trying to do. But there's -- sort of the tail end of your question on what can we do to increase penetration from here, and we are focused on anonymous request per quote. We're focused on live markets, which is part of all-to-all, Mid-X, which is our mid-market session-based trading. We launched that in euro bonds toward the end of 2020. We'll be launching that in U.S. credit in the second half of this year. We've seen good uptake on that session-based trading. It does -- it's all-to-all. It's not dealer-to-dealer. It is all-to-all. It helps address some of those resistance points that we were talking about are referencing early like information leakage. It's continuing to invest in these newer protocols. will continue to drive adoption in our Open Trading network.

Another initiative of viewers is automated and algorithmic trading. Can you just remind us how that works? And what sort of uptake are you seeing there from dealers, from market makers versus, say, your institutional clients?

Mike, it's funny because this is another one that I think back. And it's not 5 years ago, I think back 3 years ago, we were not having -- like that question wouldn't have come up on automated trading and algos on auto responding. It just -- it wasn't part of the everyday discussion. And then, you talk about today, and let's break it up into 2 pieces. So on the algo side, sort of automated pricing. Again, wasn't really in existence 3 years ago. Today, we've got around 20 dealers in alternative market makers who are ingesting our order flow and automatically responding to that order flow. And we put out stats on the first quarter earnings call, which we had close to 5 million algo responses. It was up more than 50% year-over-year. This thematically has been playing out over the last couple of years. But the real message on this automated pricing, it's resulted in a growth in the average number of responses for each inquiry. And think about what makes us successful. And it's orders come in, but there's a better chance of executing those orders if there's more price responses back, the depth of liquidity. We deliver a better cost of execution when there's competition for the order, and then that drives more -- sort of this virtuous circle drives more order flow onto the platform. So this is a big part of the story is around these algo price responders. But then you flip it over to -- this will be more of a -- more on the buy side on auto execution and auto responding. Again, something we were not talking about 3 years ago. And we're now using data that we're generating. Our Composite+ pricing engine, our liquidity scores. We're using that to help clients set parameters and automatically execute trades over the platform. And we've got around 100 clients that are using auto execution. We've got a couple of dozen clients who are auto responding against setting parameters. If an order of interest comes into the platform, they can auto respond. It's still early days on this one. I think we're going to be talking about this one for a while on how much of our orders are -- the percentage of our orders that come in that are automatically executed, still early days for us. It's around 15% of our -- by trade count, about 15% of our orders do get executed automatically. It's a lower percentage in terms of volume. But we think this is going to play out over a longer period of time. And this is why we're continuing to promote and invest in our automation capabilities. And this is a part of the story on growing market share, part of the story on helping to increase market velocity. This is all part of that theme.

Great. Why don't we shift gears and talk about the municipal bond market. I know that's part of the marketplace where you and the rest of the management team are certainly very excited about the opportunity set there. You recently closed on the MuniBrokers acquisition that you alluded to earlier. How do you see the MuniBrokers transaction enhancing your position in the marketplace? Maybe you could talk a little bit about how the integration is progressing? And how do you think about overcoming some of the hurdles for electronification within the Muni marketplace?

Yes. No, it's I know we we're completely immersed and engaged in municipal bonds now. And for very good reason, it's a big market. electronic adoption is at a nascent level. And when you look at the revenue opportunity, it's -- the revenue opportunity is as big as the U.S. high-grade or U.S. high-yield market. It's -- while market volumes are lower than those 2 markets, just -- it's market that tends to have a wider bid-ask spread as a result, the pricing or fee capture is higher. But to date, this is pre-MuniBrokers where our focus had been was in the client-to-dealer space. And listen, we're at 2% market share today, $20 million in revenue roughly. So we've had some success there and more recently, some solid organic growth. But the acquisition of MuniBrokers, that gets us into a new client segment, which is on the dealer-to-dealer side in the dealer-to-dealer space. Over MuniBrokers today, it's several hundred million in average daily trading volume over MuniBrokers today. So our mission and goal over time is how do we convert that to electronic trading and over the MarketAxess network. And we're 2 months into the acquisition, the integration is on target. The initial -- really, the initial focus with MuniBrokers is how do we get that order flow that's exposed within the MuniBrokers network? How do we expose that into our open trading network? And that's this -- the Open Trading part of it. Again, this is another conversation we're not having unless Open Trading is viable. If you look at the municipal bond market, it's one where there's over 1 million CUSIPs. The issue sizes tend to be smaller, average issue size is maybe $35 million. There's disparate liquidity. Our real -- the reason we launched trading in the client-to-dealer side was we had -- we viewed Open Trading as the solution where we can connect all market participants into one pool. And Open Trading was a real differentiator. We expect and intend on doing the same thing with the MuniBrokers and the dealer-to-dealer flow. It's how do we get flow exposed into both networks? So there's hurdles there. It's a fragmented market, but we do think that Open Trading and that Open Trading solutions are a big part of the answer to address that market. And it's, again, a big opportunity. We talk about legs to our stool. And how do we keep on adding legs to it? And municipal bonds is another one of those. We've got high -- U.S. high-grade, U.S. high-yield, emergent ports and sovereigns, euro bonds. munis. At some point, what we're doing in the treasury space, those will just be additional cylinders of growth for us, but munis is a big -- is a big part of that growth story going forward.

Well, we have just a few minutes left. Since you mentioned treasuries, maybe we could just briefly touch upon some of your initiatives there, how you're building that out? And then maybe towards the end, if you'd like to touch upon any sort of trends overall so far in June month-to-date that you'd like to flag for us, if any?

Well, I'll do the second 1 first.

Okay.

I'll do June first. I'm not -- not yet, not yet. You have to wait on the June activity. We're a couple of weeks away from our volume release. We'll probably put that release out the day that first day when we return from the fourth of July holiday. So I'm not going to ...

A preview there. All right. Well, I had to try.

On the trade side, I know we're just about out of time here. We're about 1.5 years into our acquisition of LiquidityEdge, and we feel good about what it helped us do at least from addressing feature gaps that we had in particular around net hedging. So we've -- we believe we've addressed that gap, and we've got that solution and integration up and running across our products, across protocols now as well. In the dealer-to-dealer side of trading and government bonds remains highly competitive. That wasn't the reason we bought LiquidityEdge. It's -- that market's already highly electronic, again, highly competitive, price sensitive, where we really thought we could make a difference in the U.S. treasury market and the rate space was connecting that liquidity pool to our client network. And we're -- our initial sort of phase there was offering up the streaming prices and click-to-trade solution to our institutional investor clients. We've got more than 150 clients who have -- were approved to trade in click-to-trade and who are actively trading, still early days there. We still have further investment in the client-to-dealer side and building out a request for quote protocol. But we're happy with the client engagement. This is something that I wish there was more immediate gratification, but it's an area that we're -- that we are and remain focused on. It's also given us a launching pad where more active in the European government bond space that's on the back of what we're doing on the back of the LiquidityEdge acquisition. So we remain optimistic about the long term and continuing to invest and engage with clients to create that next leg of our stool with a much bigger presence in the rate space.

Great. Well, I'm afraid we'll have to leave it there, Tony. Thank you so much for taking the time to spend with us today. I appreciate all your insights.

No, I appreciate it, Mike, and thanks again for having us at the conference.