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

Okay. Great. Well, thanks, everybody, for joining us. Good afternoon. Up next, it's my pleasure to welcome Rick McVey, Chairman and CEO of MarketAxess. MarketAxess, as many of you know, is a leading global credit trading platform, focused on bringing greater efficiencies to fixed income markets. Over the years, the firm established itself as the deepest pool of liquidity in the credit space with further expansion into new geographies and new asset classes. We look forward to getting an update from Rick on how MarketAxess is thinking about its growth prospects in '22. And of course, getting your perspectives on credit market structure broadly, which is always super valuable. So thank you so much for being here.

Thank you, Alex.

So why don't we start with the question on just the customer behavior post the pandemic? Clearly, it feels like it's been a -- it's a big monumental shift in a way in terms of the engagement of how clients access credit market. So if you were to kind of go back for the last 12 to 18 months, and summarize what are the biggest customer changes you've seen and how the sell side are responding to those changes with respect to client behavior?

Sure, happy to it. It's been an interesting 12 to 18 months because if you think about these 2 years, we -- for at least for our business model, we had absolutely the best market conditions of a decade last year with higher spreads and higher volatility and a banner year for growth at MarketAxess. We have had exactly the opposite this year with the lowest volatility in credit spreads and very low credit spreads, the lowest in the last decade. So you've had 2 dramatically different market environments. And of course, we had a blow-out year and then kind of a flattish year this year. If we had 2 20% years, people would probably feel a little bit better than 1 up and 1 kind of flat. But the market conditions have had an awful lot to do with that. But I -- some of the things that we see, one, automation is taking hold really quickly. And it just tells you how far data has come that more and more large asset managers are comfortable with a no-touch credit trading operation for more liquid bonds generally in smaller size, but there are so many tickets that fit that description in the industry that it's a big gain for efficiency to see so many investors going to what we call Auto-X on MarketAxess using our data, our CP+, to determine that they are getting a fair price for best execution on the responses of the system, and in which case it Auto-Xs and STPs from there. So we've seen about a 40% increase in Auto-X, it's getting close to 20% of our tickets, now a bigger group of clients involved. And of course, this is mirroring what all the dealers have been doing, which is using algos more for making markets, which allows them to be more responsive to their clients across more bonds. So both the market-making model and the investor trading model has moved forward very quickly to embrace more automation. And I think that's going to just continue to grow. The other change that you've written about, Alex, and it's clear that portfolio trading has struck a chord with asset managers and dealers as well. We were tracking at about 3% of total secondary corporate bond volumes a year ago. It's been running more recently around 5% or 5.5%. So these basket trades with 1 single price off of a benchmark for the entire basket have grown in popularity. We are working on a lot of things in our all-to-all protocols. We're admittedly a little bit late to the game in portfolio trading, but we're really encouraged by what we've seen in terms of take-up for MarketAxess PT over the last 6 months, and we put some of those numbers out in our November volume release earlier this week. But we have a very competitive PT offering now. We've already had 14 dealers complete portfolio trades on MarketAxess and about 70 investor firms. So we're very squarely in that game, and our goal is always is to be the #1 player in delivering electronic PT as we think about '22, and we think we're on a steep trajectory and have a real shot at that. And one of the reasons that we were focused on it is many of you will know that a big part of our business is trades that are done through bid and offer lists. And we've been doing those bid and offer list since 2001. It's a different version of portfolio trading because bid and offer list go out to the entire marketplace and you -- the client gets the benefit of the best price on each line item and select the bonds that they are willing to trade based on the prices that come back, portfolio trading, they're getting a full basket price from each dealer they go to. So it's a little different protocol, but where we think we have an advantage is bid and offer list sit right next to portfolio trading on MarketAxess. And we are sure that we have the majority of bid and offer list from institutional investor clients today and to have PT right next to it with a format that looks familiar to those clients, we think, is an advantage there. So those are 2 of the changes. The third change, we're less involved in this space, but it's actually good for the sector in general. There's been a big shift in the dealer-to-dealer business away from traditional voice brokers to various forms of electronic D2D trading. And Tradeweb dealer sweeps, as you know, Alex, has been probably their biggest success this year in a D2D format. We are seeing more dealers using Open Trading for their own liquidity. This is all about the theme of the dealers using all available electronic means to create more balance sheet turnover and velocity. They want to be in the middle of more trades, use less balance sheet, and you just see that every year that the tools that they are now using to move bonds around through portfolios, electronic trading, electronic D2D, ETF creates and redeems, they've transformed their market-making model and they've needed to because, of course, of the bank capital rules. So you see a brand-new bank trading model that continues to grow. I would point to those as some of the key themes.

Great. Lots to unpack there. So automation, data, portfolio, trading, D2Ds. So we'll get into all of them in a little bit. But first, I want to maybe start with market share dynamics. That's the #1 question we get from investors in the space. I'm sure you've done some meetings earlier today. That's probably the #1 question you guys have been getting for the last couple of months now as well. So if you look at the pace of market share dynamics in market as, to your point, they slowed down this year were really, really strong last year. Can you help us dissect what's the macro versus anything else you're seeing on the competitive side? And what are you guys doing to reaccelerate market share gains into next year? Again, macro hopefully will be very helpful from that perspective.

Sure. Sure. Happy to take that one. And again, I think if you take out longer picture, longer-term picture of the share gains at MarketAxess, which have been quite consistent. If you look at 2019 full year versus 2021 full year, you would see all 4 of our core products have very healthy share gains over those 2 years. But unfortunately, we had this banner year because Open Trading was delivering all the liquidity that the market needed through the crisis last year. And then we've seen some slippage because there's no vol institutional investor activity. It's down about 9% in TRACE this year. So our core client base is more quiet than they would be. And I will say too, we talked a lot last year about the importance of alternative market makers for a crisis environment like we had in the pandemic. So through all-to-all trading, we brought in all of these alternative market makers, many of them run relative value ETF arb books. Well, they had their best year ever last year. There's no arb this year, nothing is moving. So we have a whole client segment that was really important to our growth last year that is sidelined right now because of market conditions. The other thing is there's no question that being late to PT hurt us because even that 5% of the secondary volume that's done in PT, the electronification is so important to that because you have so many line items to get the pricing and the STP done. We think that the electronic share of PT is already about 65% of that 5%. So it was really important that we got this great release out in the spring. We're getting great feedback now. We're in the game. We just had another record week last week in PT. So that, we think, will address the 1 gap that we know that we had it competitively. But a lot of this is environmental, right, is that volatility at normal to high levels, benefits our all-to-all model because we can deliver more price improvement when volatility is high. And we had all-time high price improvement for our clients last year of about $1.1 billion. It's much less than that when nothing is moving because price dispersion in the market is very low. So we are in a different environment. What I'm more excited about today than anything is it looks like the Fed is very serious about accelerating the tapering. And if we can get the central banks out of the fixed income markets, we'll have more normal levels of yield and more normal levels of volatility that's a great thing for our trading model. And to that point, we put out better market share numbers in November. Within that story, the volatility really only started to pick up in mid-November. So we looked at the 3 weeks from November of 15 or 16 through yesterday, and the high-grade share was running around 22%, and high yield was running around 16%, and we had a record PT week last week. So it was -- it's really funny how quickly things can turn long may it last. But we got to the end of the week on Friday, and we said, "holy cow, we just had an all-time record credit volume week on market access last week." So when volatility kicks in, our share, our volumes kick back in, $83 billion in credit volume, $16.5 billion per day last week, all-time record. So I think it does point to the fact that the market environment has a lot to do with the softness that we've seen this year. And what we see is that the market conditions are improving, spreads have been moving out, volatility has been moving up, and we've been benefiting from that.

Great. Makes sense. Why don't we spend some time on some of the new initiatives? So you talked about obviously, Auto-X, there's Mid-X, there's live markets, there's a slew of things that you guys have in the pipeline. I was hoping you can kind of help us unpack to what extent these expand your addressable market? So is this something that we'll be able to bring in either new customers or address a different part of the market as opposed to maybe folks that are doing RFQ and market access today, just kind of switching to a different protocol. So kind of how does that expand the TAM?

Well, so yes, on the protocols, I think it does 2 things, Alex. So I think it expands the addressable market in terms of attracting new types of clients. And I think the reason that your colleagues in fixed income were the first dealer to back live markets is because they believe it's another important protocol to increase trading velocity and credit. It's an all-to-all order book, and we have, obviously, the installed network of clients and dealers already involved it's a huge behavioral shift, right, because the market has traded primarily through RFQ. And being live is very different than RFQ. But Goldman was the first dealer to be a designated market maker in our live markets. We now have 4 or 5. We just announced Flow Traders yesterday or today is another new designated market maker. This is the ability to trade anonymously in more liquid bonds in an all-to-all environment. So the hedge funds are obviously attracted to that. We think it has a perfect place in newly issued bonds in larger trade sizes that haven't moved electronic in RFQ. And we're seeing more systematic credit funds turn up in the industry, too. So there's a lot of appeal. We're in the first inning of this, but it's one of those things that, from my vantage point, you're kind of -- you see these green shoots every month with it ticking up, more people are trying it, more market makers are coming in. And I just have to believe that when we look to the future of credit trading, we're going to see RFQ and order books living side by side. So we like the velocity story. We like the market expansion and attracting new client story with that as well. It's also what we're doing in treasuries because we bought the D2D order book in U.S. treasuries in order to turn that into an all-to-all order book. And we just created the enhancements for the client side to make that liquidity pool attractive to them. So you look at market access, now we've got RFQ across a wide spectrum of credit products around the world, EM doing very well within that set, 2,000 clients, about 300 dealers. We've got order books in high grade and high yield. We've got the order book in treasuries, and we also have Mid-X session. So there's a complete menu of protocols, and we just think we're moving the market structure forward in a way that's going to create new tools for dealers and investors to transfer risk.

Got it. Makes sense. Let's spend a couple of minutes on Open Trading. That was probably one of the more unique attributes of the model for you guys for a couple of years now. We saw how well it done last year and still remains the deepest pole of liquidity out there in a true kind of all-to-all fashion. So talk just a little bit about how you frame the addressable market for all to all from here. Again, other asset classes we saw what sort of done in investment grade and high yield you share those stats with us. But when I think about EM, when I think about treasuries, frankly, as well, kind of what is the next iteration of portfolio of Open Trading look like?

Well, I think it has a long way to go. We're still seeing new alternative market-making models coming into existence. And quite frankly, in my investor meetings, the untapped opportunity, and I think automation is going to help with us a lot is that long-only investors are still not taking advantage of being able to be the liquidity provider anywhere near as much as they could to create natural matches and trade at Mid. That's the holy grail in terms of where transaction cost savings will go up another notch. The first chapter has really been about all this new liquidity coming in through alternative market makers. So automation is going to help with that because not only do we have Auto-X that's data-driven, we can now do auto responding, that's data-driven, too. So I think that will be an interesting piece of the Open Trading story. Super excited to see how the order book in U.S. Treasury works. I think most of you know that the U.S. Treasury market today, the client market is split pretty evenly between Bloomberg and Tradeweb. Both of them are running RFQ to 5 dealer limit protocols. It seems like the world's kind of moved on from there. But that's the way U.S. Treasuries trade electronically today. Is there a room in the most liquid bond market in the world for an all-to-all order book? We think there is. So we're attacking that market in a different way. We think it will be a success. The EM business would -- we think Open Trading more broadly would be another catalyst for growth. And we've had another terrific year in terms of volume and share gains around the world and EM massive opportunity for us, been able to add 3 or 4 new markets this year, again, including China. The biggest problem in the local markets, which are rates markets, they're the local government bond markets is oftentimes, they're not settling at DTC or Euroclear. So for us to be able to get in the middle of those trades in an efficient way for settlement, we'd love to see the clearing model evolves so that it's easier for us to intermediate all-to-all trades. But we're seeing more local participation in our EM business. We will be able to gradually expand Open Trading there, and that would be another place I'd point to for long-term growth.

So speaking again of Open Trading and you mentioned rates, I kind of want to dig into that a little bit with LiquidityEdge. The market share today is still kind of hovers around 2%. It's been a little bit better recently. You mentioned onboarding LiquidityEdge on the portfolio trading kind of rolling those capabilities out. Where are you in that process? When do you think we can start to actually kind of further acceleration in market share gains as kind of the adoption of this protocol takes place within Rates business?

Yes. So there's a very solid liquidity pool there today. It's quite competitive, whether it's hedging or outright trades, we're getting great feedback on the tight bid offer that's available on our rates platform. We're in early days of bringing more clients on board. We had some enhancements that we needed to make, to make it user-friendly for hedge funds and long-only investors. Those are in place now. We've got a little bit more work to do around the connections, the proper connections to the order management systems. But I think this is going to be a really interesting new asset in the treasury space. We do think we've closed the gap around treasury hedging and treasury spotting. So the corporate system is linked in to MarketAxess rates now, and we think that we have closed that gap.

Got it. Let's spend a couple of minutes on some of the other initiatives. Muni markets, in particular, is kind of on your sort of to-do-list when you think about the opportunity set for MarketAxess. Clearly, it's still a fairly arcane market, right? Like pretty ripe for some sort of a disruption and it's been taking longer. So maybe spend a couple of minutes on your vision for muni markets, what solutions you guys are coming to market with? And what's the time frame where we could actually see them moving the needle for MarketAxess as a whole?

Yes. Well, it's all about the pace of market share gains there because we're operating at a relatively low level of share now, but the benefit of electronic trading and all-to-all trading specifically is so high that the fee capture is attractive. So we're probably 2.5%, 3%. If we can get that to 10% or even 20%, that makes it a real difference to revenue and earnings as another important market on the system. It's an arduous journey, right? These are muni traders that are used to blasting Bloomberg e-mails generally to the free world, hoping that somebody might respond to their muni order, and we think we have a much more efficient all-to-all marketplace that's fully electronic. And we clearly, every quarter, we're making headway there. We would love it to be faster. And I think at some point, we will hit an inflection point, but we have more clients and dealers active on the platform, and we're encouraged that the institutional market is starting to move in that direction. And we're hopeful there, again, that munis will be a nice add to our growth numbers in '22 and beyond.

Great. Another area you spent time talking about is China. You're making a push there on China's onshore bond market with the recent launch, and again, it sounds like client onboarding has been ongoing. So clearly, it's a very large market, but what are your kind of aspirations in that market? And when do you expect them to sort of materialize as well?

Yes. I think like most firms, we view China as part of the long game. There's a very small part of the Chinese government bond market that's owned by international holders. My own view is the international investment community is probably taking a little step back in the short term with some of the decisions that were made in the Chinese public equity markets and some of the challenges in the Chinese real estate market on the debt side. So we're happy to be involved. We think it fits very neatly with the global EM franchise that we have developed. We think that installed base gives us a natural advantage. We're onboarding clients now. I do think it's a multiyear process before China stand-alone will become something that's really material to our revenues and earnings.

Got you. You mentioned EM and that's been a big success story for MarketAxess, not just this year for a couple of years now with everything happening in the U.S. market, I think that might get lost a little bit, but you guys seen really nice share gains in the end market really over the course of this year that sort of continued. What separates you from competition? How is the competitive landscape different in EM versus some of the other offerings that are out there for you?

So I think we've been at this for about 20 years. So there's a benefit because every year, of course, we're enhancing the technology for these 30 local markets that we run. We're getting more dealers on board and the local markets, it's a great combination of the global banks plus in most of those markets, a handful of local market makers that are really important to clients. So we've been building that whole network over a 20-year period. And I think we've got an enormous head start there. In hard currency, we can run open trading as well, so we can attract all-to-all liquidity in our hard currency and in some local markets. I think there's more of that to come. But we also just have more boots in the ground. We put a bunch of salespeople in Miami that are covering Latin America. We've built up our teams in APAC in Hong Kong and Singapore. So the key for us really is not just to get the global investors more active but get local market investors that own the majority of the debt up and running more actively on our platform. But you're right, really attractive market share gains again in EM this year. And in international, in general, our Eurobond gains have been really good as well. And we suspect that we're winning share against the primary international competitor, which historically has been Bloomberg.

Got you. That's helpful. Let's pivot a little bit and I want to spend a couple of minutes on data. In your very first answer to the first question, you talked about clients that are automating more and using our Axe, are focusing on CP+, and that's a real differentiator because you guys see an actual price in the trades that are happening in your platform real-time, it's not derived prices, actually real prices. Talk to us a little bit how much you're thinking you could monetize that outside of the trading ecosystem as we've seen with other market structures as they develop, cost of data goes up because people start to say, look, trading will get cheaper, but the cost of data in Axe will go up? Is that kind of how you see the evolution of the credit space as well? And what role does CP+...

Yes. And listen, as our share gains continue to grow, and we have all-time high price responses per order now because of the level of automation plus open trading. We had something like 42,000 orders on month end last week and Open Trading alone delivered an extra 2.5 price responses to each order on average on top of all the dealer liquidity. So that gives us a lot of price points that we're able to aggregate into fantastic real-time data products. And we certainly see the validation with the dealers subscribing actively through APIs to CP+, more and more investors being highly confident in using it for Auto-X, looking at it for Auto-Responders. So we have used the data to really increase trading velocity and activity on MarketAxess. But Longer term, we mentioned this in our Investor Day, when we look at the total addressable market, we're looking out over the next 10 years, we see about $13 billion in revenue opportunity in fixed income electronic trading. We see another $13 billion out there in fixed income data. And I think as we collect more and more real-time data points and continue to develop those products, there's a much bigger way for us to participate in index creation, data delivery indices, end-of-day valuations, ETF developments. So I think there's a lot of ways for us to participate over time that will make data a more important revenue engine for the company.

Got you. Let's pivot a little bit and spend a couple of minutes on P&L. So lots of growth opportunities. You guys have to obviously invest behind these opportunities. Inflation has been a common theme over the course of the day today. I'm sure we'll be tomorrow as well as we speak to more companies. How are you thinking about balancing your growth initiative against kind of investing in the business? And what does it mean for the operating margins for the business over the next couple of years?

Well, so I think we're at an unusual and fantastic position on the P&L because we've had certainly some of the best growth rates in our sector for a long period of time. We went public at the end of '04. And if you look at a long period of history, our growth rates have been at the top of the pack. So to have that growth and to secure the position of future growth that we now have and still have 48%, 49% margins is a pretty good combination. And so people ask me, "are you going to slow down the investment?" There's no way we're slowing down the investment. All we could see is demand for more electronic trading, demand for more automation growing in every sector of global fixed income. We would be crazy to slow down the investment spend just because we've had on quiet year in credit markets. So we've taken a hit, right? That's fine. But the next time the markets turn around and we get the market conditions showing up in our core and all these new initiatives kicking in at the same time, we'll have some really good years. So this is a -- when I think about the next 10 years, we want to keep investing in both protocols and new markets and trading automation and data because we see an enormous opportunity. It's not easy for anybody new to step in and hope to compete in that space because the incumbents have so much connectivity and so much integration with our clients that just is a long, long haul to put together. So we're going to keep investing. We'll certainly have our guidance out in January as we always do, but it's going to include another year of investing in what we see as a massive long-term opportunity.

Great. Sticking with some of the kind of strategic points here. Let's talk a little bit about M&A. You've guys been a little bit more acquisitive in the past than we've seen before. And some of that is the way, obviously, you view the evolution of fixed income markets broadly, whether it's things you guys did to muni market, et cetera. So as you look out at the landscape today, anything inorganically, you think might be interesting for you to participate in? Should we be thinking about more kind of tuck-in adjacencies? Or is there something a little more transformative that you'd be interested in doing?

So yes, so our slightly higher M&A activity might be kind of simultaneous with bringing Chris Concannon in the MarketAxess 3 years ago, and Chris has done a share of that successfully over his career. But we've done 3 that we really like, right, because we've been able to almost double our Reg Reporting business in Europe between -- by acquiring the clients of Reg Reporting Hub at Deutsche Börse that onboarding is probably 75% complete and should be mostly done by January. The treasury platform was D2D. We saw the vision to make that an all-to-all order book. That's -- we're in early stages of executing on that vision. So there's a lot of work going there. Muni brokers just this week, the first D2D orders and bid list from muni brokers we're showing up in the market access all-to-all platform to accelerate our muni business. So there was a common theme in all of these, which are bolt-on and product capabilities that we'll be able to take advantage of the all-to-all client network that we have built. So we're busy, and we think we've got a great agenda of things that we're working on right now. We don't really see that much to buy out there right now. When we think about our core space of fixed income electronic trading and data, we don't see other interesting assets at the moment. We will certainly continue to look at bolt-ons and it could be anything from data to analytics to clearing to trading platforms. But I think you'll see more of the same. The focus on the company is investing in organic growth. We're in early stages of executing on the acquisitions we've already done, and we've got a big agenda in front of us already.

Great. Well, I have a couple of more questions on the market structure related, but we've got 5 minutes still left. So if anybody has got a question in the room, we'll have a mic come around to you. So one right there, please.

Is there any way to quantify a certain minimum amount of share gains that you should inherently get each and every year that will automatically guarantee certain percentage points of growth? Or is it really that dependent on spreads and volatility and so you'll get bigger share gains, obviously, in those volatile markets. But there isn't a way to say inherently, you've always got 200 or 300 or 400 basis points of growth just based on the fact that your spreads are always going to provide more efficiency to dealers and to customers on either side. I'm not sure I understand it as well as I should. Any clarification you can give?

No, it's a good question. I really think that there are 3 things to think about, which is the way that we think about long-term growth for the business. One, what we consider the core business to be is U.S. high-grade, U.S. high-yield, global EM and euro bonds. If you look historically, we've gained somewhere around 1.5% to 1.8% across those markets year in and year out. You'll get some years like last year that are way above trend line, some years like this year that are below trend line. But that core market share gain is part of the growth. Number two, we think we're in the early stages with all of this increase in all-to-all trading automation, new market participants coming in, where trading velocity is likely to grow over the next decade in global credit. So whether you look at the market-making models that are emerging or the systematic credit funds, a great example of new participants in our market. So we think about some level of velocity gains that will accrue to the benefit of our growth rates over the next decade. And then, of course, we've got 6, 7, 8 other growth areas outside of our core that we expect to be a much bigger part of our revenue and earnings growth over the next 5 to 10 years. So the other pocket of investment is getting munis right, getting global EM to a higher level, getting treasuries right, getting the private client bank business right. So there's lots of investment going into that third level of growth, which is really to expand our offering in terms of more products and protocols. And it's funny because there's a 2-year trail of market share. If you look at '19 full year versus '21 full year, close your eyes, you would see the average growth coming through in the core market share. It's just this anomaly from last year. We always check with the banks, right? We always ask the banks. When you look at the institutional client business where we focus, what is the electronic share that you see from MarketAxess in your institutional customer order flow and your electronic -- your fully electronic volume for U.S. high-grade and U.S. high yield, the answer still consistently comes back 75% to 85% of that flow is coming from market access. So we think we have an incredibly strong market position in our core markets here in the U.S.

Great. One more, please.

Sorry. How do you think about potentially using pricing as a lever for growth? And was there any temptation this year to maybe be a little bit more competitive on that front to kind of recapture some share?

Well, we talk a lot, and I think it's a really hard thing to execute. But you could also ask the question, did you think about increasing pricing last year when our price -- our cost savings back to clients was way through our company revenues. So bid offer blows out, price dispersion grows, Open Trading price improvement is delivering massive savings. So you could have a variable pricing model that says the more we save you, the more you'll pay us in transaction fees where our transaction fees would have been higher last year and lower this year. It's just really hard to execute that model is if you're moving pricing back and forth with important and very large clients, every month, every day, every week, however you would do it, it's hard to do. We think we're in a great place. Our pricing model has scaled really well. High grade and high yield have a dealer fixed distribution fee and a markup model to gain our transaction fee through the price that's included in the trade to the client. So that model has worked really well for us. But no, we feel good about where our pricing is relative to the value we deliver back to clients and transaction cost savings, and importantly, in trading efficiency to drive everybody's cost of trading and post-trade down.

Great. Well, this is perfect. I think we're actually right on time. So we'll leave it there, Rick. Thank you so much for coming in. Always a pleasure to have you here.

Thanks, Alex.

Great. Thanks.