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

All right. We will go ahead and get started. Thanks, everybody for joining us after lunch here. I suspect I have a few more people wander in as they're finishing up, but we'll go ahead and get started. I'm Patrick O'Shaughnessy, cover capital markets here at Raymond James. Up next, we have MarketAxess and on their behalf, we have CEO, Rick McVey. Format is just going to be a fireside chat. I'll try to pause and open up to [ Art's ] Q&A towards the end and we'll see what the ground we can cover. So with that, thank you, Rick.

Thank you, Patrick and it's great to be back in person. So thank you to you and your colleagues for all the work that you did to make this possible and hopefully this is the beginning of many events to come where we'll be able to gather together in person.

Absolutely. So I want to ask you about market share trends. Obviously, I think it gets a lot of focus of attention for your company. I think that the story for 2021 was, hey, we had muted market volatility, credit spreads are pretty tight and that sort of stalled that market share gains. And I think a lot of people were looking at February is, hey, credit environment is becoming a little bit more volatile, maybe a little more conducive. How would you evaluate how MarketAxess performed in February and in particular in US credit? And just in general, how the macro is either working in your favor or not?

Sure. Well, you've been following the story for a long time, so you know that following one month market share numbers is a tricky business because whether we like it or not, there's a variety of different market conditions in any given month and you get this ebb and flow based on what's going on with new issues and the nature of the order flow that just happens to be in the market. So, if you look at January and February combined, I'm actually really happy with the share and volume trends that we are seeing. The share is up for the same period last year across the board. And this is a kind of market environment that very much favors our business model where we are certain that we have a broader and more diverse liquidity pool than the competitors. And when volatility picks up and credit spread start to widen, it's where that liquidity pool really comes in to be most valuable back to our clients. You're right that if you look at January -- December, January, February, February was the outlier. And the only thing that was different there is, we've had a couple of months where portfolio trading activity in US credit was down substantially in December and January and there were a handful of large PTs in the market in February. We're not yet in the place that we want to be in terms of being #1 in portfolio trading and they are episodic when they come in, they're large trades. But in the aggregate, they've been averaging about 5% of secondary market volume. So important to keep that in context, but that was one of the factors that probably influenced the month. And I'm glad you made the point more broadly because we really look at our business as the collection of markets that we run. And the international share trends continue to be very positive and we had a very good year last year in the international share trends with emerging markets and Eurobonds performing exceptionally well. We think that's about half organic where the market -- the electronic market is getting larger and have taking share from competitors because of the benefits that clients are seeing in our international offering. And in the first 2 months of this year, our international volume has reached a new all-time high at 34% of total volume. So the investments that we've been making to diversify our business internationally are clearly paying off.

So what are your clients asking from MarketAxess right now? Obviously, you interact with them every day. There's a variety of different market models out there. What are they asking you in terms of improving their access to liquidity?

Well, yes, so great question. There are a couple of recurring themes, as you would guess, right? Investors in my mind really want a limited number of electronic systems where they're able to trade [ fee ] income products roughly around the world. So continuing to add product areas for MarketAxess has been a big request, which we've been doing very actively with the investments in munis and treasuries and new areas of emerging markets because it's an investment for clients to connect with systems like ours too. They have to go through the legal and technology due diligence and process upfront. But most importantly, there's a big lift in terms of the order management system connectivity. And as a result, they do that for a fairly limited number of venues and we're fortunately to be one of those. So once you get in that position, then they want to leverage those capabilities by showing that we are continuing to move into new products. Secondly, trading automation is a huge theme. It's another area where we can dramatically reduce costs for our investor clients, where if you think about the smaller order flow, the data quality is so good on our system, primarily through CP-Plus that their ability now to execute in a no-touch environment is really compelling to them because they're getting the number of responses that they need. They can prove with data that they're comfortable with best execution. And on those trades being able to flow them through -- straight through with no touch trading environment is a big deal. So automation is another investment area that has been a big one for us and that's why we refer to those metrics every quarter in our earnings calls. And then finally, I think the last piece is the menu of trading protocols. Clearly, open trading has been a hallmark of our success with the investments that we made in all-to-all trading. And that primarily has come through our core RFQ protocol historically, but now investors seeing the level of both market making automation and data in the market are very interested in matching sessions and even live order books. So you'll see now that we've got a menu of protocols that goes well beyond RFQ to operating live market order books in both credit and rates and also operating matching sessions. So I think it's just -- they want to grow with the venues that they view as partners and it comes across international growth, product diversification and new protocols.

On the topic of the newer trading protocols, so things like live markets and Mid-X, how would you characterize buy-side interest right now? And what are some of the sticking points to getting accelerated adoption?

Yes, so it's funny even dating back to when I started MarketAxess in 2000. There was a lot of buy side interest in a live order book. I don't think they appreciated the complexities of operating in a truly live environment for the market makers in credit because it's far less liquid than the equity markets or even the US treasury market. So the behavioral changes, most importantly on the market-making side. And there's been a tremendous transformation among the large banks in terms of how they think about market making and global credit over the last 3 or 4 years, where they've embraced algos, they've embraced electronic trading for a larger percentage of the business. They're using Open Trading both as liquidity provider and liquidity taker. They're doing creates and redeems into the ETF market all day long to produce or shrink bonds and inventory. So there's a totally different process going on right now with those market makers. And I just -- I think that this trend is here to stay in terms of the way the market is embracing automation in all parts of fixed income.

Well and would you say that you're in terms of market maker liquidity for live markets?

I could say we're still in the first or second inning. We've had announcements on about 5 big market makers that are already dedicated market makers in the live markets. There are 3 or 4 more that are testing and in the process of coming on board, which I think what you get to 8 or 9 were at critical mass. And we think where this works really well is on the liquid end of the corporate bond market. So if you can take the large -- the 4 -- the top 400 or 500 corporate bonds and create a continuous tight live market, it's another outlet for risk transfer that will help even in the off the runs. So I think we're in the first or second inning, but I'm optimistic based every quarter, it's getting a little bit bigger. And I'd say in terms of long-term upside, being able to build a true exchange-like environment for the liquid end of corporate bonds is a big deal. And we think we have a better chance to pull this off than anyone else because of the investments that we've already made in all-to-all trading.

And then you mentioned automated trading technology as well. And I believe that your average trade size in auto execution is a little bit less than $200,000 per trade. What is MarketAxess doing to encourage utilization of that functionality for larger trade sizes?

Yes. What I think it's going to happen organically, it's a fairly significant change in trade process for most asset managers to get comfortable with the quality of the responses and the quality of data to check those responses, to go to no touch in credit. So I think the fact that they've gotten comfortable in the odd lot trading is a great first step. And you will see, especially in the liquid end of the market where the number of responses now on average is up around 15 per order of competing responses that can then be checked against mid-market data. I think you'll see those trade sizes grow. This is the first step in gaining their confidence that, that process is working very well for their best X obligations. And I think it will mirror exactly, Patrick, what you've been observing and we've been implementing with dealer algos. If you look back 3 years ago, the dealer algos were in credit were mostly in the odd lots, you look now and at the liquid end, they're up to $5 million and under. So the amount of responses that we're getting from the algos is dramatically different today than where they were 3 years ago. I think you'll see the same story emerge with auto execution with investors in terms of the trade sizes going up and the breadth of securities that they're comfortable with no touch trading also increasing.

Got you. And in terms of trading protocols, you also mentioned portfolio trading and you guys really leaned into your development of a portfolio trading functionality during 2021. What was the thought process to roll that out? Why [indiscernible] you maybe rolled out earlier? What are the trade-offs involved in portfolio trading?

Yes. No, great question. This too is an important development in the market 3 years ago, probably close to 0% of secondary market share in portfolio trading and now 5% or so. But there's a very complicated prioritization effort that goes on deciding which products, which region and which protocols should come first. And the reason that you're seeing our expense budget grow is that we want to significantly increase the surface area of our network with products and protocols. So there are a lot of competing priorities and we are funding more of them simultaneously than ever before. And when you think back 2 years ago, that's at the same time we did our acquisition of LiquidityEdge, which launches what we think will be a transformational product area in US treasuries. We did the acquisition of MuniBrokers to expand what we're doing in municipal bonds. We did the acquisition of the Reg Reporting Hub in Europe to expand post-trade services and data content. And then we were building out live markets in Mid-X, so there was a full plate there of priorities and we will be the first to admit portfolio trading fell further down the list than it should have. And it grew a little bit more quickly. And one of the reasons I think it does very well in a lower vol environment and it did grow more quickly. So we did increase that investment over a year ago to launch a very competitive portfolio trading product in May of last year. We now have 70 large investors that are trading portfolios on MarketAxess and all 15 of the dealer market makers that are active have traded with us and prepared to do so at any time. And I honestly believe that the amount of time that credit traders spend on our platform is so dramatically different than others. And they've been trading basket trades through bid and offer list for 20 years, which is something that we innovated in the market a long time ago. So those 1,200 basket trades that we do sit right alongside portfolio trading. And we will ultimately convert some of the functionality on both to give clients an efficient choice of whether they want door #1 or door #2. So we think we're in a great place. It's our goal to be #1 in portfolio trading by the end of this year. In the short-term, that would be a nice addition to share here. Longer-term, we think that really working to continue to grow the all-to-all marketplace is the most important thing we can do for clients.

And I think tying those parts together, how do you create a differentiated portfolio trading solution? Are you able to integrate your open trading liquidity into that?

Well, we could and that will be up to the clients to decide. But we are one small step away from being able to do that now because we have bid and offer list which are these baskets of bonds, but the way that they are priced is that the best price on every line item wins that line item. So on a list, we might have 40 counterparties on the other side of that trade. So there's best x on every line item. By the way, there's certainty of execution because there are so many responses on every line item on the system now that it's highly likely that clients are going to be able to trade every line item. The pricing mechanism is fairly straightforward to change. If we -- if clients would like to see a portfolio trading equivalent from a bidder offer list or a bid and offer combined list, that's something that we could add where we're taking the collection of those best prices by line item and creating one basket or portfolio price for the whole basket that could be compared to portfolio trade pricing that's coming back from a few selected dealers again side-by-side. So it's quite possible that, that theory might converge. And I've said, as Patrick knows that my experience and experience on the platform has been that when volatility picks up, which, of course, it is doing right now, portfolio trades on average take about 90 minutes to price because there typically are so many line items in those trades and there are negotiations on which bonds should be in or out of the portfolio. And it's easy to do a 90-minute price discovery process when nothing is moving. It's really hard when everything is moving around and the prices are changing all the time. So what you saw 2 years ago from MarketAxess is the open trading liquidity differential won the day in volatility because you could manage through those price differences if you're waiting for 2 or 3 dealers for 90 minutes to price a portfolio and everything is moving around, it gets much more complicated. So I do think the PT percentage of the market will ebb and flow and you have clients asking a lot of questions about how does transaction cost analysis compare in an open trading bidder offer list versus a portfolio trade? And it's no surprise to us that if you look on average, the pricing is tighter on an open trading bidder offer list that a portfolio trade. There are key differences in terms of the number of line items and the size of some of the tickets that have to be taken into account. But in especially, again, in this kind of environment, you do hear questions from asset managers about Best X and does this really qualify?

So we talked about trading protocols, let's talk about product expansion. So as you think about having more points of interaction with your clients and then asking to do Eurobonds or EM, how do you think about rates versus credit?

Yes, so our primary focus has always been credit and the investment budget is still heavily weighted to credit, because when we look collectively around the world and include Eurobonds, global emerging markets, which includes China Bond Connect now, we don't even think we're 10% of the opportunity with where we are today. And that's where our competitive advantages have been built up over the last 20 years is having a unique technology and liquidity solution for global credit. So everyone should expect that that's going to be the primary focus for this company for the foreseeable future. But having said that, we're very intentional about what we're doing in rates and specifically in US treasuries. And that was all started with the acquisition of LiquidityEdge, which had a very interesting tech solution and a very strong liquidity pool in the D2D market. They were in early-stage D2D disruptor when we bought them 2 years ago. And clearly what we've been working on with the integration is to turn D2D into all-to-all. Well, as crazy as it sounds in the largest bond market in the world of US treasuries, which trades $650 billion in notional volume a day, half of which is in the on the runs. There is no all-to-all order book that's flourishing in that market today. Everybody trades treasury bond futures on an exchange, but the client base in particular is trading on the run in US treasuries and in RFQ protocol with a limit of 5 dealers per order. So we think that there's room for something very different than that, given the level of automation that's going on in both market making and with clients. And the order flexibility and the diversity of liquidity that's available in the true order book, so the last step of the technology work for the on the runs is going out in a couple of weeks. And you've already seen our volumes start to grow in US treasuries, 20 of the 24 primary dealers are active on our rates platform. We're starting to onboard more clients. The 2,000 client counterparties that we already have for Open Trading in credit are eligible with no further credit or documentation work to trade US treasuries. So we've got an installed client base, a new protocol in the most liquid market in the world, with very tight bid offer in an order book. And we think the upside optionality of this is really attractive to complement what we do well in credit. And I will say, Patrick, talking about the international success when we're working with clients in Europe and Asia, it's far more common that the traders are trading both rates and credit out of the same desk than it is in the US. The US asset management industry is more concentrated, as a result, traders tend to be specialized rates or credit. When you go to the international business, there's much more going on with people trading both rates and credit from the same trading book. So this will help us there too where we have a full offering across the rates business and the credit business.

Got you. And then I think building off of that point and you touched on it a little bit earlier, but how would you evaluate the competitive landscape in credit outside of the US, Eurobonds, emerging market? Because obviously, we've spent a lot of time focused on US credit wing, stare at the market share numbers, but there's a little bit less transparency into non-US credit.

Yes what and I will say what I always say, which is buyer-beware on reading venue volume reports because the practices of how venues report volumes are all over the map and some of them are a lot more aggressive than others on the practices that they have and what they put in press releases. So my disclaimer there on how to measure competitive volumes, but the -- our biggest competitor outside of the US for electronic activity in Eurobonds and EM for a long time has been Bloomberg. And there was an important change a year ago because one of the competitive advantages that Bloomberg has had is they have not separately charge for transaction fees in fixed income historically. It's been free of trading fees because they were earning their revenue from terminal fees. While they changed that policy a year ago and they implemented transaction fees. And if you look, our market share is accelerating since that change took place. Part of it's because of the unique open trading value that we add around the world. Bloomberg does not have an open trading offering. It's purely client to dealer, but part of it is because there's a new transaction fee that's been imposed where people are comparing platforms and they're now deciding that there's no real transaction cost differential and there's a different technology solution in a much broader liquidity pool here. So we -- what we've heard back from the dealers in EM specifically, given our historical roots here in the US. We have always been dominant in Latin American EM trading. The dealers tell us about 80% of their client order flow electronically in Latin America comes from MarketAxess. We were a distant #2 in CEMEA and APAC, the dealers told us based on their data at the end of last year that we're the #1 electronic trading venue now in all 3 regions in Latin America, CEMEA, APAC, that is fantastic for future growth because APAC is at very early stages of electronification. CEMEA is coming up the curve, but still early. So if that's now a true global leadership position, which the banks tell us it is, it makes me very optimistic that our competitive position has strengthened and we are in a great place. And by the way, it's -- I wish I had a history of all the challenges that shareholders had worried about over the last 5 years because there are always 4 or 5 that have press releases that look interesting, but a couple seem to be going backwards right now and haven't done as well as people would have expected. So one of the unique parts about our future growth story is there really are only a couple truly global fixed income venues with broad-based client connectivity, dealers and investors, a big investment in technology and a broad product offering. This is a massive global opportunity with very few leaders in it. So as much as we like to look at the tug-of-war that we might have with the other guys in New York, that is a small part of a story. The big story is massive opportunity, early stages with very few incumbents, with true leadership positions.

Maybe one more for me before I open up to audience Q&A. You guys recently announced a new CTO. How would you -- taking a step back, how would you evaluate your technology from usability everything that your clients are looking for? And what sort of changes would you expect from the new CTO?

Sure. So our philosophy on electronic trading is different than the competitors because we run one technology platform, one marketplace globally. So when we say all-to-all, we mean all-to-all. All of our orders across every product are on the same system and they're available as submitters or responders to every one of our dealers and clients full stop. That is all-to-all to us as all orders are in one market, one solution, one technology platform. We think that has advantages. That's not where our competitors are. They have dealer-to-dealer platforms, they have client to dealer platforms, they have retail platforms and their order flow doesn't connect naturally across those silos. That's not all-to-all. So our technology platform is broadly viewed by both large investors and dealers is unique for that capability to bring the order flow together in one place. And our retiring CIO, Nick Themelis did a great job getting us there across products successfully. So ease of use and the fact that it's one common framework, one marketplace gets very high responses. The reason that we think we found the best possible new CIO for the next decade and beyond in Nash Panchal is that, he was a Cambridge computer science major and has spent 24 years at Goldman Sachs, the first half of which was being a technology leader on the dealer side of Goldman fixed income, the last 10 or 12 years has been as the Co-Head of technology for GSAM. So he's been a technology leader knowing exactly what a leading dealer needs from their technology environment. And then a leading asset manager that's one of the most forward thinking about how to use technology and automation to lower transaction costs and their own cost in their client business. So we think we've got a great new CIO and I can tell you firsthand, he's really focused on future automation and more use of algos for dealers and clients to make it even easier for our clients to find the best price across all of our protocols and products. So we think this is the beginning of a new era for our technology.

Terrific. All right. Let's see if there's any questions in the room here? All right. Group folks post lunch, so I'll keep going then. So the SEC has proposed increased ATS requirements for fixed income trading platforms. What might be the implications for MarketAxess if at all?

Sure. Yes, so some of you may know, I was asked to serve on the FIMSAC committee that Chair Clayton set up when he was at the SEC and I chaired the technology and trading subcommittee and we actually proposed regulatory changes for fixed income, e-trading venues to standardize regulation and create a resilient regulatory environment. While our 2-page recommendation turns into a 607 page rule proposal for fixed income ATS. So there's a little bit more in it, Patrick, than we had expected. I will say, we've been a public company now, we're coming up on 18 years. So we've been regulated by the SEC. We've been a broker-dealer from the beginning in 2000, we're regulated as an MTF in Europe. We're approved for Bond Connect in China. So I don't think the lift for us is going to be that large. I'm actually -- you will see in our comment letter that the SEC should be careful that the rule set is not so cumbersome that it limits new competition because innovation has always been a great thing in our space and it will be tougher for new entrants. But it is a comprehensive set of rules and it will require that all of us have a higher regulatory responsibility to fulfill. It will add some cost in the grand scheme of things, we don't think the number is a large one for us, but it will come with some new costs. It's -- I think just not to digress too far, but they've drawn a very wide circle around their definition of a fixed income ATS. So even instant message communication that has some structure to it to transact with electronic means even if it's a bilateral trade with a [ VCON ] in their current definition qualifies in ATS. That to me seems like it's going too far. I don't think a bilateral message between BlackRock and JPMorgan should qualify necessarily as an ATS, but that's what they put out, there will be an important comment period ahead. But there will be new regulatory responsibilities in any event. We think we're prepared for them and we will not have a difficult time meeting that new standard.

Terrific. Well, I think that's a good spot to wrap up. Well, thank you, everybody for coming out this afternoon. Thank you very much, Rick.

Thank you.