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

Great. All right. We're going to get rolling with our next session. Thanks, everybody, for joining us. It's my pleasure to welcome back Rick McVey, Chairman and CEO of MarketAxess. MarketAxess, as many of you know, is a leading global network that's dominating the credit space and has been for quite some time and increasingly expanding into the rate space as well. Over the years, the firm has established itself as the deepest pool of liquidity in the credit markets with further expansion into new protocols, geographies and asset classes. So with lots of volatility and certainly continued evolution in fixed income trading. It's always a pleasure to talk to Rick about what he's been up to and what MarketAxess got in store for the future. So thanks for being here.

Thanks, Alex. It's great to be here and great to see all of our Goldman friends as well.

Awesome. All right. So why don't we start with the -- a little bit of a bigger question on just the state of fixed income electronic trading. We've seen really a wide range of market conditions over the last several years. What were the key sort of changes in client and dealer behavior that are shaping fixed income electronic trading today? And ultimately and most importantly, how do you expect that to evolve looking into 2023?

Sure. If you think about the last couple of years, I think the key theme from my perspective has just been the rapid adoption of trading automation by both dealers and asset managers. Dealers have had a tough job, right? Debt markets have grown a lot, and there are very real capital constraints on their balance sheet. But they've done a terrific job of transforming their market-making models to embrace greater levels of electronic trading. You see active ETF share trading and creates and redeems as part of the market-making model, serving clients actively across a variety of different trading protocols and doing that all generally with lower levels of balance sheet, especially relative to the amount of debt that's out there. But the algos have been a big piece of it, certainly in credit, where the algo amount of business was not that high 4 or 5 years ago. And the major dealers in particular have had great success developing their algos. And something close to 2/3 of our trades now are won by an algo-driven price from one of the dealer market makers. So tremendous use of technology and sophisticated tools to really serve their clients well. And it's a similar perspective from asset managers, where auto execution has just become such a -- much larger part of the credit market. And it makes perfect sense. And my guess is that, that will only accelerate going into the New Year with the challenges in the asset management industry, given the asset values this year relative to last. And it's data-driven. It's technology-driven. But again, another area where you see 35% or 40% compound growth rates, in clients embracing auto execution as a way to do no touch trading and just drive more cost out of the trading process for themselves and their clients.

One of the bigger areas that you guys continue to have lots of success is Open Trading, and that really dovetails, I think, on both things you just sort of talked about, execution, search for automation, obviously, search for liquidity in difficult markets. As you think about the success you had in both high grade and high yield on the Open Trading side of things, can you talk about the opportunities to broaden that further out and think about Open Trading and all-to-all protocols to other asset classes?

Sure. This has been an investment area for MarketAxess for about a dozen years now and we've really embraced the importance of all-to-all trading across all of our product areas and all of our protocols. And really, it was just observing the market need when bank capital reform took place a dozen years ago or so and watching both public and private credit markets grow dramatically against a backdrop where there were new capital requirements on the banks. And we were certainly guided by client feedback that alternative forms of liquidity would be a big part of the solution. So this is something that we've been working at and building out our capabilities on all-to-all trading. And from my perspective, that's the biggest differentiator of what we do relative to our key competitors, who were very good at lots of things as well. But I think it comes through in a year like this. It clearly came through in 2020 with all the volatility we had in the market, the need for alternative sources of liquidity, very rapid market share for the MarketAxess system. And it came through almost as clearly in some product areas this year, tremendous increase in market share in challenging areas like high yield and EM. And again, it's just as soon as volatility picks up, there have been some challenges in the leveraged loan books with the banks, and clients just feel that change at moments when volatility is higher. And I think the diversity of our liquidity pool has made a big difference in the quality of execution. And we put out November volumes the other day, but the estimated price improvement that we've been able to deliver through all-to-all protocols this year is close to $900 million back to our clients. So it's not only important from a price improvement standpoint. It's increasing market participation. You see a lot of new market-making models in fixed income today because of the availability of all-to-all order flow. But it's a key element of ensuring market resiliency. And this is a hot topic not only with market participants, but also with regulators, is making sure that we're welcoming new forms of liquidity to make sure that markets operate efficiently and smoothly through all kinds of environments and that they can be resilient at key times. And this year has certainly been one of the more challenging years in terms of market liquidity during different parts of the year.

Right, right. Let's spend a couple of minutes on some of the individual product categories. And one of the segments of the business that really stood out this year is high yield. I know you mentioned that very briefly with your response with respect to Open Trading. But really fantastic market share gains this year. You've seen real acceleration. Can we just unpack that a little bit and talk through the sources of these gains and how sustainable, both the existing level of market share you see in high yield and where you see that going? Because at this point, it's basically the same as high grade, which I think even a couple of years ago people thought that probably would take much longer to get there.

Yes. It's been a pleasant surprise even to us to see the adoption and the share gains in high yield, and quite frankly, EM this year. But it's coming from a variety of sources. Clearly, we're attracting even higher levels of asset manager order flow in high yield. I think you see that with our numbers and some of the competitors as well in terms of the trends. So we're gaining share with key asset managers. That's the key to long-term market share growth. We've also done a better job in both high grade and high yield with portfolio trading this year. It was not a big part of what we were doing a year ago. We've been winning share there. And then another part of the high-yield market that has evolved because of all-to-all trading is the ETF community and ETF arbitrage strategies, where you see active market-making models that are interacting between ETF shares and the underlying bonds. And those opportunities grow when volatility is up. And this has certainly been a great year for those strategies as well. So a variety of different levers that are coming into play. But we are well above where we expected to be, which is one of the handful of reasons we're super excited looking into '23, is knowing that our exit rate in some of these key markets like high yield and EM is so much higher than it was when we started '22.

Yes, yes. And on the EM side, would you say the drivers are similar? So is it also expansion with larger asset management clients kind of being the key driver? Because I could see the high yield being a really -- or the ETFs rather being a big part of the high-yield story. Is that as big of a part of the emerging market...

It's not as big in EM, but I just think it's a sign that we've done a better job with our -- through our sales force with the EM community in general and internationally, in particular. One of the parts that I really like about the trends in EM is that our local market business is driving a significant part of the growth. And we really built out the foundation for our EM business in hard currency debt denominated in dollars, euros or yen, global market makers, global investors. The bigger part of the market are the local markets, and we've got 30 local markets available for trading on MarketAxess. We're seeing better trends within local market makers, local investors. And probably 75% of the global EM opportunity is actually in local market. So getting that right and seeing these trends that have been driving our share higher this year has been really encouraging. I also think competitively -- we certainly hear from all the banks that we are doing very well, gaining share in international products, largely EM, but also Eurobonds. And that's coming through as well.

Yes, yes. Let's talk for a couple of minutes about some of the new initiatives. So we talked obviously about the high yield business, the emerging market business as both been pretty big drivers. But when you take a step back, there's a number of new initiatives you guys have in play as well, whether it's munis or whether it's rates, there are a number of things. So maybe just to level set, what are you most focused on into 2023 among some of these newer verticals?

Sure. Well, you certainly mentioned a couple. But the muni market, it was interesting to us and the client demand was coming in partly because this is the most fragmented bond market in the world, close to 2 million unique CUSIPs in the U.S. municipal bond market. So lots of small deals, very, very challenging secondary liquidity conditions and clients felt that it was ideally suited for all-to-all trading. So that demand was coming to us. And the muni solutions electronically in the market were mostly focused on the retail market space, not the institutional space. So we really went after building out a full front-to-back institutional solution. It's been a breakout year for us. If you look the last 3 years at the volume and market share gains that we've seen, I believe this is going to become one of our major credit areas in the next 2 or 3 years. And we're onboarding more and more clients every quarter. We have almost all of the major market makers actively involved, and then we have the additive liquidity from all-to-all trading in munis at work as well. So super excited there. I think one of the key surprises this year is how much attention there is on the need to think differently about U.S. treasury market structure. And Tom and I and others were at a Fed conference just a couple of weeks ago, but there's a clear sign that the regulators are interested in seeing the market evolve. The Fed treasury, SEC, all talking about the importance of market structure enhancements, market structure reform, because you've got a $24 trillion market now that at critical times had air pockets in liquidity and it's not where anybody wants the U.S. treasury market to be. So there were 2 key themes coming out of the Fed conference. One is a serious effort to think about central clearing and how do we get the foundation of the market to a point where trade settlement and margining and those kind of things are in a place where the market can evolve and grow. The other was all-to-all trading. And so this is another one where we made a bet through an acquisition about 3 years ago of -- what was it? -- D2D order book called LiquidityEdge. But from day 1, the goal has been to make that an all-to-all marketplace. And we're really encouraged by what we see there. It's primarily on-the-run liquid treasury trading, but we're around a 4% market share, but it's all all-to-all. And the business that we bought was D2D, but because of the network of institutional clients that we have, we've now been able to connect that to all the order management systems and make that liquidity pool available to asset managers and hedge funds and other buy-side clients. So we're happy with the foundation we have, but we expect this to be a growing theme across the treasury market and something that we are very focused on. We've also built out the RFQ capabilities because the feedback we continue to get is that less liquid treasuries, namely the off-the-runs still benefit from an RFQ protocol. The twist that we have in our RFQ is it includes the client option to go through Open Trading, to make their orders available when they choose to, to the entire network. So we're applying what served us well in terms of differentiated liquidity through Open Trading to the U.S. treasury market. And the third area that I'd point out is that -- you've seen a series of announcements, but we're investing a lot in the entire data index ETF space. And we've rolled out a couple of indices this year. The MarketAxess 400 for high grade and an announcement just recently that we've done a very similar index in high yield and partnership with MSCI. The high-grade index is now an ETF managed by State Street. And we think there's a bright future there because there are lots of gaps in the fixed income ETF offering. And as we gain market share in all these product areas, we have great access to real-time data. So we think we're in a great place to deliver new indices, new ETFs. That is all part of a strategy to broaden out that ecosystem, but also to build out our data capabilities.

Interesting. A couple of things I was hoping we could expand on that. I'm going to jump around a little bit. But you mentioned regulation. I had that actually as one of the topics I wanted to zone in on as well. And just thinking about central clearing of treasuries and all-to-all being as kind of the 2 important factors, but are they dependent on each other? Because if central clearing is, let's say, too difficult to execute, too much uncertainty with respect to the cost it will take, how much the industry wants to participate, whether there is an ultimate benefit because the cost of getting it in place might push some people out and make liquidity worse. So can you still succeed in the all-to-all piece without central clearing? And what sort of the regulatory push that could exist to move people more into all-to-all without central clearing, by itself?

Yes. No, it's a great question. It actually came up in the panel on all-to-all trading during the Fed meeting. But we're 12 years in and 38% of our credit volume is through all-to-all trading in our core business, and we are comfortably managing that as the broker-dealer of record settling those trades. So central clearing -- and the point I made is that there may be long-term benefits to central clearing for treasuries, but it's not a prerequisite for all-to-all trading. And most of the trading venues are registered as broker-dealers, many of us also as ATS. We have a variety of different ways to settle all-to-all trades. I think what the regulators are focused on is the clearing structure has become fragmented, where you have different market participants settling trades in different ways, which means there's less real-time matching in the system, which means that counterparty risk takes longer to clear out than it should. And ultimately, if all-to-all trading is going to be a very significant part of the market than central clearing in the same way that it works for the futures markets, will be an important thing down the road so that all-to-all trading can scale indefinitely.

Got it. Got it. Okay. My second follow up was around the data element of the growth story that you mentioned as well, specifically related to the index business, but data broadly as well. So I guess on the index side, do you see an opportunity to come to market with a replacement of some of the existing indices? Or this is really more of a launching of new ETFs that will be tied to your indices, and therefore, that kind of stuff could take some time to scale?

Yes. So right now, we're thinking about where we can be additive and complement the indices that are in the market. Most of the large investment-grade corporate bond ETFs are on very broad indices. LQD, for instance, has almost 4,000 unique CUSIPs in that fund. So what we're trying to solve for is to make something much more tradable by really identifying the 400 most liquid bonds and running an index on those bonds that's tradable, dealers can offer TRS against that, fund managers can consider ETFs on the back of that. So we're trying to create an index that will have a change in constituents very regularly, but will be more tradable because it's at the very most liquid end of the market. You mentioned EM earlier, and that's an area where the fund managers would all like to see more growth in ETF funds under management. And I think there's a real opportunity for us in EM to use the data and the presence that we have in that market to help develop indices that could be very valuable down the road.

And what about the data strategy broadly? CP+ is super valuable. It's one of the few sources of real-time market data the way -- not quite like the way it exists in equities, but close to that in terms of just the depth of book and all the information that people can get out of that. Any new ways you're thinking about monetizing that?

You see, we've historically used CP+ to help our clients trade more efficiently. Now we think we're at a point, where, given the share and the developments that we've made in CP+, there's a more specific data revenue opportunity emerging. And we're clearly developing what looks and feels like a real-time trade tape both here and in Europe. We have more product areas that we can add to that. It's quite common for end-of-day valuations to have secondary sleeves on specific data assets that are market leaders that can fill in as an extra source of end-of-day valuations as well. So that's a part of the market that we think a lot about. So it's kind of a combination of trade tapes, indices, ETFs and end-of-day valuations that we're thinking about around the data strategy.

Got it. Great. All right. Let's talk a little bit about the high-grade business. We haven't really talked about it yet today. It's still a very large part of the pie for you guys, but the growth has been obviously slower over the last couple of years, kind of in the 20%, 21% market share. So maybe just taking a step back, what do you think has been weighing on growth there and why haven't we seen more acceleration? Is that the market that's sort of getting to sort of whatever is kind of tradable, you kind of get into that level? And are you working on anything to further reaccelerate growth there?

Yes. So no -- and a fair comment. And yes, I would say the summary of market share on MarketAxess this year is upside surprises in EM, high yield and euros and kind of a flattish year in high grade so far. So we are focused on a number of things that we think will improve high-grade market share as well. Number one is we obviously are doing a much better job on portfolio trading than we did a year ago. Portfolio trading has flattened out this year. If we look at all of 2022, PT, by our estimate, is running around 5.5% to 6% as secondary trace volume. So it hasn't had the same growth in this more volatile market than it did in prior years. But we're now capturing something close to 20% of that market, where it was much lower a year ago. And we're really pleased with the client feedback that we're getting and the opportunity to increase that share more. We're also delivering new tools to dealers, because one of the trends -- and Tradeweb has done an excellent job with D2D trading and converting more of it to electronic. And we see that continuing. So we're delivering more automation tools to dealers so that they can take advantage of the breadth of liquidity that's available on our platform for the traditional D2D business. Historically, that has not been an area of focus or strength for us, but we think there's real opportunity there. And then the last thing I would say is every quarter there are new enhancements going out in automation. And they're all designed to make it easier for clients to access all of our protocols and all of our products more efficiently. And I think the more we can do of that so it's seamless to move across protocols and take advantage of liquidity no matter where it sits on the platform, we'll have a chance not only to increase share, but also to increase client interest in doing larger trade sizes on the platform. All of those things to me are a critical piece of getting the high-grade share to higher levels from here. And I don't think in the aggregate we're anywhere close to topping out on high-grade electronic market share. I see cost benefits, liquidity benefits for both dealers and investors that will last for the next decade. And my view is still that we're going to end up at 75% or 80% electronic in most of these large fixed income markets. So that view has not changed. And I'm sure you're going to get to it. But one of the frustrating parts of the year this year -- and everybody has had their own shocks to deal with. So I probably need the world's smallest violin. But everyone has dealt with market shocks that we didn't expect this year. The biggest shock for us was the rapid increase in interest rates that crush duration in corporate bonds that brought our fee capture down. And institutional investors, as most of you know, trade corporate bonds spread over treasury. So our transaction fee has always been in basis points. We haven't changed our fee model one bit, but the high grade duration dropped so much that it, by extension from yields, dropped our fee capture significantly year-over-year. And as a result, we're not showing the same top line growth that we would have had the high-grade fee capture stayed anywhere close to last year. The good news on this as we think about the headwinds that we've had this year, that's already starting to improve. As the 10-year yields are starting to come back down, durations going back up, our high-grade fee capture is going back up. I think most people expect that the Fed is going to raise rates until economic growth is negative. We're going to end up with lower rates probably in the second half of next year. That will take care of itself and create what we hope is a tailwind instead of a headwind of getting high-grade fee capture back to a more normal place. The second is FX. Everybody is dealing with that. The dollar index has also started to decline in a material way. So we think that, that headwind is disappearing. And then market volumes that were in the state of shock that I mentioned in the second quarter are really starting to improve. And those are the 3 key things to get revenue growth really on track for us in '23. But if you looked at just the month of November, the high-grade TRACE volume number was up a full 25% from last November. I think that's here to stay. There's plenty of reason that this market is more tradable at these yield levels than it was with quantitative easing and much lower controlled rates over the prior 3 years. You still have all kinds of uncertainty around China lockdowns, inflation, the situation in Europe, Russia, Ukraine, you name it. So my outlook is very positive on volatility continuing into the New Year, but I see some of the headwinds that we faced this year turning into tailwinds as we look into '23.

Great. Let's talk a little bit about pricing. So -- and thanks for kind of covering the more cyclical kind of market share -- the mix shift dynamic, which obviously suppressed the capture rate. But to your point, pricing on a same-store sales basis really has not changed. But when you fast forward, when we look at the space, you guys are -- obviously remain the biggest player in the space. Tradeweb is getting momentum as well. There are other players that are coming in as well with perhaps a cheaper offering, nowhere nearly the same liquidity. But it feels like the place is likely to get more competitive among just a handful of players, which means pricing is likely to come under a little bit of more scrutiny over time. How do you think about that risk? When do you think that will likely happen? What would be the response from you?

Yes. Actually, if you look at it, the big 3 platforms, pricing has converged over the last 3 years, is that -- if you look at Tradeweb's average fee capture for credit and ours, they're right around the same level. And many of you know that Bloomberg added transaction fees that have been increasing to our levels over the last 18 months. So the gap has closed there, where all 3 of the large incumbents are not too dissimilar. And by the way, we're all investing a lot in technology for our clients. And the most important thing for them is that we deliver more and more tools to make trading more efficient and drive transaction costs down for them. So I don't -- and every year, there are new entrants that come and go, but I still think the majority of the institutional activity is sitting on the big 3. The key in my mind for us is that we just have to make sure that we're always driving more value to our clients than we're charging. And we're not only driving trading and operational efficiency to clients, we're delivering more products each year. But then again, Open Trading is driving the $900 million in transaction cost savings to our clients so far this year, which is greater than company revenue. So we focus on the value proposition to make sure it supports our pricing, and we're very comfortable that it does exactly that right now.

Great. Well, let's spend a couple of minutes on the investments you guys are making in the business. You've been sort of steadily on that path of continue to innovate, continue to expand internationally, which resulted in a 10-plus percent expense growth for the company over the last couple of years. Where are you adding resources now? And you kind of think out in the next few years, what's the right expense growth algorithm for the business given the opportunities that you're seeing?

Sure. Well, the path that we've been on is to make sure that we're constantly adding new product areas and new protocols on the platform for our clients. And so a lot of that's technology. I think it's fair to say that the vast majority of dealers and asset managers that are active in credit are already clients of MarketAxess. So it's not necessary about new clients increasing penetration with the clients that we already have. And that's all about delivering more functionality, more products, more protocols every year. Some of that we've done inorganically. Treasuries being the biggest example. But we also made an acquisition in the muni bond space to add to our client community there as well. And some of that is done organically. But a lot of that is in just expanding the technology resources so that we're constantly delivering new value and new functionality back out to our clients. When you think about EM, that comes with boots on the ground in many cases, too, where to get to that EM local market opportunity, we need to do a better job selling to the local investors and the local banks and dealers. So there's been some expansion in our sales force, but much more dramatic on the technology side in terms of building out the platform.

Yes. How far away you got -- where in that journey are you guys? Is that a continuous process, so like we should think about the next several years kind of thing?

I think -- it came up in our third quarter earnings call, but we think it's a completely reasonable and defensible investment strategy. This is a massive long-term opportunity. And quite frankly, there aren't geographic barriers. If you look at Bloomberg trade with MarketAxess, we're all operating globally. And the 3 of us have the vast majority of electronic share across fixed income product areas. So it's -- when your expectation is that electronification still has a long way to go, I think you want to be in as many markets as you possibly can be. And it won't all be one protocol. There are a variety of protocols that clients care about. So we think we're doing the right thing to get our stake in the ground in as many markets around the world and be able to serve our clients across regions and across products.

Great. Well, we've got a couple of minutes left. So if there are questions in the room, please raise your hand. We're going to have a mic come around. Maybe I'll ask one more. You mentioned inorganic opportunities and the way you've invested through LiquidityEdge or one of the other things. As you think about where the opportunity set is for MarketAxess over time, is M&A still part of the framework? Or there's plenty of runway to do things organically?

Well, probably both. But there are not that many additive electronic trading properties out there around the world, which is a good and a bad thing. But we found a few things to do in munis and treasuries as bolt-ons. And we have this new consortium that we're part of, is RFQ-hub for ETF share trading, which you'll hear a lot more about in the New Year as well. But there's still a lot -- there's still a bigger agenda on investment organically than there is inorganically. So we're always interested in anything that would expand the client experience. So that could be data. It could be more post-trade assets. We're doing a lot of reg reporting in Europe, as you know. And it could be trading. But there just are not that many properties on the market that would be additive to our business to expect that to be transformational in nature. I think it will be episodic bolt-ons.

Great. All right. Rick, thank you very much. We're on time. I appreciate you being here. Thanks for joining us.