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

We're going to get started. We're running a little late. Thank you, everyone, for joining. My name is David Wicks. I'm Vice President of Listings at NASDAQ, and I'm pleased to be joined by Chris Gerosa, CFO of Market Access. And I'll leave plenty of time for questions. So if we can hold the questions off till the end and kick-off, Chris, we're going to cover a wide variety of areas.

But let's start with the state of fixed-income e-trading. And I think we can probably all agree we've seen a lot of different market conditions over the last several years. What were the key changes in client and dealer behavior that are really shaping FIE trading, the FIE trading ecosystem today? And when you look out to 2023, how do you see this evolving?

Well, first off, David, thank you for having me here today in the conference. Very good to be in person and in front of all of you. But I just want to recap the last 3 years because each year was very different. 2020 was very good for MarketAxess in our e-trading platform, elevated volatility, high credit spreads, wide bid-offer spreads. And we did extremely well in 2020. We essentially had 2 years of revenue growth in 1 year. And then 180-degree turn in 2021, as we all know, probably one of the most benign credit environments in our lifetime, challenging for market access, albeit we were coming on the back end of a very successful 2020. And where we are today, we're seeing market conditions return to what we saw in 2020. So we're very optimistic about the market conditions today. But to get back to your question, we have seen increased adoption in fixed income electronic creating over the last 3 years. as evidenced with our market share gains across all of our core products. And in particular, Algo and automated traded solutions for the credit markets is seeing increased adoption. And that's where we're focused today is we recognize the opportunity in that arena, and we're focusing our investments to invest in the technology and use the data and the deep liquidity pool we've built through Open Trading to capitalize on that opportunity. At the end of the day, that solution is going to drive cost savings and trading efficiencies for our clients, which their clients will ultimately see the cost savings we're providing to them.

And let's talk a little bit about Open Trading. It's clearly been a big success in high grade and high yield. Can you talk a little bit about the opportunities you see to broaden Open Trading, the A2A protocol to other asset classes?

Yes. So the all-to-all trading, that is our competitive moat. That's where we've invested for the future. And we just put our November release out this week, so I just want to call out a few compelling stats. This year, year-to-date, we've delivered over $860 million of cost savings to our clients, more than our full-year revenue for 2022 with our full-year revenue expectation. And 20 -- 38% Open Trading penetration. That was a record for us this month, second record we've achieved this year. I think it's an indication that the fixed income community is recognizing the value they're received by trading in Open Trading. So we're starting to see that flow come back on to the platform. And where we're focused on is expanding that liquidity pool across the other products, particularly in emerging markets and local emerging markets. There's a lot of markets we don't participate in today. So expanding our geographical footprint by investing in people and technology, that's an area of growth and attention that we're focused on to further deepen that liquidity pool we have in Open Trading.

Let's talk a little bit high yield, and that's been a big source of strength recently with market access market share now at the same levels of high grade. What do you think is behind the share gains? And more importantly, probably, are they sustainable?

Yes. High yield is a very strong story for us this year, 19% market share, just slightly below the high-grade market share that we saw in the month of November. But this is where Open Trading is the differentiating factor. We've got that alternative liquidity pool that when the traditional liquidity providers such as the dealers decide to step away, and we saw this in March of 2020 during the pandemic, our institutional clients have access to that depth of book and price improvement by coming to Open Trading. And we've been investing 12 years on that front, and high yield is benefiting mostly today. We're also seeing very strong share gains in emerging markets and Eurobonds. Again, a function of Open Trading. But I do want to set expectations that the 400 or 500 basis point year-over-year increase that we're seeing in our high-yield share gains, we're not expecting to see that year-over-year consistently for the next few years. Just like other products, we're emerging markets and Eurobonds, we've seen 400, or 500 basis point year-over-year share gains. There's products that will do well in certain cycles and products such as high grade, which hasn't seen a strong share gains. But for the longer term, we'd expect our product set to see that average 100 to 200 basis point year-over-year share gain.

Let's talk emerging markets and euro market. So again, good gains this year as well. Can you update us on the drivers behind those gains? And what do you see the addressable market there?

So Open Trading, we think is fueling growth in those 2 product sets. The competitive landscape is changing as well. Bloomberg is introducing a transaction price. So we feel that some of the volumes coming to our platform because they're getting the best price of execution, including our commission fees, which gets back to the value proposition around Open Trading or I should say, open trading within the Eurobond and emerging market product set. But where we're focused, in particular, on the emerging market opportunity, it's a massive opportunity. The share gains that we're publishing are just representative of the TRACE and TRx data that we have access to the print. The reality is a lot of those markets don't report their trading activities. So it's very difficult to size up the total market. But our best estimates, our total market share in emerging markets is probably somewhere in the low to mid-single-digit share set. And we feel that there's tremendous opportunity in emerging markets, and that's where we're focusing on our investments.

A lot of new initiatives going on. And in the pipeline, we can't talk about all of them, but if you were to say, what are your top 3 and what investors should be watching for in 2023? And more importantly, maybe what are some of the milestones we should be thinking about as it relates to those?

Two of the trading products are very early days, municipal bonds and U.S. treasuries. I'll start off with munis. We just posted 5% market share for the month of November. We've made a lot of investments both organically and inorganically by acquiring muni brokers to expand our client set in muni trading. But within muni trading, it's really a behavioral change in how those traders trade the bonds. There's a lot of desks populated with a lot of traders, and we feel that as there's more comfort in the value of open trading with a municipal bond trading, we're going to continue to see the share gains within that opportunity. And it's very early stages. It's only 5%, so we're excited about the muni offering. U.S. treasuries. We got into that product in 2019 by acquiring liquidity Edge -- our share is around 3%. We've done a lot of work to roll out the all-to-all network within our institutional client base. So very excited about the U.S. treasury offering. And finally, the data revenue opportunity, we've initiated an ETF and index strategy earlier this year, very focused on that strategy. But the longer-term opportunity and what's most compelling about data is that the success of ETF and indexing is going to drive an end-of-day revenue opportunity for us, which we don't participate in today. And that's something I'm very excited about is the end-of-the-day revenue opportunity around our data product offering.

Excellent. High grade, if we can switch a little bit. You've also seen strong gains across all of your asset classes with the exception for high-grade hovering, I guess, in the 20% to 21% range for the last 2 years. What do you think is hampering high-grade growth? And is this part of the market reaching kind of the full penetration in terms of what could ultimately trade electronically? And if it's not, what are you doing to kind of reaccelerate growth there?

Yes. We're not going to stick our head in this in on this and with probably the most popular question we're fielding an investment relations program and high grade has been relatively stable over the last couple of years at 20%. We've got the reasons why in '21 challenging markets around high-yield high new issuance calendar for the high-grade market. And we're making investments to have better success on the headwinds facing high-grade market share gains. We were behind the curve with portfolio trading 1.5 years ago. We made the investments. We made the adjustments. I think we've done very well on getting to where we need to be for portfolio trading and addressing the competition on that front. Investing in automation and the automated solutions that I talked about earlier, a big piece of high-grade trace is block trading, where we own about 10% of that market. And the overall block market in high grade on trace is 40%. And that's an area that we've faced a headwind some primary focus of ours where we think the investments in automated trading solutions is going to help us further penetrate the block arena, which will add to our high-grade market share gains.

Following along, we've seen your high-grade capture rate slip, but that probably has been more a function of the environment. Can you talk a little bit about the pricing trends broadly across your product lineup?

Yes. High grade is the one product that is very sensitive to market conditions. I just want to make it clear, we have not reduced our fees in order to address the competition. The mechanics of how high-grade fee capture works, it's a function of the duration of the bonds that trade on the platform. And in the last year, we saw an unprecedented movement in bond yields, where the 2-year yield went from 20 basis points to 450 basis points in almost the 12-month period. we've sized up the math on this, but every 100 basis point move in high yield is about a $5 impact on our high-grade fee capture. So just over $20 of that high-grade fee capture decline was due to the movement in bond yields out of our control. The good news is that we've seen that stabilize with respect to bond yields. And so the remaining impact on duration is years to maturity of bonds trading on the platform. And we've seen that stabilize in the recent months and years to maturity and bond yields are driving duration. And there's a public data point out there, corporate bond index that post a daily duration benchmark for corporate fixed-income bonds. And the good news is it's been very stable over the course of the last 3 weeks, hovering around 7.2% to 7.3%. So albeit we're not disclosing our high-grade fee capture on a quarterly basis. We are putting out our total credit fee capture on a monthly basis. The takeaway from that data point, which is in the market is that we're seeing stabilization in our high-grade fee capture.

So fixed-income markets have seen one of the worst price declines in history, resulting in record outflows from fixed-income mutual funds. But at the same time, fixed-income ETFs are seeing inflows. If this divergence of inflows continues with ETFs gaining accelerated share of AUM at just a few managers. What does that mean for MarketAxess' trading ecosystem in credit?

We think ultimately, the investment needs to go to the underlying issuer, the bond longer term. The first half of 2022, we saw ETFs being utilized as a very efficient means to transfer risk as we're embarking on this unprecedented rate cycle that we're experiencing on the back end today. But as I mentioned, ultimately, we feel that there's going to be a reversal where the investment flow is going to go into the underlying issuers, and that's where you'll see the outright bond that volume pick up. But this is an area that we want to invest to diversify our revenue cylinders. And so we've made the investments early days with ETFs and index strategy. We partnered with Virtu and a consortium of players in that field. So we're recognizing that we need to participate in that space. And it's early days. But longer term, we want to have a diversification that in different types of markets and cycles, various products will outperform others so we can continue to deliver mid-teen revenue growth as we've done in the past.

So we have a few more questions, but maybe I'll pause here and see if there's anyone in the audience that would like to ask a question...

I apologize. I should have worn my sunglasses this light is very bright.

Any questions -- all right. We'll continue on. So MarketAxess has been steadily investing in the business with 10% plus expected growth over the last several years. So what are the key areas where you are adding resources?

Yes. We continue to invest in the platform. And yes, our expenses are up double digits, but we recognize that opportunity in front of us. And we're instilling expense discipline outside of our revenue-facing and technology investments. And I mentioned in the first question, David, that investing in technology to drive our Algo and automated trading solutions is a top priority, expanding our geographical footprint, which involves onboarding revenue-facing employees that we don't have on the ground in certain markets today. So that's the area of focus for us is in our technology and our revenue-facing personnel. But as we get into some of these local markets, there will be regulatory oversight. So there will be additions we'll have to make to the compliance staff to make sure that we're adhering to the new regulations that may be employed on us as we enter those new markets.

And as people are thinking out in the firm's expense growth algorithm, how -- what do you see over the next 2 to 3 years?

It's going to continue to be in that double-digit -- low double-digit 10% range. But as we've seen in the past, like in 2020, when market conditions return to more normalized levels or we have a period like we saw in 2020, there's significant margin expansion. And albeit our operating margins due to the investments that we made around M&A are at mid- to slightly high mid-40 range. Our EBITDA margins continue to be in that mid-50%. So the takeaway for the investors is don't just look at the operating margins, the EBITDA strips out a lot of the noise around associated with the M&A -- but over the long term, we'd expect margin expansion to get us back to a 50 handle on the operating margin we expect to see. I just don't have a timetable because we're investing for today.

Fair enough. So regulators continue to focus on centralized clearing of UST, which should be a tailwind for your business model. Can you update us on your U.S. treasury offering and how A2A is positioned to benefit from potential regulatory reform here?

Yes. And this comparison goes to the credit all-to-all network that we've built within our credit Open Trading solution. The idea was resurrected in the wake of the financial crisis when liquidity dried up. There was nowhere to trade corporate debt. And I give the management team of MarketAxess working with our institutional clients to come up with a solution that we've been investing in for 12 years. But it took a while for that to gain traction until 2014, '15 is when we started to see the volume and the revenue materialize on the investments we made in all-to-all for credit. And now we see the opportunity within the treasury market, and I think the regulators see that as well. If you go back to March of 2020 in the pandemic, liquidity dried up in credit, Open Trading did very well. We had an arena for credit to trade fixed income. You didn't see that in treasuries. Market volumes in treasuries dropped in our treasury volumes and other competition dropped as well. And so centralized clearing is a fragmented clearing solution today that they're trying to address. But we continue to believe in this all-to-all solution for U.S. treasuries. It's just going to take time to evolve but we've made the changes, and we're well positioned in '23 to start to capitalize on that opportunity.

Okay. And when you think about acquisitions, if you look out 2 to 3 years, 4 years, how do you -- how do acquisitions play into the company's longer-term strategy?

Yes. So our capital management strategy continues to be #1, invest in the platform, enhance the functionality, deliver those needs to our clients. Number 2, there may be opportunistic M&A, just like we saw with the last 3 acquisitions that we made since 2019, which is either going to introduce you into new products such as treasuries with LiquidityEdge, or expand an existing product offering like we did for our reg reporting, our post-trade business and the muni business. And we measure the capital allocation to get the best return for our shareholders. And we don't envision there's anything transformational out there, but -- we continue to keep a close eye on any small assets, bolt-on-like assets that can either advance our technology development, expand our footprint geographically or expand a product set. And the final capital strategy involves returning capital to our shareholders, which continues to be something we'll employ through our dividend and our share repurchase program.

I'll pause here again. Questions from the audience?

It's [indiscernible]. I have a question concerning the ETF. Can you give a bit more color on that? I saw that you have one listed ETF on investment rate. Can you give us -- I mean, is this something where you will take the same way like S&P Global? Or is it something that we have a different...

Yes. So we're offering the ETF for the 400 most liquid bonds in the market that is going to complement our live markets solution that we've introduced as well. And it's an area of focus where we're getting into the high-yield space and partnering with MSCI and State Street to get the offering. But it's still early days for us to materialize a significant revenue opportunity, but it's an area that we want to invest and participate in. So it's something that's going to be a cylinder for the medium to longer term and then be a fuel to help grow our data business, as I mentioned earlier.

So the -- you would provide the data and they give you like they pay a subscription fee on the AUM or how to -- have you already thought about how to kind of model that...

Yes. So our CPs is being utilized. And if you're working with an ETF, our end-of-day CP pricing solution will be one to utilize to price either the index or the ATF. And longer term, if that price is being recognized on the street as a credible end-of-day valuation price, that's where that's the opportunity that can really expand the client base that we're dealing with on our end-of-day pricing. It goes beyond the 2,000 institutional clients that we have. Any corporate treasurer who's managing a corporate bond portfolio and is going to have to look for an independent end-of-day price. That's where I see a lot of value in that opportunity.

Other questions?

Just in treasuries, you're obviously going up against Tradeweb and Bloomberg kind of incumbents. I guess Open Trading as your weapon what else can you offer to sort of take on the incumbents?

Yes. I think it gets back to the Open Trading network and that all-to-all solution, introducing it to the institutional clients that we have on the platform. I know Tradeweb and Bloomberg have access to the institutional clients. I think we have much more on our plate compared to them, and we've got that true all-to-all network. It's just -- it's early days. It's going to take time to change that behavior, but we think it's complementary to the product set that we're offering to our clients. Part of the algo trading solution is if somebody wants to trade credit rates, they can come to MarketAxess, and we'll utilize that technology to push it through our ecosystem to get them the best price of execution. And it's the early days that we're starting to do that for U.S. treasuries.

Other questions? Chris, maybe as you've -- I know you've been meeting with investors over the past several months and quarters. What seems to be on their mind? What do you hear from investors as far as when you talk to them?

Yes. It's really the story that we touched upon earlier, high grade. It's the high-grade share and it's the fee compression around the high-grade fee capture. I think we've done a really good job explaining the math behind how duration impacts high-grade fees. And if you go over the last 10 years, we've seen ebbs and flows of where high grade has peaked out at $200 per million, which happened in 2020 when rates were at 0 and years to maturity were above 10%. And now we're seeing a complete opposite effect in 2022. And we purposely stopped disclosing that. We're going to give you all the data points you need to calculate what high-grade fee capture can be on a quarterly basis, because we've been -- we spent so much time on high-grade fee capture discussions that we wanted people to focus on the investments we're making across all the other products. And if you go to the release this week, the share gains and all those other products were enormous. And I don't think we're getting enough credit for the diversification strategy that we're employing.

Other questions? Great... Yes. Chris, anything we didn't cover that you would like to talk about in terms of the business, competition, pricing, capture rates?

I think we've covered the major themes that we've been fielding in the Investor Relations department. But I know I've got a few one-on-ones after this meeting, which I think a few of you are participating in. And our line is always open for Steve Davidson. If there's nothing we cover today or something surfaces in the market, please reach out to us. We're always happy to interact with the investment community.

The last chance. All right. Well, Chris, thank you for your time. Thank you all for your time.

Thank you, David.

Yes.