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

Everyone, we can get started. I'm Craig Siegenthaler from Bank of America, and I'm joined on stage by [indiscernible] also from Bank of America. And it's our pleasure to introduce Chris Concannon. Chris is President, COO and [ CELECT ] of MarketAxess. MarketAxess is a leading global fixed income e-trading platform and prior to MarketAxess, Chris served as President and CEO of Cboe after its acquisition of BATS. And then before the acquisition, he was BATS' CEO. Chris, thank you very much for joining us.

Thanks for having me.

So Chris, let's just start with your new job. It was just announced in January, you will assume the role of CEO. So first, congratulations.

Thanks.

Okay. My question though is, what do you have in store once you take the reins and what will be your areas of focus?

Well, first, again, thanks for having me. It's great to be. It looks like a great conference so far. There's some things I'll share and some things I'll keep the secret. First of all, I don't start the job until April, but pretty excited about what's ahead because the timing of the role is fairly convenient. We're actually in this cool golden age of bonds. Bonds are really back again. Yields are up. It's an attractive investment vehicle, and it's just -- if you look at obviously where inflation numbers are coming, they're being a bit dogged. They're not going away. And so, I think, this rate increase could continue and obviously, we'll stick around for a while. So you have an entire sector of fixed income that is certainly an attractive investment vehicle, not only to institutional investors, but, we're seeing it retail as well. So talking about the good time to take on being head of an electronic bond platform, there's a lot of wind at our back as the market is moving in our favor. So pretty excited about it. I think maybe bonds will be cool like crypto is cool, and we'll have like teenagers trading bonds online again. But yes, it's a great time to be at the helm. It's a great time for the industry as well given some of the challenges that were left over from the early years of technology challenges and people have to make sizable investments to take advantage of the market structure that's coming, not the market structure that's here.

So maybe Robin Hood should be investing in their bond platform.

I think they will be. I know the folks at Robin Hood, and it's actually an interesting vehicle -- when you look at how retail trades bonds, it's not ideal. They don't trade them manually like other investors, it's a little bit clunky. And so I do think retail is going to evolve in this new environment where bonds are attractive. I think institutional is going to evolve as they look at the market getting bigger and getting more attractive from an investment standpoint.

So in terms of both asset class and protocol, what do you see as the biggest opportunity over the next 5 years?

Well, obviously, U.S. high-grade, U.S. high-yield, U.S. corporate is an enormous opportunity. I do think we're early days in the evolution. As I think about electronic trading, we all focus on this electronic market share and there's lots of research reports on it. We still have a sizable portion of the industry that is clicking a screen. And in other asset classes, that's not, that's electronic, it's not perfectly electronic. And so automation is just early days in the fixed income arena, particularly in the institutional market, and it really doesn't exist in the retail market and it's a very efficient tool to use, particularly when you're looking at a growth in small ticket sizes. So one of the outcomes of this new attraction of the bond market is as AUM flows into the market, we're going to see it coming in 2 different channels, 2 main channels. The ETF market and the SMA market, the separately managed account market. Those are very attractive vehicles in terms of efficiency for investing. And they create small tickets. So on the ETF side, it creates secondary trading because everyone -- every market maker has to hedge their underlying and those are generally smaller tickets than block-size tickets. And there's a series of turnover that happens when the ETF turns over. SMA is an institution trading small tickets. And that's where we come in perfectly, and we fit in that market exceptionally well, automating that entire massive tickets that are being pushed into these large institutional investors. They have to get tickets off their desk. They cannot do it clicking a screen.

Got it. So do you have all the capabilities you need at the moment? Or do you see inorganic opportunities to help kind of accelerate your progression to gain share?

So the opportunity is organic. When I look at the space, there's really 3 players in the space. Obviously, Tradeweb who they themselves have a new CEO in Billy Hult. I try to give him compliments when I can. He sometimes gives me compliments that might change over time, who knows? And then obviously, Bloomberg is a major player in fixed income. When I think about the space and call it the protocols and the opportunities, there's nothing out there that is massively inorganic. Everything is much smaller opportunities, things that help create accretive technology solutions, advanced tech or advance how we look at data and massing data. If you look at our recent MuniBrokers transaction, that's really a data play, right? We're acquiring a muni-platform, not just for execution, but also the data and what we're going to do with that data is super exciting. The one piece that we're building right now, and I alluded to this on the last earnings call when I think about the world of automation, I think about a trader hitting one button for a multitude of line items. And we have those solutions, but they're getting smarter, and we're using AI to drive them, and so true automation is where the trader fits one button and executes a long list of trades without touching it again. No human engagement, trading bots that automatically execute bonds. And on behold that we've built something that we're rolling out before the end of this quarter. And I do think it will revolutionize how the market looks at bond trading.

I wanted to get your perspective on the intensifying competition in the high-grade credit market. How do you plan to address this vertical with competition you are intensifying?

It's funny. The chat that everybody uses to trade bonds so competitive. We have to crack into that chat market. Look, I kind of being sarcastic that people are still trading over chat. That is the largest market share in the high-grade market and we trade with one button, one click. When I look at high grade, it is not a quarter-over-quarter battle. It's a year-over-year battle. So when we think about high-grade share monthly, quarterly, the long haul, we're just early days. And if you truly think of take a really big step back theoretically, Open Trading is a big important component of our offering, all-to-all, we're an anonymous client and an anonymous liquidity provider meet each other. That's only about 6% to 7% of the high-grade market share. That's true. We've amassed this unique liquidity pool where we -- and that's that piece is continuing to grow quarter-over-quarter, month-over-month because it's unique liquidity. It also can be where an investor meets an investor, and that does happen on the platform. So that becomes a competitive weapon. If you're just trading chat -- over chat, one thing you're doing is you're crossing full spread. So you might be getting 3 good prices, but you're getting 3 relatively okay prices. And one of them you have to choose the real market dynamic change is when clients can actually provide liquidity, not cross spread. It's ironic that the largest financial services industry sector called fixed income is largely -- doesn't use limit orders to trade. Every other market futures, FX and equities use limit orders. In this market, you rarely see a limit order. If you see a limit order, it's sitting on a dealer desk and it's actually going to be used when the market moves into the limit price, not as a price providing liquidity to the market. That's all radically changing. And that's really, if you look at the treasury market, when the Fed and treasury and other regulators talk about all-to-all, that's what all-to-all is about, about other industry participants providing liquidity to the market rather than just a pure dealer model where dealers are the only providers of liquidity. That's all changing, and it's changing for a reason because we need alternative liquidity in the market. It can't be a dealer-only market. Sorry, that was a long-winded answer.

No, it's very helpful. To move a little bit into the macro backdrop. In the U.S. in 2022, we saw a little bit of a deceleration in electronic share, how much of that would you attribute to just normalization after COVID versus maybe like secular or macro factors?

Well, definitely, we saw new issue market explode in the market, and that is typically not electronic. It's highly efficient new issue turnover, certainly for the first week, but it's largely not electronic on platforms. So you tend to get -- new issue market can impact electronic market share of the overall market. The other piece is the spread. The wider the spread, if you really compare last year to 2020, which everyone really compares where electronic trading exploded during the pandemic, certainly the early days of the pandemic, it was more associated with the spread gapping out dramatically. And as spread widens, you tend to see -- and again, the irony is open trading, that all-to-all market where you get unique liquidity when spread gaps, that market share jumps, and it makes the overall electronic market share jump. And so this alternative liquidity solution, which doesn't really exist until we started offering it in treasuries is going to be the fastest-growing piece of the overall electronic share. And that's really the way we think about it is all-to-all, if you look at all-to-all in munis in emerging markets, even in Eurobonds, it's a sizable piece of our market, but it's also the fastest-growing piece, and so the overall electronic market ebbs and flows in terms of market share, it just continues to grow. So it will hit a flat line and then will grow again. But it's really if you look at the all-to-all unique liquidity, that's the fastest-growing piece. And the other fastest-growing piece, ironically, last year was our automation suite where large institutional investors have too many line items to work on individually manually and they just send them via API into our machine and it automatically executes across thousands of tickets. And that's the piece that grew 33%. So you have to kind of peel back the broader electronic market share and look at all the pieces that make up it -- make up that share and that -- those pieces are growing.

Got it. And already in 2023, we've seen the macro backdrop evolve a lot with the reduction in volatility, the Fed planning to use rates later this year.

Maybe.

Possibly, so I guess, can you walk us through what that could mean for overall industry volumes and then e-trading in particular?

Yes, I'm excited about 2023 because going back to bonds are cool again, like that's an attractive investment, higher yields. What we haven't seen is credit spreads. Today, when you look at the market, obviously, credit spreads are still tight. So what the market is saying is all those bonds issued by all those companies seem relatively safe as I compare them to the treasury market. And as you face more difficult economic times, history is a great predictor, those spreads widen out. As ratings start to be adjusted, we are seeing early signs of slowdowns. We're seeing layoffs happening at big companies. Typically, in this environment, after you see a huge rate increase like we've had, you do see economic challenges across certain sectors. And that starts to impact the spread of how that bond trades versus the treasury, and that spread is where we make money. And so it could get very interesting. Obviously, we also pay a lot of attention to years -- to maturity in the secondary market. That has been going up, whereas last year, we saw very low years to maturity, which impacts our capture rate. But as I look at 2023, the behavior and the overall macro environment is quite friendly for many of our economic drivers.

Got it. And do you see any catalysts on the regulatory front? I know we've heard about Chair Gensler floating and expansion and post-trade reporting and a reduction in the TRACE reporting time line? I mean can you help us make sense of what all this means for the market?

Sure. In nontreasury, so think corporates and munis the TRACE has been around for over 20 years. And so they're just moving up the time to report. When we look at how reports are conducted in our market, we see most clients already reporting -- most dealers already reporting within the proposed time line that the SEC has proposed. So we don't see that as impacting transparency because it's only minutes increasing. And so it doesn't really impact a great portion of the business. The SEC is spending a lot of time on the treasury market. Ironically, we've had -- corporate bonds have had transparency for over 20 years. The treasury market still doesn't. So TRACE, we report to TRACE, but no one sees it. So it's -- I always say it's the largest dark pool on the planet, ironically is our U.S. securities. But there are lots of discussions around TRACE for treasuries. Hopefully, someday we'll have some real-time reporting of treasuries. But the other area that DSE has been spending time is on clearing for treasuries. And I think that's helpful. We want centralized clearing. We don't want systemic risk sitting outside the clearinghouse. The clearing house is designed to be a shock absorber for systemic risk. I don't think it changes how electronic trading occurs in the treasury market. It doesn't have a huge impact, but it is from a policy standpoint, makes sense. The other piece to watch on the regulation front is best execution. The SEC is now engaged in best execution for fixed income. That means treasuries, corporates, munis, you name it. It covers everything, and there's a lot of interesting things that can come of that. In other best execution rules, it's typically ironically regulated by the courts because of history of cases, but also FINRA. FINRA is a big, what I'd say, the governing body for best execution in the U.S. So it's interesting that the SEC is going down this road for fixed income and then securities generally. But that could have an impact on just the behavior. We're still living in a 3 price rule. So technically, institutional investors, the largest institutional investors on the planet just have to ask for 3 prices, regardless of what those prices are relative to the market, technically, they just need 3.

Got it. And can you walk us through how you're thinking about high-grade fee capture? I know we saw some pressure in 2022 there.

And that goes back to years to maturity, the secondary market, the robustness, and then just the overall spread between the treasury market and the underlying high-grade market. We're seeing behavioral changes. Obviously, with the new issue market, we're seeing average yield to maturity stable with where the market was in the fourth quarter. But as the secondary market turnover increases, which we're seeing in the first quarter, you get large institutions trading further out the curve. And that's favorable for our capture typically generates a higher capture. So when a robust market for us is when the full curve is being traded, not just the short end of the curve, and we're seeing wider spreads gapping in the market. And you typically see that if there starts to be credit challenges.

Got it. So I'm going to hit it on a few growth areas here, but relatively new business use indexing. You launched the 400 Index last year. So we're wondering what synergies do you see with the indexing business with your existing trading platform? And what's really the plan here?

So at the macro level, what we've seen is the ETF market, and a lot of people struggle with this, how could it an alternative vehicle to trading the bond be helpful to a bond market? And the answer is the market makers that trade the ETF actually hedge in the underlying market. And we live in that all-to-all markets. There's a lot of ETF market makers that are able to execute their underlying hedge in our market. So we do see a correlation between success of the ETF in fixed income and our overall market. ETF market makers by definition, trade electronically. That means they also trade the underlying electronically. So they have been one of the reasons why electronic trading of bonds has grown so rapidly. I'll get to the index part. I know there's another long-winded way. So we're incented to see more indexing, more passive investing, more fixed-income ETFs on the market. We want to be a player in that space. We think we have unique data that help selection, bond selection our MarketAxess 400 is the 400 most liquid investment-grade bonds on our market. And so we see that liquidity like no one else sees it. We're able to score bonds with unique data. We get to see -- remember, every RFQ is private. The depth of book is only seen by the requester of price. We see all of the depths by everyone requesting price. So we have a full depth of our market that no one else sees. And so we're able to select bonds using that unique information. So you can look at TRACE and say a bond has been traded actively for the last 6 months. It may not be liquid on our market. We're able to create this unique view into the market, and that's how we select the bond. So getting the most liquid bonds into an index is, by definition, what all ETFs are striving to do because it actually makes the spread of the ETF that much narrower. The more liquid the underlying, think about the S&P 500 ETFs, those are super liquid, super tight spreads. And so there are more efficient investment vehicles for fixed-income investors. And so we want to see the market just have dominated by fixed-income ETFs with very liquid indices, and we want to play a part in that. We can play a part either as a direct index or like the MarketAxess 400, where we partnered with State Street to create this ETF or we'll partner with other index parties that have just a stronger brand in the index space. And that's the MSCI relationship we've established where they're using our unique liquidity information to select bonds for a high-yield index, which launched just in the fourth quarter. So we're super excited. It's early days. But from a macro level, we benefit from more passive investment strategies in fixed income. Obviously, as bonds are cool again, we think those are going to be collecting lots of AUM as people start thinking about reinvesting in fixed income.

If you remove a lot of the friction from the creation-redemption process and improve tracking error, I mean that can really help perform and can serve to the addition of fixing the ETF.

If you think about our MarketAxess 400 Index, which is sitting in an ETF, it is doing exactly that. It's tracking errors down. It's performance. That's outperforming other indices in the space. So we're super excited that our unique selection process is actually proving out in that index.

Got it. I think you've also teased this a few times, it may be getting into equity ETF. What's the synergy there with the existing business given your fixed-income chart?

So what you discover -- and this goes to the friction of trading fixed income. A lot of our institutional clients rather than trading a big list, so let's say they get $100 million of AUM in the door in the morning, and they have to trade a list of bonds to put that into the fund. Sometimes it's more efficient for them to get instant exposure trading of fixed-income ETFs, say a highly liquid, high-grade ETF like our State Street partnership ETF. You could get exposure to the high-grade market instantaneously, given the liquidity of the ETF market and then slowly wind out of that ETF position and into your underlying bonds. And so that's a strategy that's being deployed in large institutional investors across the U.S. and in Europe. And so we partnered with Virtu Financial, BlackRock, Jane Street and Citadel and Flow Traders on the acquisition of RFQ Hub. We're still a major minority player in that investment, but we're excited about the partnership that we've established to execute in the fixed-income ETF market.

So there's a lot of electronic platforms and equities right now. So do you think you're late that I can...

Interestingly, no. I mean, the -- I have -- having lived in the equity market, I don't look to dive back into the exchange-based equity market that's -- I'll leave that for someone else to do. Some younger folks can have that fight. It's really about RFQ in fixed income. So it's really taking what our clients are used to is RFQuing fixed income bonds and allowing them to RFQ fixed-income ETFs. These are large blocks ETFs. Even in an equity world, they're not going to be traded electronically using an algo. They're going to be traded in a large block form and they're by clients that are used to trading RFQ. So it's a natural synergy for us to just target the small slice of the market and engage in block ETF trading.

Got it. So MarketAxess has been growing its footprint rates against a few very entrenched competitors. So what's your strategy to steal share from [indiscernible]?

Sure. It's really changed what it looks like to trade treasury. So if you think about the treasury market, ironically, it hasn't really evolved in the last 10 years. Large institutions trade anywhere on the curve using RFQ generally. So they're requesting price from dealers and trading on that price. As I see it with my equity lens, they're using market orders. They're requesting a price, crossing the spread and executing. And if you look at the overall market, it's bifurcated. Dealers trade on electronic platforms, true order books similar to equities, clients trade on RFQ slow moving, RFQ, requesting price, it's not efficient for clients. They want to move more efficiently and some of the automation tools that we see in corporate credit are applicable in treasuries. What we've done is we've taken an order book, LiquidityEdge acquisition a couple of years ago and made it available to clients. And the behavioral changes that we're seeing is astonishing: one, it's an all-to-all order book. So anyone can trade with anyone. Two, clients are actually using limit orders. They're resting limit orders on a book trading as a liquidity provider. That's a unique behavior that the treasury market ironically hasn't ever seen. And so it's really using tools that have existed in all these other markets, used by the same investors and just giving them the tools in the treasury market. We're seeing great outcomes from that. We are delivering new technology that makes it easier for them to trade on an order book, things like average order types, pegging order types. All of these tools have been deployed in many other markets. So I don't feel all that innovative, but we're bringing it into the treasury market ironically 20 years too late.

So Chris, how is the SEC's recent push into central clearing potentially benefit your all-to-all initiative here?

Well, by definition, all-to-all tends to clear centrally. So there's some mild benefit from aggregating all clearing into a clearing house. It's also a policy perspective, just better for all of us from systemic risk. The bigger question around the regulatory activity in the space, they're really calling for all-to-all. So you've had both the Feds. You've had Fed studies and you've had the SEC talk about all-to-all. Clearing helps it a little bit, but I'd say the real push is behavioral change. All-to-all does benefit end users. It gives optionality around alternative liquidity. And you can trade all-to-all on an order book or you can trade all-to-all in RFQ. We have both, so our unique offering in treasuries allows you to all-to-all RFQ or all-to-all on an order book. And there's benefits of both depending on what you're trading. If you're trading the old, a 30-year-old, like you probably want to RFQ that if you're trading a 5-year and it's a liquid 5-year, you might want to trade that on an order book. So it's really giving those optionalities. The biggest, I think, struggle will be traders changing how they trade that market. That's a conversion that has to take place and training a trader, how -- instead of using RFQ to use an order book is a unique change in behavior.

So Chris, I know you closed on the MuniBrokers deal, was it 3 years ago?

Well, technically 1.5 years ago.

Announced it really very close. So why has munis been such a nut -- tough nut to crack in trade?

So it's interesting, and I think munis is just the last one to convert. It's a small ticket market. It's honestly a market that's not driven by CUSIP. And what I mean by that is people enter that market with an investment thesis, not a CUSIP. They just want a New York State bond in a certain sector with a certain maturity. And that's why, so it's -- I call it a Google search market. It's not normal market behavior where you have -- I have an instrument, and I need to go find that instrument. So that's part of the reason why it hasn't evolved quickly. I will tell you when I got to MarketAxess and being an equity guy, I never thought I'd like munis. But I got to MarketAxess and I've realized this muni market is in desperate need of electronification. It's all small tickets. Average sizes are way under 500. You see ticket sizes of 200 to 300 and those ticket sizes are falling, particularly given the attractiveness of munis in this rate environment. So again, munis are cool. Again, I hate to stress that they probably won't trade like crypto, but they are pretty cool yielding investments right now. And so I see retail coming back into munis, and the demand for electronic trading is going to skyrocket when you have this demand for the investment vehicle. When I did get to MarketAxess, started paying attention to munis the electronic share, our share, our electronic share of munis, was under 0.5 of a point. It's now over 6%. So electronic is growing. It's just -- we're all paying attention to high-grade market share. Munis is going to go quick because the difficulty of executing those small tickets for large institutional investors. They want those tickets automated. They want them off their trading desk and they don't want to be in a broker market. And in the fourth quarter, we finally rolled out our full automation suite to the muni market. So we have large institutional investors, trading thousands of tickets with a one-touch trade, which will change and revolutionize the muni market. So I'm super excited about munis. The MuniBrokers transaction was an exciting transaction, not just because they grow our share, but more importantly, it grew our data. And we also announced relative -- related to munis that with that data increase, we are launching our real-time CP pass for munis. This is going to change the muni market. The current real-time muni prices aren't great, we're going to have real-time prices across the muni market. And that will change how people trade and how they adopt automated tools.

So you've obviously been very successful in all the own credit. What did you learn from that success and give us your thoughts on your ability to replicate that in the rate side of the business?

Sure. I will jump to one other product where all-to-all is actually very interesting, and that's emerging markets. It's one of our fastest-growing products, it is a global product. It's $65 billion in ADV, average daily volume, and we're just a small portion of that, but a fast-growing portion of that. What's interesting about all-to-all is it's a sizable part of our emerging market business. It sometimes hit 40% of our overall share. So it's -- what it's reflecting is the network effect of all-to-all. When you start signing up clients and alternative dealers and I mean dealers around the planet, dealers from Asia, dealers from LatAm, dealers in Europe and dealers in the U.S., including your large global bank dealers, you get a better liquidity impact. And that's truly what all-to-all is doing in emerging markets. In treasuries, it's still early days. We're excited about what all-to-all will do, and it's really onboarding those alternative liquidity providers into the all-to-all markets, so they can both RFQ and trade treasuries on order books, which they're used to doing. So it's really a conversion ironically of some of the largest nonbank liquidity providers and treasuries onto our platform so they can trade treasuries, like they do in other markets.

Before you jump, I just want to take a moment and see if there's any questions in the audience. And if not, we can on the international side of the business. Great. [ Eli ], I would say, good to go.

Great. So then moving on to the international business. I know emerging markets has overall kind of been a little bit slower to electronify than most other regions. Do you think we're reaching an inflection point? Or is that really more of a longer-term story?

It's going to take a while, particularly in the local markets of emerging market bonds. When we look at the dollar-based hard currency emerging markets, where our large institutional investors trade those, they want to trade them electronically. So when you look at from the client perspective, the largest institutional investors on the planet globally have heightened needs to trade electronically. It's more efficient, it's cheaper. And if you think about those large institutional players, 2022 was a more difficult year for them because AUM across equities and fixed income went down. So when they're looking at their 2023 budgets, they're cutting budgets. They're not growing budgets in the face of that AUM decline. And so they're looking at technology solutions that they can't build. And so many times they look to us to outsource that technology solution and trade electronically. They don't want to have 30 emerging market and local bond traders across the globe, they want to reduce that number. And you can do that electronically. When we look at the EM market from a competitive standpoint, we see chat as our competitor and no one else. EM is one asset class that we are racing into, as I said, all-to-all is becoming a key ingredient to EM because you can have a unique bank in Asia, trading with a U.S. investor that they don't meet in normal face-to-face chat trading. They're just not counterparties. And we see that network effect in the emerging market, the international game of the emerging market growing pretty dramatically. And what -- the other interesting thing, and I keep coming back to data, the emerging market, there's no TRACE, there's no trade reporting. It is a dark market. And so our data is that we're collecting in the emerging market bond market is going to change that market as well. It also allows you to adopt electronic trading. When you know what the price is, you're more comfortable trading in electronically versus chatting with a large dealer.

Great. And to cap things off, maybe we could touch on Europe a little bit, maybe not as much of a growth area, but still growing pretty quickly. Can you give us some color on how market share is trending in that region?

So we continue to go up and the competitors go down. That's how it's trending. The overall market is -- it's a sizable market. Obviously, it's the corporate. Eurobond is the corporate market. We're head-to-head in competition for RFQ, standard RFQ with Tradeweb and Bloomberg. It's in a market that embraces electronic trading. So the overall electronic share of that market is quite high. And where it's head-to-head, we continue to win and we continue to grow share. If you just look at January, we continue to grow share, our volume was up, the overall market was flat to slightly up depending on currency conversion, but we love that eurobond market mostly because it truly embraces electronic markets and our share is growing against the competition.

Well, Chris, I think with that, we are out of time and out of questions. So on behalf of all us at Bank of America, we just want to thank you very much.

Thank you. Thank you for having me.

Thank you.