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

Thanks, everybody, for sticking around to join us for this next session. I'm Patrick O'Shaughnessy, Capital Markets Technology Analyst here at Raymond James. Up next, and I think the last presentation in this room tonight is MarketAxess. On their behalf, we have CFO, Chris Gerosa. We're just going to do a fireside chat. So Chris, welcome.

Patrick, thank you for having me here today. It's been long successful today. So I'm glad this is the last one.

So for those of you in the room or those in the room who are maybe a little bit less familiar with MarketAxess, Chris, could you spend just a minute or 2 kind of provide an overview of the company and kind of how people should think of it.

Yes, MarketAxess was established in the early 2000s electronic trading platform, focused on credit. And the original business model was really consummated on addressing small tickets, making them a much more efficient experience by trading on MarketAxess. And the business has evolved over the years, particularly in the wake of the financial crisis. We recognize the need for an alternative liquidity pool. And we established by working with our leading clients Open Trading, which I think today is the deepest alternative liquidity pool for trading credit and that model was tested in the pandemic -- early days of the pandemic in March of 2020, where when traditional dealers stepped away from credit, there was this alternative liquidity pull through Open Trading, and we were able to accommodate credit fixed income trading with our institutional client base. And so I think of ourselves today as a leading electronic trader in supporting your credit business. Also recognizing the access we have to trading data on the platform is establishing us in the early days of formalizing a very credible data franchise as well.

Got it. Thank you for that introduction. What do you think MarketAxess does better than any other company? Why do you compete effectively?

I think it's to my earlier point around the liquidity pool. We're very focused on the needs of our clients, both the dealer and institutional side of the house. And we've recognized that need for continuing to develop and deepen our liquidity pool through Open Trading. We continue to add clients on a quarterly basis. We're continuing to expand that liquidity pool across our other products in the EM, eurobonds and high-yield. And so it's just further expanding that network that provides the best liquidity for trading credit. And the next leg in the journey is going to be replicating a very similar liquidity pool for our U.S. Treasury business.

And then how would you evaluate how MarketAxess is leveraging its commitment to developing liquidity pools versus competitive set because obviously, there are some -- more established some newer to the space who are trying to get into U.S. credit.

Yes. This has been years in the making. It took a few years in the wake of the financial crisis to get the dealers and the clients on board with establishing Open Trading and we continue to invest in expanding that liquidity pool. So for new entrants that are coming into the space, I think it's difficult for them to engage the institutional clients for the clients to allocate resources to connect the new platform when where is the value proposition of where we already have that this liquidity pool. And I think the coexistence of Tradeweb, Bloomberg and MarketAxess, we're going to continue to be the leaders in this space. Ours is credit, others is rates. And I think that where we are in terms of electronification of fixed income, there's a lot of opportunity and runway for the 3 of us to participate and succeed.

Yes, that kind of stole my next question, which is, to what extent do you see yourselves as really competing against the other electronic platforms versus the phone?

In terms of electronification, it varies amongst the product set, and high-grade has been in our wheelhouse, it's been our leading product. Collectively, the electronification of high-grade is around 40%. We think that can double to 80% or 90%, not taking away everything from the film because one of the headwinds and challenges for us in high-grade is the new issuance market, and I think the institutional clients will continue to value the relationships they have with the dealers who are managing the new issuance activity. But I think that relative to where we are in high-grade, high-yield, emerging markets and even eurobonds is a more mature electronification trading product set. There's a lot of opportunity. And I think where we get really excited is the emerging markets when you size up the entire marketplace, it's hard to come up with an actual estimate of what the actual addressable market is because you don't have required reporting like we do here for U.S. credit and trace. But we think of the current share from a MarketAxess perspective is roughly 5% to 6%, which leads to a tremendous runway of addressable market growth in emerging markets. And that's a primary focus for us in the years to come is how can we invest and further expand our EM product set.

So I think I had some questions on EM in a little bit, but to focus on high-grade right now, U.S. high-grade. You mentioned the new issuance market is a tough one to electronify because that's very dealer-centric, blocks have also been, I think, a little bit more challenging to electronify in the past. What sort of solution does MarketAxess working on to really gain some momentum in the larger block trades?

Yes. We've invested a lot in the course of the last few years on automated trading solutions. And I'm very excited about the last phase of this rollout with r Adaptive Auto-X, which is an algo trading solution that Chris Concannon came on board and his vision of further penetrating Fox was to introduce algo trading and how algo-trading solution works is purely predicated on the network effect that we have in Open Trading. So the success of the algo trading solution is going to benefit from that liquidity pool and open trading and the other piece of the penetration for blocks is the user experience. We've invested a lot in our UI, and we're really excited about a new rollout of UI for our dealer and institutional clients that will improve their experience and bringing a block to MarketAxess, we can use our algo trading solution that will dismantle the block and feed it through all the various protocols we have in the MarketAxess ecosystem to get the best price of execution. And one of the concerns from the clients with our box is the information leakage about unloading very large high-grade box. And we believe that the more comfort that our clients get on our algo trading solutions and they can see the efficiencies and the cost savings they're receiving that will lead to increased share penetration on the block, which is roughly 37% of high-grade trades today.

Got it. Interesting. Speaking of U.S. high-grade, one of the challenges that MarketAxess faced in 2022 was headwinds to your high-grade fee per million. It's not that you're cutting pricing, it's just that the revenue capture that you guys did as a function of duration interest rates. Do you feel like that has probably stabilized at this point? Do you feel like if rates move up like higher here because inflation reaccelerates, there's some risk there? How are you guys thinking about U.S. high-grade pricing? And then how do you manage your business in light of the unpredictability of that pricing?

Yes. The pricing has definitely stabilized. I will say that. We had a low in our high-grade fee model in October of 2022. And it's the one product that we have that trades on a spread protocol and to get technical in bond map, the DV01 of a bond has a direct impact on our high-grade fee capture. And duration of a bond is impacted by bond yields and years to maturity of the bonds traded on the platform. What we experienced in 2022 is an unprecedented move in bond yields, where the Fed had rate hike 400 basis points in terms of the Fed funds rate in a span of 9 to 10 months. Rick's been around a lot longer than we have, and he's never seen any bond rate movement like that in his professional career. But just to size the math of every 100 basis points in bond yields is roughly a $5 impact on fee capture. So over $20 of the year-over-year decline in U.S. high-grade fee capture was due to bond yield performance. And where we are in the yield curve today, we don't feel that much more pain because we don't feel spreads or bond yields can go that much higher. So the remaining component of duration is years to maturity, which has been relatively stable around 9 years in the last few months. And Patrick, you did a great piece on the actual vintage of high-grade bonds today. Over the course of the last 3 to 4 years, new issuance has been much longer dated than what we had seen prior to the pandemic, which is a good story around duration because the overall mix of what's trading in the marketplace today has a longer years to maturity than what was in place 5 years ago. And so the stabilization around the years to maturity over the last few months, is leading us to a rebound than where we saw high-grade fee capture, and it's been relatively stable. And we pointed out in the volume release in February, actually, we've seen a slight improvement in deviation on high-grade during the month of February, which helped elevate our total credit fee capture to 167 from the lows of 160 in January.

Got you. And then as we think of high-grade revenue, the math is basically you have market share, you have fees per million and then you have industry volumes. And industry volumes in high-grade have been particularly robust the last few quarters. What is driving that really healthy volume growth in industry volumes? And how sustainable do you think that trend is?

Yes, fixed income is an actual attractive investment today where corporate treasurers 2 years ago, bond yields were yielding 0 or 1% on a single A corporate. Today, you can get 5% to 6% on a very short-dated investment-grade corporate. And so it changes the dynamic of how corporate treasurers are thinking about allocating their cash into higher-yielding investments. We haven't seen bond yields like this in investment-grade credit since the crisis of '08. And so it's just become a much more attractive and I think a permanent investment that -- it's going to be a good year or many years for fixed income to come because you're not seeing that 1%, 2% yield on a corporate. And then longer term, in terms of our automation strategy, we believe that automation is going to cause more velocity, more turnover in high-grade and high-yield. And so that will be a beneficiary that overall market volume should see a benefit from that increased velocity which is driving pretty stark year-over-year increases this year, which is mainly driven by, I think, that redeployment into a fixed income asset class that wasn't heavily valued before. And we also benefit longer term from the new issuance calendar where we may not participate in the first 2 to 3 weeks of a new issuance but in the secondary market, it's just adding that many more bonds to trade, and that's where we're benefiting as well.

What role have ETFs played over the last couple of years, both in terms of industry volume growth as well as maybe as a market share catalyst for MarketAxess?

Yes, it's been a much more actively used risk transfer mechanism in fixed income. And we've seen that in the first half of 2022. I think as the investment community in fixed income was experiencing the stark increase in bond yields and actions by the Fed. They were using ETFs as a very efficient macro means of transferring credit risk and our business was suffering as a result of that because we weren't actively participating in an ETF. And we've made investments and we've got ETFs on our investment strategy in order to be able to participate in that in the future, but more recently, with new issuance activity, we're seeing rebalancing of ETFs at the end of the month. Where ETFs are rebalancing into more liquid, new issue on the wrong corporates and unloading the off-the-run not newly issued bonds. And our month-end volumes are seeing a pretty stark increase. And we hear that it's due to these ETF 3 balancing just to get more of this new issuance activity into the portfolio.

And do you guys feel like you punch above your weight class with ETFs that your trading solutions are particularly conducive to how they want to manage their portfolios?

Yes. And we've made investments with RFQ-hub. We have a minority investment with a partnership with Virtu and a couple of the key market players to help establish fixed income ETFs. And so there's the right investment that we've made in order to increase our participation there as well.

And then switching gears to U.S. high-yield corporate bonds. That product is quickly catching up to the U.S. high-grade, both in terms of revenue and market share. You've had particular success with Open Trading in high-yield. Why is Open Trading even more popular in high-yield than it is in high-grade?

So high-yield -- and just to compare high-yield and high-grade. High-yield doesn't have the same headwind factor that we're experiencing in high-grade with the blocks because high-yield just blocks defined differently. It's a block trading high-yield is $1 million of warrant size and high-yield doesn't intend to trade at $20 million or $30 million blocks given the distressed nature of that rated asset class. And within Open Trading, our high-yield penetration rate has been north of 50% since we've seen those volumes increase in November. And it gets back to a more normalized credit environment where you have wider bid offer spreads, elevated credit spreads, more volatility, the dealers -- traditional dealers tend to slow down their activity in that asset class when there's more volatility while a bid offer spreads. And this gets back to the deep liquidity pulling Open Trading. Open Trading has that network effect that we can provide liquidity for high-yield trading in the event of traditional players slowing down their activity given the elevated risk in that sector.

So one thing with high-yield that hasn't been particularly as strong as just industry volumes, where high-grade industry volumes are up substantially year-over-year and high-yield are not. Is that just a function of -- I guess, to go back to your earlier comments, people are looking at high-grade bonds as an attractive asset class, but high-yield is not given concerns about the macro?

Yes. high-yield new issuance activity has not been robust. It's been good for our share gains as well as we just haven't seen that healthier high-yield new issuance calendar. And it's hard to predict. It's going to come back at some point, but I think there's still a lot of uncertainty on how this economic cycle is going to play. They keep kicking the recession came down the road, and it's going to be -- we're benefiting in the near term with our share gains. And as there will be more volatility, I think we'll continue to be a beneficiary of the high-yield volume contribution on the platform. And getting back to the revenue model, that's a very good thing for us because high-yield is one of our highest fee capture products that, on average, $300 per million, plus or minus $10 given the dealer fee plans that are in play. But from a total credit contribution, it's really positive for the revenue model as we experience higher and higher high-yield volume contributing to the platform.

Got it. And then I promise I'll get back to emerging markets. Obviously, another nice growth story for you. As you look forward, emerging markets is really 2 different markets, right? It's hard currency versus the local currency. Hard currency for you has a higher fee per million, but maybe it's a little bit more penetrated. So how are you seeing your EM opportunity across those 2 buckets?

Yes. The local market is where we're very selectively looking at the markets we're not in today, and the value proposition for MarketAxess is Open Trading. But with Open Trading, we're the counterparty to the middle. So to the extent that we're offering an Open Trading solution in some of these local markets, we need to be very mindful of what investments we need to make to adhere to the regulatory responsibilities as being an onshore broker-dealer and being a counterparty to those trades. And so from my perspective, as CFO, I want to make sure that we're prioritizing the investments and absolutely certain on what the all-in cost relative to the revenue opportunity because some of these local markets trade like government sovereigns, which have a much lower fee card, as you alluded to earlier. But at the end of the day, it may not be all about the economics. There may be such a high demand from our clients that they want us to be in these markets that we will move forward. If it's not achieving those operating margin targets that we strive for internally, and it's more of a commercial relationship to keep the stickiness on the platform. But each one of those local markets is different, Patrick. And we're very -- we've got dedicated resources to selectively assess what our responsibility would be for offering Open Trading in those new margin markets that we're looking to get into.

And then to wrap up our product-specific conversation here, municipal bonds. That's an area that's been a big focus of Chris Concannon since he joined MarketAxess, and it's been an area that you've had a lot of success with. Obviously, that's probably another product that benefits from a higher rate environment. But what are you guys doing to increase MarketAxess's penetration within munis?

We're approaching the final phase of the MuniBrokers integration this year in 2023. That was an asset that we had acquired 2 years ago. Where this year, we're introducing Open Trading into the MuniBrokers network, which MuniBrokers was a small asset we acquired 2 years ago to give us additional exposure in to the dealer market. And by opening up Open Trading, it gets back to that liquidity effect, the MuniBrokers is very fragmented, 10x the amount of [indiscernible] that you have in the corporate debt market, it doesn't -- sometimes tends to trade on an appointment basis and could be a buy-and-hold product because it doesn't actively trade. But by opening up Open Trading with further price discovery, improving the data pricing around municipal. So it's not just the commission revenue contribution from munis, but further building out a data franchise around a muni bond price offerings and fueling the automated trading solutions in communities. That's where I think Chris and all of us in management see that as tremendous opportunity in it's 5%, 6% market share for us today. So there's a lot of runway there for us to grow.

And then most of the conversation so far has focused on transaction fees, but you keep brining up market data. So how do you think about the opportunity for market data? Is it coming up with new products? Is it better monetizing your existing products? Is it -- when you have more market share, your products become more valuable? How are you guys thinking about that?

For data longer term, where I get really excited about this, and I'm sitting in the seat of a CFO or a controller that is managing a fixed income portfolio is the end-of-day pricing opportunity. Our intraday CP+ pricing is deemed to be a very valuable data set, which we can leverage off of that and establish a very valuable end-of-day product offering, spanning across high-grade, high-yield, emerging markets, muni bonds, all the products that are in our wheelhouse, it opens up the client base beyond the financial institutions that are trading on the platform. Any corporate treasurer that manages a fixed income portfolio, if they know there's an alternative end-of-day price that can help independently validate the value of their book, this is something that they'll -- they'd be more than happy to pay for. I think the auditors of those firms would want that alternative pricing solution for the end of the day valuation. But that's a few years out because you need to decide the customer-facing team investment that you need to make, we don't have that at the moment because you're dealing with the middle and back office of these financial institutions or you're dealing with the controllers of nonfinancial institutions, but that could be a huge opportunity for us, Patrick, if we get it right.

How do you think about pricing power across the business and probably mostly as it pertains to transaction revenues, but as you gain more market share and as you get a more and more differentiated liquidity solution, does that give you pricing power?

We have pricing power across all the product sets. And we've got various discount or rebate programs that we have offered to clients over the course of time to get them onboarded with Open Trading, get them acclimated to getting their systems up and running. And so in terms of the rebate programs, we revisit those once they're up to scale. They may not need the necessary level of rebates or discounts that they had to incentivize to get them on the platform. But as we think longer term in terms of the pricing power, I think longer term, as there's more velocity and bid offer spread is tightening, we may have to adjust our fees accordingly in order to make sure we're producing that best level of execution in Open Trading, which I think is fully achievable because we're providing a deepest liquidity pool and any adjustment to fees the increased velocity and market volume contribution will more or less make up for any fee compression on that front. That's a much longer 8- to 10-year issue that I'm sure we'll be dealing with down the road.

Got it. And then how would you describe your philosophy on operating margins? Are you more focused on maximizing top line growth where margin expansion is just an output? Or is there a balance that you're trying to strike?

Number one priority is revenue growth and we want to invest across the products, the protocols, and geography to make sure that we're capitalizing on the revenue growth opportunity. In the last 3 years, we've made a lot of investments across the 3 M&A deals starting with LiquidityEdge, to get us into a new asset class, expanding our geographical footprint with post-trade through Reg Reporting Hub. And more recently, the MuniBrokers, as I alluded to earlier about the opportunity we're monetizing on that front. Behind the scenes, we also invested in self-clearing. So we made a big investment to transition to a self-clearing model in 2020, which the economics are there. We're saving a lot in terms of our variable costs. So the economic play has worked out for us. And commercially, we have a better management system over our failed activity that was being outsourced to purging in the past. And we also moved to an agile work in the environment in terms of the technology strategy in 2018. And so those latter 2 investments are outside of M&A that elevated our operating expenses, but it's all coming together this year where I believe that we've got a very good expense discipline strategy, and it is about driving that revenue growth back to a historical mid-teens rate. But I'm all about expense discipline as well. So we can see that operating margin expansion come through.

Got it. Well, why don't I pause and see if there's any questions in the audience.

[indiscernible]

The BlackRock announcement? Yes, with Tradeweb? Yes. So I'll start. Trumid pops up every once in a while. And more recently, they announced their efforts to get into portfolio trading, where I will give full credit to Tradeweb for being a leader in portfolio trading, which did really, really well in an environment in 2021. I believe we were quick to react and offer a very comparable solution because it's the same dealer and the institutional clients that use portfolio trading. And we continue to report record quarterly gains on our portfolio trading success since we made the adjustments we needed to make in 2021. Trumid did say they got into that space in January of this year. But the connectivity to new clients getting back to the Open Trading being a differentiator in terms of our competitive moat, I think it's an uphill battle for them to replicate that liquidity pool in Open Trading. Where portfolio trading is just a protocol, a tool that our clients and dealers can use to rebalance or unload large positions in the portfolio. It represents 4% of TRACE overall in high-grade. So just to put things in perspective, it's -- overall, it's a very small piece of the total TRACE volume in high-grade. And we believe that the rollout of our new user interface with our algo solution by taking trades into our ecosystem and delivering it through the -- it could be executed on portfolio trading, live markets, that's where the algo solution will be a differentiator. And now we have a suite of protocols that the competition just doesn't have available on their networks.

And then BlackRock?

And the BlackRock announcement. So we've been a party with BlackRock for 10 years. They're launching a new initiative, Aladdin Trader, where Tradeweb had announced -- they're signing up for Aladdin Trader. We're in discussions with BlackRock. We got a very good relationship with BlackRock and determining with them what's our role with this new Aladdin Trader initiative. So there's I'm sure going to be other news, announcements of other participants that are getting into this new Aladdin trading opportunity. But we are in discussions with BlackRock. It's not an exclusive deal with Tradeweb, and we've been dealing with BlackRock for the last 10 years. They've been a very strong partner for us with Open Trading success.

[indiscernible] We will wrap it up. Thank you, everybody, for sticking around for us. And thank you, Chris.