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

Okay. So we're going to get started. Welcome back, everybody. Hopefully, everybody's well fed. So for our next session, it's my pleasure to welcome Chris Concannon, CEO of MarketAxess. Chris became CEO earlier this year. Under his leadership, MarketAxess continue to drive innovation in fixed income trading through new protocols, enhanced use of data and further customer expansion. The firm also made a number of acquisitions to expand its addressable market as electronic trading of credit continues to evolve. We'll obviously spend time with Chris on the ecosystem broadly. And of course, what MarketAxess is up to and the strategy as we kind of head out into 2024. So thank you for being here. Great to see you. as always.

Thanks for having me. Love this conference.

Thank you. it's a busy time. Look, so I wanted to start with just the state of electronic markets in credit. Obviously, it's a big topic. It's something we talk about every year. it feels like volumes generally continue to move in that direction. More things are trading electronically. Recently, the pace of that electrification might have slowed a little bit. But what are your expectations for both U.S. and non-U.S. market when it comes to electronic trading of credit, call it, for the next 3 years?

I mean, it's a conundrum that everyone asked, right? Everyone asks me in every investor meeting, what's the true opportunity, how much can convert. We've seen other asset classes in the high levels of conversion to electronic like high 90s in some markets. So it's a very difficult question. I look at a couple of data points. The #1 data point that I see right now is -- and we'll talk about this, portfolio trading. If you think about the electronics market, right now, we've penetrated the small ticket size, highly electronic, a good portion of that, call it, that 40% of electronic market is smaller tickets in a typical evolution of an electronic trading market going from phone to electronic. The last thing to go is the complicated block size market. this market did it in reverse. Like we've obviously converted the small ticket to electronic. And then we jumped all the way to the largest ticket. Portfolio trades are $200 million to $2 billion. very complicated dealers, 2 to 3 dealers, sometimes one dealer pricing those portfolios. It's the more complex end of the market, and it's now been electronified. So we've actually made it clear that this thing can go pretty far from 50% into the 90s because we've just tackled the more complicated part of the market, the PT. The question is what is the conversion ratio of the middle. And I would argue that we're just now addressing what I'd call non-all to all size, more complicated. You -- it's -- I call it the $3 million to $10 million market. It's a little bit bigger than sending it into an all-to-all environment where you're announcing the trade to all by definition. So you want to be a little bit more careful and selective in who you're showing that trade to. 1 or 2 dealers fully disclosed, that is now being electronified. We see that opportunity, our rollout of our new platform is targeting that specific part of the market. And it's the piece that we're hearing from our clients and from dealers that they would like to see move into an electronic form. And that last piece about -- from dealers, that's unique, and that's new. From the client side, they would like to automate a good portion of their market. They're not hiring -- this is across the board. I've been around the globe talking to our investor clients, and they are not hiring traders. So the workflow could increase. They're not hiring traders. They need more electronic solutions to get them to the same outcome, but doing it electronically. And that sweet spot for us and for the market, I'm predicting is that $3 million to $10 million in, call it, U.S. high grade, it's a real sweet spot. And the dealers ironically certainly not fans of the electronic in the early days. They're using it more. They've made the necessary investment to price bonds electronically. But they go -- they automatically execute up to a certain size. But they're still willing to price bonds that are -- come in through an electronic means. They just need a human to price check it. And so they don't mind that instead of coming in through a chat or over the phone to a very expensive sales trader, we're seeing that electronically and quickly pricing it is beneficial for their economics as well. So we're in this place where both the dealer and client has made the natural conversion to electronic and now they both want to grow that piece of the pie.

And that's what can get that sort of next leg of the trade[ indiscernible ].

That's -- we have -- I look at the numbers and the overall electronification of the bond market has stalled. It's in the 40s. I think the next leg of this -- ironically, we jump to the giant block trades and skip the middle market. But what's important about the block trade is we've proven that the electronic solution works at all sizes. And now we're going back and finishing the rest of the market. So we're a little bit more bullish than you would have seen me here a couple of years ago. It's 90, it's 95%.

Right we'll attack some of the drivers because obviously, you guys have a lot going on in terms of innovation in new protocols. But let's kind of zoom in on the most recent trends. I know you guys put out the monthly metrics for November. So maybe at a high level, let's just kind of hit on some of the key notable market share trends look like, stabilized, improved a little bit, obviously, slightly better fee per million as well. Any notable trends that stood out to you from the November trends that you saw.

I mean, hitting records, again, is always nice to release into the market. It's always well received when you hit a record look, record total credit volume record Eurobond volume. That's a market that we've done well in this year and then record munis. When I arrived at MarketAxess, I fixated about the muni market. It's a market that is way behind. And It's still operating almost in the '90s, and that transition to -- and it's all small tickets. So I'm super excited about what we're doing in munis. It's a big deal to have record volume in November when the muni market isn't as robust as some of our other markets. So -- but the market backdrop, I think, was more favorable to MarketAxess, just -- we're still not seeing high levels of credit spread volatility. Volatility has ticked up a little bit, but it's really -- I think the stable rate environment is helping our clients move back into certain credit products, and we're seeing it in volume, and we're seeing it in turnover in the overall market. Market volumes have been up in November.

Yes. No, certainly helpful. All right. Let's go through some of the products, starting maybe with the U.S. credit. And on the last call, you mentioned that you guys weren't happy with the recent performance in the U.S. credit business. And then certainly, there's been some environmental issues that we're all aware of and maybe some things that are more kind of MarketAxess specific. Can you help us maybe unpack between these 2, the recent performance in IG or high-grade rather for you guys. How much of this was just the environmental problems and kind of low volatility and the duration issues that we've seen versus maybe some of the capabilities issues and how you're looking to solve those.

Yes. And look, I do think November is a little bit more of a better market environment. We are addressing the product and the product suite challenge. Look, as a manager of a large global institution, we should be -- we should offer products and solutions that are good in all different times. So we shouldn't be vol-dependent. We should be really -- and portfolio trading is a perfect example. We're coming from behind in the portfolio trading solution. We've done a lot in that suite of products, and I think we're going to achieve a much better outcome, particularly for our clients in the next phases of our PT offering. But that's a product that's much more attractive in low vol and all to all is highly attractive in high Vol. And so as we enter new levels of volatility, we tend to MarketAxess tends to do better. We really need a product offering that is offering solutions in both times. And so a portfolio trading solution, or a block trading solution. Those solutions tend to grow in lower volume. They're easier to price products and use the platform. So we definitely have to deliver kind of a complete offering. The PT offering is interesting. I think that's an area that we have a lot of ground to cover. Pretty encouraged in November, the growth of our portfolio trading solution, really, the next round. What's interesting about portfolio trading is early days portfolio trading was a PM dropping a portfolio that they preselected to a trader to go, "Hey, go and trade this as a PT". The clients have finally gotten a little bit more sophisticated and then traders are now kind of massaging the basket to optimize price. And a critical ingredient in that optimization is pre-trade data. And so the clients came to us and they said, "We want to see more pre-trade data so we can make better selections at the line items to improve the overall price of the portfolio" and we're seeing that. For example, if you correlate your list of line items to an ETF, well and behold, your pricing tightens and gets better. Because the other side of the trade is really trading this as a basket relative to the ETF. If you remove large chunky line items, your portfolio pricing gets better. And so what we've been delivering to clients is pre-trade analytics that help them optimize that basket. We've done that in November. There's another series of development coming out in January. So we feel good about that product offering. More importantly, it's proprietary data, and we don't think the competition holds. So we can deliver an offering that is a competitive advantage using our proprietary data.

That's great. How do you think about the opportunity set for portfolio trading for you guys relative to the existing operates. So if you think about the market share, and I know we're kind of slicing and dicing we're going from like overall, like IG market share among a couple of providers to now specific kind of protocol level market share stats. Anything you want to share with us in terms of where you are now and where you'd like to be with respect to portfolio trading specifically?

Yes. I mean it's a global offering. I think we're still kind of messaging the product in U.S. credit. We have products globally. So we have a portfolio trading solution in Europe and in EM. But our rollout of our new platform, EXPAREL is really where we're putting all of our energy and all of our proprietary data. And it used to be, like I said, here's how to trade the portfolio and get a best price from a couple of dealers. Now we're saying, here's how to optimize to improve the overall outcome. And I think that's the strategic advantage that we can actually hold. We made a decision back in the spring to stop building on our legacy platform and build everything in the new platform. So we're still rolling that platform out for portfolio trading and starting the old.

Okay. Let's talk about high yield in a little more detail now. There's been probably more volatility in MarketAxess market share when it comes to high yield in the last, I don't know, 6 to 9 months than I've seen a couple of years covering this company, right? So I think you've got as high as low 20s, I think, at the end of last year and as low as kind of mid-teens, it's important of that this year. So help us just kind of level set what's been driving such big swings in market share? What's the ideal environment for your high-yield business?

So high yield is definitely -- we've seen a lot of volatility in our share. And when you unpack it, what you see is high levels of ETF market maker activity. And the best market, which was probably last year, this time last year, was long only coming in and looking at high yield, or dispersing of high yield and turnover of high yield and then the ETF market maker activity. So ETF turnover. So when I look at high-yield ETF volumes, I see better market share for market access. So highly correlated to that. We've seen some, particularly over the summer, a number of the ETF market makers, the high-yield ETF market makers struggle through that low vol and low volume in ETF. But certainly, our ETF market makers activity in November was up 18%. So it obviously is helping to drive some of that market share gain. But I would say there are better environments that we've seen in the past for high yield. The good news is if you're kind of long fixed income, which I am, and at these higher rates, I think the fixed income market is certainly ready for growth from a capital asset allocation. High yields and interesting asset allocation and there's a strong demand, and we're hearing it from all the institutional investors, they're creating ETF products, particularly in high yield. That's an attractive product offering. So we do think there are more high-yield ETFs coming to market, more growth in the current high-yield ETFs in 2024, which turns into turnover. And so we're pretty bullish about what that high-yield market will look like in '24.

Yes. And we've heard from a couple of asset managers earlier today, speaking exactly to this point that the bid for credit as an asset class feels as like getting better into 2024 as opposed to people just kind of sitting in cash. So that should be obviously helpful to the to the underlying asset class.

I do think the biggest driver of that and what helped the macro market backdrop that we've seen is a stability in rate and rate forecast. If you are predicting that rates are going to go up, people are hesitant to move into fixed income because you're going to buy into a declining market. once rates stabilize and the forecasts are stable to down. it feels like a much better asset class to move into.

Yes. One of the other topics I was hoping to discuss is just the matter of sort of relative size of trade as a constraint. And we touched on that a little bit in the beginning of the conversation. But there are a couple of ways to think about penetrating the market further, right? Like either you move up market into these larger trades like the block stuff is taken care of by portfolio trading, but this middle or there's an ability to maybe break up some of these trades into smaller orders. Where are you in that journey? What are you guys doing to kind of facilitate that? And could that be also another element to drive electrification in the market further?

My view was rather than bet on one or the other, do both. And so -- and we had this opportunity with EXPAREL rolling out a brand-new platform to retool our delivery of our offering. So we've delivered a very successful all-to-all offering. I'll just focus on high grade because that's where share is most interesting. We've delivered an all-to-all offering all the time, and there's limits to all-to-all when you move up that trade size. Traders do not want to announce a $10 million size order for sale to the market. They'd much rather go to trusted partners and show them that and then work through an RFQ in a more private way. And so we're missing those orders from MarketAxess. Now what's interesting is depending on what you're trading, if it's Verizon 10-year, it should go to all the all you're going to get lots of responses. We have data that will tell you what's the best way to treat that order. Traders don't have that data readily available. So they just say, "You know what, any one -- anything $3 million and over, I'm going direct to chat, which is not an efficient way to trade a bond. And so the new rollout of X Pro is really targeting above $3 million and giving them data to say, should this go to all-to-all or should this go direct to a dealer. And by the way, if you do decide to go to 3 dealers, we can even tell you which dealers to go to. We're using AI on our dealer activity. We know who's responding, who's [ Axed ] and who's responding to the idea because there's -- I don't know, there's fake Axess out there I've heard. So there's really -- we're kind of testing those Axess testing that pre-trade analytics and helping traders make decisions on which protocol. We've been pretty much focused on 1 protocol, RFQ all-to-all. We're now moving in -- we now have PT, which is a dealer-only protocol -- a more complicated protocol, but we're moving into that bigger part of the market, which is too big for all to all not in a portfolio trade. How do I really electronify that piece of the market. And we're using a lot of proprietary data to help the trader decide what protocol to go to.

I got you. That makes sense. So I get a sense that you want to talk about EXPAREL, just from your comments so far and the automation theme. So why don't we go there, so as I think.

What I didn't talk about was the algo which I also wanted to talk about.

Let's talk about some of the new things you guys have rolled out. So EXPAREL Adaptive Auto-X you've obviously talked about in the past. Help us maybe with the road map of how you're planning to roll these out? What's already rolled out? What are clients using today versus really what is the catalyst to maybe see the uptick of these products that could reinvigorate the market share.

I'll start with automation because in November, we saw a 35% increase in automation volume relative to last year. That's a big jump. We continue to see automation adoption at a very high rate. And now let me explain automation. Automation is just taking a basic RFQ and having a computer do it. So it's a one-off Q, 1 line item, go to dealers, get prices back, automatically execute. We have 2 flavors. One is a trader can take a bunch of line items and automate that off a screen or some of our clients will just API in and send it right to automation, preselected controls, anything that doesn't satisfy those controls comes out and sits on the traders desk. That is about 24% of the trades in MarketAxess are automated -- no human intervention. And then it's about 10% of volume, our overall notional volume. So it's a big part. It's also the fastest-growing piece of MarketAxess and it's now spreading into things like munis, which is ripe for change. It's in EM, it's in Euro bonds. It's a highly penetrated inside U.S. credit. The interesting bit about automation, when I look at the client penetration, our #1 automation user is double the size, just automation volume to the next automated user. One interesting note, they are 1/3 the asset under management to the #2 automation user. So if you really use this stuff you're going to grow, and more importantly, you're going to be really sticky to MarketAxess. These are embedded uses. But you can see that they've really spent years perfecting their automation solution because they looked around and they said, if there are high levels of inflows, smaller tickets for like separately managed accounts, things like that, we need to be fully automated. We need to consume it, execute it, and have no human engagement. And so they made substantial investment. When I look at the larger asset managers, I just look at the opportunity that we have. The fact that someone is 1/3 the size and double in volume automated is telling about the penetration opportunity. That's just basic automation -- automated RFQ. The next suite of products which we just rolled out this year in pilot now out of pilot is adaptive Auto-X. So it basically says, you don't automate, but you want to actually not cross spread or have an opportunity to not cross spread it's funny, like the fixed income market rates and credit globally is the largest market on the planet. And it's the only market where clients even the most sophisticated cross the spread all day long -- pay full spread. In FX, these same clients have determined that, I could be passive and not cross spread. In futures, in equities, every other asset class derivatives, they try not to cross spread. In fixed income, they haven't developed the skill set to not cross spread. The reason why is there's huge human intervention. Traders are not good at pricing bonds on the fly. The places where that passive trading has really taken hold has been automated solutions right? So we have an auto RFQ, which is crossing spread. We have an auto responder, which is not crossing spread. It's pricing other people's inquiries. Adaptive Auto-X tries to put them both together. And they say, just give us a larger size order. We'll wait patiently. We'll post that order in our live order book, so that order is working. And then if an inquiry comes in, we'll automatically price it and price it better than anyone else in the stack, and we'll -- we have statistics on what we'll win. And so you save spread. If it doesn't complete your full size, we'll go into the market and start RFQing through auto RFQ. So we complete a larger size order. We maximize our opportunity not cross spread, and we do it all through a complicated algorithm. And then X Pro. The last piece, is basically taking it all and putting it together and giving a trader a view of the market that they can take in any size order if it's smaller size, we give you pre-trade data that says this is good for all to all, automate that, send that to your automation suite. It's all RFQ line items. We do -- we manage much more items is if you want to do something that is larger size, greater than all-to-all, we will tell you exactly how to size that order. We have something called tradeability that tells you what the market can consume in that [ indiscernible ], and then we'll tell you what dealers to go to. And we'll give you axis, pre-trade information. And then if you want to do a portfolio, you can wrap that line on them up and trade portfolio as well. So X Pro brings it all together altogether.

I got you. And again, the timing on X Pro is [ indiscernible ] out.

It's our. We're probably just over 50 users out of 2,000. So we have a long way to go globally. We've been targeting our heavy users and our portfolio trading users because this just manages bigger line items gives more pre-trade data just look for that rollout to continue through the first half of next year.

Tech uplift on the client side that's required just rolling it out.

The best part about this is if you already logged in to MarketAxess, you technically can log into X Pro. So it's a very light lift for the client. It's more -- we're being very methodical in the rollout, training traders, letting them figure out how to use the better tooling and a lot of training on the pre-trade data. This is data that no one's ever seen before, where we can tell you how to size your order, we can tell you, in fact, we have a new data product called CP+, which actually tells you based on the client type. So if you're a Tier 1 client and you have a size, let's say, $10 million, we'll tell you exactly what price to expect back with high levels of accuracy. And right now, our CP+ tells you average size order, here's what the price would be, whether you're on the buy side or the sell side. This new tool will tell you, if you're a seller and you're a certain tier of a client and your order size is a certain way, this is the price you should expect. This changes how people are going to engage the market -- and it also does wonders for TCA and all kinds of post-trade analytics.

Yes. So let's talk about data. It's actually was one of my next questions I wanted to hand on. So clearly, a very powerful set of data that exists in your ecosystem. And we talked about how you're really using that to power things like X Pro and continue to drive automation. You also talked about that there might be ways to monetize that data in the future that you're currently not doing because, again, the goal is to get more trading. So how do you think about the right time to go down that path? Is there a way to do both -- and just broadly speaking, any other ways you're thinking about monetizing this data set?

Yes. First, I think by segment -- client segment like there's certainly new engagement, a new entry from the hedge fund systematic users coming into the market. We typically make them pay for data. So those are typically hard dollar data users. The #1 strategy and it's part of the X pro's strategy in X pro rollout is take our exclusive data, our proprietary data that's unique and embed it in X pro and you only get the data if you use X Pro. We're not reselling that data. We're not redistributing that data. It's not for consumption in someone else's training solution. So you -- it's very exclusive to the X Pro rollout. And it's important because it's unique data that tells people how to trade. And that's an important part. And we spent 2 years kind of working on this data, and it's just finally hitting the market. It's really to collect orders into X Pro. So you can still, by the way, in X Pro pick up the phone and trade and just right click and send that trade into process trading. So it is protocol agnostic. So we want people to see the data, become addicted to the data and how to trade. And then over time, I think we can convert that into monetization. But more importantly, it's converting into trade likelihood of trade, which is probably more important to our share, our growth and our revenue growth.

Let's talk about some of the inorganic things that you guys done over the last couple of years, a couple of deals, largely on the smaller side and not particularly demanding from a capital utilization perspective -- if you guys have obviously a very clean balance sheet. So how are you thinking about return on capital and some of the deals you've done recently? Any kind of targets on accretion and methodology as you're thinking about potential future deals and just broadly outlook on M&A?

Yes. I mean, M&A in this -- there's a reason why this space has high multiples. The asset class is scarce from an M&A perspective. The -- it's not a lot of people doing what we do. So we look and search the globe for anything in the space, and there's not a lot. There's technology solutions, there's kind of geographical solutions. There might be other product classes. And so when you look at our acquisition history, it's small. It's really product extension, geographic extension or its tech enhancing. And so the way we think about it is, certainly, it needs to be accretive. And then it needs to be strategic to the core. So is it expanding our geographical position? Is it expanding our technology? Is it what we call tech accretive. If you look at the Pragma acquisition was the most recent acquisition. Did we want to be in ETF and FX? FX is pretty interesting, but that's truly tech accretive to us. This asset comes to us. It's got an EMS solution embedded in it. It's got Algo solutions. It has an order manager embedded in it. Like these are all things that a market like us going through Evolution desperately needs. So that is an interesting and tech accretive acquisition. The muni broker acquisition is really product expansion, but it's protocol expansion arguably because we are in munis, but it really -- if you look at our muni volume, muni brokers helps with that record of muni volume growth. It also engaged us in a broader set of clients. So some of the dealers that weren't coming to MarketAxess are now fully connected. So it's a better distribution channel. So -- and then our rates acquisition going back to 2019 liquidity edge not what I'd like it to be, but it did do a product expansion and also solved one of the biggest challenges for us from a competitive perspective was net hedging -- treasury hedging on the back of an IG trade. And so we solved that. We closed that gap with that acquisition. So it was accretive from a strategic perspective, economic perspective, we need to do more there.

I got you. All right. Let's switch gears a little bit. Let's talk about operating margins and just the P&L a little bit broadly. You talked about a significant amount of investments into technology and non-U.S. distribution that you've made over the years, you guys actually are including amortization of intangibles in your P&L as well. And obviously weighing on some of the expense growth as well. Most of your peers don't do that. Is the heavy limit. -- or you use GAAP and is a other to get away from using yet. So -- but if you think about the heavy lift on the expense side of things with respect to some of the bigger technology initiatives. Is that largely behind you guys? And how would you think about just a multiyear expense growth trajectory for the business?

Yes. When you think about our evolution as a global company. We've certainly made heavy investment in tact. We're going through a transition of legacy tech to new tech. So there's a heavy weight of investment when you're going through those transitions. You're still supporting legacy while you're investing in new. Pragma is an enhancement to that new part. So think of that as another big investment in tech, largely the employees of tech of Pragma are heavily weighted towards tech. The other areas of investment that we've made, it's people investment in geographic expansion. And think of Asia, which is -- we've made a substantial investment in Asia over the last 2 years. We're seeing the return on that investment in November. We've seen APAC growth. So it's a quite attractive growth, record volume coming out of the region. I think from a technology investment, we've hit high watermarks like we've made substantial investment. It doesn't mean we stop investing, but I think our level of investment and our trajectory of year-over-year investment both goes down because of the level of investment we made in the most recent 2 years. I think we will continue to invest geographically, it's a little bit more targeted and it's not as fast as the growth rate that we've had more recently. So I think we start to settle into a healthier level of growth rate on the expense side. And then -- and arguably, those investments should start yielding returns. If you look at X Pro portfolio trading, algorithmic trading and our international franchise, it's starting to yield returns. 24 is really test for the investment in our new platform, X Pro and our investment in automation. But if you look at this year and our return on the international business -- that's where we're seeing growth all year long with high grade and U.S. corporate not growing. We really saw substantial growth in the international business, and that's all the investment we made geographically.

I got you. Great. We have about a minute left. So if anybody has a question in the room, just choose your hand and we'll have a mic come around. All right. Otherwise, I'll squeeze one more in. pricing. There's not a tremendous amount of transparency in the marketplace. We see everybody's kind of fee per million, but the particles are different, the client structure is different. So -- as you think about this market evolving and becoming more electronic, typically that comes with some degree of pricing compression. Are we there yet? Is that a likely risk and kind of how you think about that risk for MarketAxess?

So the prediction around pricing compression is slightly flat, but it's not inaccurate. The level of compression is where I think there's kind of misunderstanding. If you look at history, and I lived it, pricing compression comes when you're delivering a product to a party that's redelivering that product. When there's a middle layer or a middle person, like a dealer, a broker, that can redistribute your product out to the client base. So think equities where we saw a massive price compression in the face of competition. It was always because there was -- you were delivering the same service to a broker who is then reselling that service to a client. In our market, we go direct to clients. So where the clients interact is where the dealers price that activity. It's a profitable event for a dealer to price that activity. There's a fee associated. So it's a dealer pay model globally, largely. And the clients are less price sensitive because they just need to get a trade done. And so we're -- it's a slightly different competitive environment. The other piece of the puzzle is you could have 15 exchanges in some markets. Because we're on the desktop because the client actually uses our platform, they can't have 15. So just in terms of what the market can really consume it's a much smaller sizing of a competitive landscape. When we look at the market globally, I'm talking globally, not just U.S., there's 3 players: Bloomberg, Tradeweb and us, and that's it. And that's who we talk to clients about that choose on the desktop. The clients can't consume lots of different services to conduct the same outcome. And so there's going to be competition, but there's going to be competition and unique liquidity and unique outcomes. And data matters, workflow solutions matter and ultimately, the liquidity that you have in your network matters the most because that's going to drive outcomes.

I got you. Great. Well, that's super helpful. Chris, thank you so much for being here.