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

Hello, again. Welcome to our last fireside for the day. Hopefully, it's been a great conference for everyone so far. For those of you who don't know me, I'm Alex Kramm, senior research analyst at UBS, obviously, covering exchanges and business services. Excited to have MarketAxess here, Rich Schiffman, Global Head of Trading Solutions. I hope you guys had a great day. I know this is the last presentation, as I said, and I think everybody is eager to get outside, it's a beautiful day, and to have a cocktail or 2. So why don't we just jump in, but thanks for coming and doing this.

So look, maybe we'll start very, very big picture. You have quite a lot of new initiatives in the work, new platform, new protocols, new trading functionality. Can you give us a sense of how your new growth initiatives are progressing? Which have the greatest promise? And what are your thoughts around the timing on when they actually make a material impact to your earnings?

No, sure. Happy to, Alex, and thanks for having me here. And I want to add, I did suggest we do the last session out on the patio because the weather is pretty nice out there, but I think everything was set up for here, so we'll work it from inside. But we're really excited about the many different investments that we have underway right now. We've got things in the short-term range and longer term as well. And I guess I'll start with the longer-term ones, and we had fielded a lot of questions in the sessions we've had throughout the day. And one in particular we're excited about is X-Pro. That's our new EMS like front end for our trading system. And it's a really important development in the company's history. It's really only the second time that we're making a shift of this magnitude and it's important for some of the new things that we're doing, including portfolio trading in particular. It is conducive for managing large lists, and that's really what portfolio trading is about. So it helps in both the PT front as well as in-comp list that we get from most of our customers. And it is, again, just very productive in terms of doing that. X-Pro is also important for our focus on larger size trades as well. That's a big segment of the market that is undertapped at the moment, I would say. There's a considerable amount of volume -- notional volume that's available in that segment. And X-Pro is designed to incorporate all of the data, all of the proprietary analytics that we have and help traders make decisions about where to trade, what kind of protocol to use, who to interact with and in particular, for larger sized trades, that's an important element. We want to help them make that decision about where they might want to send that inquiry, whether that's widely in comp, which we think is an excellent option in many of the cases. But when that fear of information leakage creeps up and that often happens with the larger sized trades, we're able to share information with them on who is most likely to engage on that inquiry at that time, in that size, in that direction. So a big part of that is coming from X-Pro as being the delivery mechanism. I'll also mention our automation efforts. We have a significant investment now in automation and algorithmic trading. We've had, let's call it, first-generation automation has been in place for several years now is widely used, particularly for smaller-sized trades, it's a really efficient way for a trader to process hundreds of trades and have the system do it automatically for them when it meets their criteria and then allowing them to focus on the outliers, and spend their time in that regard. So that's on the automation front and then adaptive is kind of the next generation of automation and algorithmic capability where we're basically putting the system into like a self-driving mode in a way allowing it to make calls on what protocol to use, placing the order in the different services that we provide and really doing a lot of the work for the traders. So exciting things on the longer-term front, and we believe it's going to have a big impact over time.

Right. So now that I've buttered you up with the longer-term question. I do need to obviously press you a little bit on the near term. And the first one is a little bit backward-looking because it's about January. But obviously, those market share trends in January, particularly in high yield, Surprised a lot of people. So maybe for everyone in the room and to my benefit, too, maybe you can just flesh out again what the biggest factors were on both a month-over-month and year-over-year perspective because it seems like it was an unusual month.

Sure. Yes, it definitely was a disappointment to us. And a bit of a surprise. So if we -- and we did a lot of digging into it, and let's understand why that occurred. And had we kind of had a look into what was happening during the month, we would have had an indication that an outcome like this would have come to be. And of the roughly 500 basis points or so of share loss that we saw from December to January month-on-month, the 300 basis points of that roughly was a result of a significant increase in the distressed segment of the market. So we say CCC credits are below normally been representing about 27%. I believe that was the December number. That activity shot up to 38% in January. And that type of business and use the example, DISH was 1 credit in particular that had some really significant volatility and activity going on with it and people wanted to know what's happening with this credit. It's the kind of situation where a trader is going back to the phone, getting on the phone with their coverage at the banks, trying to get some information, trying to get some insight into what's happening. And then if they're going to trade, typically, that trade is going to happen on the back of that phone call. So it's not really the type of trading that we would see naturally for electronic in comp type of activity. And we saw a big increase in that in the market. The corresponding decrease of that activity of what we would capture typically also going down as well, and that was a big part of it. Contributing as well. I mean, new issues were very active in high yield. And that's another area that the in comp RFQ, our typical business. It's not capturing the activity in new issues right at the break. That's another one where it's a lot of direct activity with dealers, a lot of swap activity that takes place that bonds will be flipped back to the underwriters. So not our natural strength in the business. We tend to capture some declines in dealer business as well. Although interestingly, we did not see that going to the competitor. And then finally, on PT, Portfolio Trades. That's been an area that we've been fighting back on. It's one of the few times if that happens, our competitors did get to PTs earlier than we did. We feel really confident about the solution that we have in the market today in some ways, and I think it's even a more competitive offering, but we did lose a bit of market share on portfolio trades. So it's a combination of events. Some of it external, we can certainly do a better job in getting our awareness with our clients raised and say, hey, you can do this type of PT business with us as well. It's a longer-term answer in terms of getting to some of the business that is not a natural fit for our protocols today, though.

Staying on the near term, maybe given where we are, if I look at the date, you can describe a little bit what you've seen so far in February. If I look at the environment from an outsider's perspective, volumes actually appear pretty strong. Spreads are down, however. So any other things we should think about as we think about how you're doing, in particular, as it relates to share so far this month?

Yes. I mean, I guess it's always hard to tell. In terms of our business, these last 4 days of the month are a considerable impact on how the month will turn out. We have a very big business particularly with indexers who do a lot of rebalancing at month end and repositioning and so forth. So it's -- even though it's 4 days to the end, it's too early to say how the month is going. I would say in terms of the trends that I just mentioned that impacted us in January, new issue has remained active. Credit spread volatility is actually quite low right now. And I guess the best indicator for that, we've seen over time, there's a pretty high correlation between the fix and credit spread volatility. So that can give some indication of particularly a business for our professional community, the alternative liquidity providers, ETF market makers, credit arbitrage players. That is something that is going to be influencing their behavior. And that's a big part of the business for us. But I think absolute levels are good, certainly in the IG market. And as the ebbs and flows of the market and volatility happen, we expect things will return to more of a normal trend for us.

All right. Zooming out a little bit and maybe shifting gears slightly, but pricing is certainly a topic that keeps on coming up. If I look at the last few months or even a couple of quarters, it seems like overall pricing has stabilized, but there are a lot of different factors underneath, including duration and mix, so maybe you can help the audience a little bit in terms of what you've been seeing there. And yes, what's been -- how you feel going forward, obviously, as the environment could change.

Sure. Well, we've got 29 minutes left, I could use all of that time to talk about the fee models and the various dynamics that occur with it. I'll refer to investment grade first and those who follow our company, sure aware. It's a yield-based fee model. So it is impacted by average years to maturity, absolute level of interest rates and for the last year or so, that's been working against us. And that has been a factor in the fee capture rate and investment grade coming down. We have seen a recent uptick in years to maturity. So that's a positive. And I'm not going to make predictions about where I think interest rates are going right now, but it seems to be the next move is that things are coming down. When that happens is an open question, but it will tend to lead to people moving further out on the curve and writing those rates back down. And that will help us from a fee capture perspective and certainly from an interest rate level as well. The general -- the general theme about our fees, the main factor is what is the bid-ask spread for the particular assets that are being traded. And the wider the bid ask the relative greater capture that we can take and also about the level of service that we are providing to our clients when they use the system. So for example, we talk about portfolio trades. It's really just a couple of notches above a process trade in a way. It's not a high fee capture service. It's relatively low in competition, it tends to go out to a small handful of dealers, call it about half a dozen direct trading. It's not a place where our open trading is at play at the moment. So it has a commensurate lower fee capture rate. So with PT share gains, we would love to have the market share and offer that service, if that's what our clients want. that is -- that business is at relatively lower fee capture rates. On the other end of the spectrum, the more open trading we do, the better that is for our business, the better that is for our fee capture. It is the highest value service that we provide, allowing participants to get inside the bid-ask spread and capture some of that for themselves. Especially when they act as liquidity providers, that's the greatest game that they can make. It's also our highest fee capture opportunity. And we run -- about 1/3 of our business right now runs through open trading. As that number increases, and it can fluctuate a couple of hundred basis points here or there depending upon business mix. But that tends to contribute to an increase in fee capture.

Great. Maybe this is a catch-me-all of some of the things we already talked about, but I'm going to ask the question anyways. If you -- because we were very near term and long-term focus, but if you look at the last 12 months, clearly, it's been a challenging environment. But again, maybe you can help us a little bit think about what were those challenges, what's debating? And then in reality, I think sometimes people don't really know what's the best environment that you're actually hoping for, right? And which you hopefully will get at some point again.

Yes. I'm sure that definitely happens, the market goes through its cycles and things. And one thing that's kind of interesting, and we've seen -- we've generally done better in falling interest rate environments than rising rates. And not exactly clear why that is, although in certain circumstances, there are some clients of ours who don't necessarily want to sell at a loss. You take insurance companies. They might not do that and not trade again, holding on until rates come back down and then they might reposition. So that's potentially one factor. But certainly, an environment with relatively higher volatility is going to draw people to our most valuable services. Again, the in-comp trading, open trading, where spreads widening out, makes for a lot of opportunity to capture that spread. We saw that the most extreme example of that was back in 2020 during the pandemic when with all of the disruptions in the market and everyone's situation at work and having to work from home and things. We don't expect an extreme example like that, but that type of market disruption and what was going on at that time, that's a great environment for our business, and it draws people in to take advantage. An interesting phenomena we've seen when things are quieter, it gives clients sometimes an opportunity to kick the tires a little bit of a competitor and hey, maybe we'll try that out in things. And then we've always seen when it really comes down to their most critical business to get done in times of turmoil, in times when the market is very active, they come back to do that business where they know they've got the most comprehensive liquidity in the market. They've got solutions that they're most comfortable with and that type of reflection. But I'd say that, that big factor is around not very tranquil markets, but a little bit of activity in. Again, I'd point people back to the VIX as a good indication of when it's going to be relatively better than some of the more quieter periods.

Helpful. And then as you're well aware of, I'm sure, is that investors are very much focused on market share in the U.S., which, quite frankly, appears stalled. So again, can you just, bigger picture, help us a little bit about what are competitive dynamics, which I think a lot of people are obsessed with? And then also -- or is there, maybe, just a saturation of electronic trading altogether?

Yes. A fair thing to be wondering about, and I'll give you our view on this. And we like to think about it long term. There's no question. We watch -- we put the numbers out monthly. We watch it day to day. We watch it intraday and things. But it's very easy to get lost in the weeds there and miss the bigger picture about where we're going. And I would ask anyone who covers this and thinks about it, where are we going to be in 2, 3, 5 years down the road? And I think it's unquestioned that there will be a significantly higher penetration of electronic trading than there is today. Everything is leading in that direction. Buy-side firms are on a quest for more efficiency. They're lowering their costs. They have to with all the pressure that they have that they are facing in terms of their fee capture for managing money. They have to figure out a better way to get things done with less resources. Electronic trading is the answer for that. In terms of the way to get the best execution in the market, there's nothing better than being able to interact with everyone who participates in this marketplace. That can only be done through electronic trading. We're at a -- we're 24 for our company, say, 24 or so years into this, in investment grade. The survey data kind of shows it's about 40% penetration today in investment grade. 60% is still happening the traditional way, which is traders still picking up the phone and Bloomberg, IBs, and things of that sort, that's not a sustainable model. And I would make the argument we're going to see virtually 100% electronic penetration but in different forms. So a big part of that is going to be in comp trading. There will be new protocols coming in. PT has a small niche of it, about 7% is portfolio trading. Anything that's still done the traditional way, it's going to be processed electronically. So I don't think there's any buy-side firm that sees a future for doing things in a manual fashion in this market. And it's up to us to put the protocols out there that are going to track the different ways that our clients want to interact in the market, and that's going to grow the share over time. And I'll just add, we've seen the kind of ups and downs in the past. It's not been a straight line up from the starting point. There's been some up and down. And then sometimes something new will come along or shift, and you see a jump up. And again, that's something that we saw in 2020, highly likely we're going to see that kind of jump step as well.

My next question actually was where you're thinking the long-term electronification of credit markets is. You somewhat answered it. I don't know if that 100% number that you mentioned is the right number, but what's the latest number you're working with internally? Do you think it is almost all of it?

Well, that's a long-term view, and I don't want to get too far ahead of ourselves. But just given the -- looking broad scope and over time, I'd love to hear the argument for trade staying on the phone. It really doesn't make sense. Now the debate is only about the speed. How fast do we move down that path -- and for the overall industry not just for ourselves, it's been kind of at that steady kind of 40%.

Staying on the same topic then. I mean, obviously, you've done a very good job on the smaller trade spectrum. So -- and you've alluded to some of this already in our discussion. But again, what can you really do to gain share in that larger, larger trade size?

Yes. It's been a challenge. And a large part of it is behavioral. I mean we've got investments in new protocols and new ways to interact and it's also about changing trader behavior. And I always like to point out when I'm asked that question, we do plenty of block trading on the platform today. And say about 1/4 of the volume, the notional volume takes place. It's a small number of relatively smaller number of tickets. So we know we have solutions that work in the market today. In-comp, RFQ can work. If a trader is willing to set aside concerns about information leakage and there's a lot of resistance that kind of comes up about I have this large block to trade, maybe I shouldn't put it out there in competition. What we can say with confidence is those who do get great execution, and actually get more responses on those inquiries than some of the smaller trades that go in, some of the smaller inquiries. But not everyone is there yet. And again, that's up to us to say, well, what else can we offer for the traders who are going to be a bit more hesitant, maybe it's a less liquid piece and they don't want to go out in that same way. And that's part of what we're investing in with X-Pro right now, which is trying to give them the data to help them make those decisions about what is the best way to trade that block in the market. And if they come to the conclusion like, well, maybe they want to keep it narrower. Well, we can recommend these are the best 5 dealers to go to with that inquiry right now. And on the horizon, we want to do that same type of connecting with other buy-side firms through Open Trading. Because there could be nothing more valuable to that trader who has a block to get done. If we can tell them, hey, these 8 or 10 buy-side firms, who you don't know, are very likely to have interest in that position right now. And be able to make -- think of it as a narrower version of Open Trading. So that's another possibility as well. The last point I'd make about blocks, and we believe pretty strongly about this in time that it will start to look more like the equity market, where often a block trade is done by breaking it up into multiple pieces and running that through an algo. And that's what Adaptive Auto-X is about, is making it very easy for the trader to allow the system to help them get that block position done. Without disclosing all the information about what it is, but leaving a piece in an order book, being able to automatically respond to inquiries as they come in, in that name. And then when they've given the time that they can for that, the system will then automatically send out RFQs in pieces on their behalf. So another approach and it can be a great way to get liquidity from some of the providers that are out there that don't necessarily or don't have the ability to bid or offer say, $20 million or $30 million, but they can do really well in the $1 million to $5 million range. So it's going to be a combination of things, but we don't discount the effort required is behavioral quite a bit as well.

Flipping the question around. And I actually asked something like this on the earnings call just a few -- a couple of weeks ago. But again, the penetration on the smaller trade size market as you've done a phenomenal job there. But do you still feel like you're defending your share in that area well? Or are you seeing some of the other entrants, Tradeweb, Trumid, everybody knows them, actually gain real share in that core market of yours?

Yes. Look, that is a stronghold for us. We felt that we've held that business up quite well. And we'll continue to do so. It's an area of the market where the Open Trading is so impactful to give up that liquidity and go to a different network. It's just hard to reproduce. So I think that gives us confidence that we will continue to hold on to that piece of it. There's no question we want to do better at portfolio trading. And it's interesting. We do see portfolio trades coming into our system as well as those that we monitor in the market, that there are times some are being chosen that you'd kind of scratch your head and say, why is that one being done as a PT where we believe the client could do much better with an in-comp trade. So that's on us to bring some of the features that might be causing them to choose the portfolio trade and have them still do it in-comp. We want to get the benefits of portfolio trading, together with the benefits of in-comp, that better execution, that ability to execute with the best line items and let's see how it compares. Right now, it's very hard for the client to make that choice. They're kind of guessing and saying, well, maybe I could do better over here. I'll try that PT. It's up to us to make sure that we give them the information that they can execute in the way that's optimal for them.

You just mentioned portfolio trading, thanks for the segue. Do you still think you can be the #1 player because I think maybe 2 years ago, you kind of made that, I don't know if assessment is the right word, but you set that goal.

Yes. And we definitely do believe that I said we came to market with a solution later than our competitor did and it took us a little time to catch up. Now we have high confidence in the solution that we have in the market. It's highly competitive. In some ways, we believe that it's even better. We support a larger number of line items, for example. We can go up to 5,000 line items on a PT right now, and that's not matched by our competitors. We also have features that, for example, enable a client to see which bonds are affecting the price on this portfolio. We call it outliers, which very quickly lets them identify the bonds that are having the most adverse impact on the price of that PT and then be easily able to exclude that and trade the rest of the line items. So it's features like that, that we think are unique. The good thing for us on this point is that we have all the clients onboarded. It's not another set of clients that we have to find in the market or somehow now spend a lot of time onboarding. It's the very same clients that use us every day for their in-comp business, and we need to again, make them aware of the great solution we have in PT and have them do some of that business here. So we feel really good about what we have out there, and we expect that share to grow.

Stepping back a little bit again and coming back to the overall growth in the market and electronification. Some -- one of the things I've something here is that even though the market has become more electronic, turnover velocity has not really increased. So anything you would remark why that hasn't happened even though electronic trading has been more adopted.

Yes. I mean we have seen some modest growth in the investment-grade space. I think there's a lot of other factors aside from just the electronic trading that may affect that turnover. But on the long-term trend for this, and we've seen this in other markets, the easier you make it for people to trade and the easier you make it to trade smaller sizes and again, through things like automation, it's naturally going to lead to more turnover in the market. I don't think there's a scenario where we would say like turnover is going to be reduced. I think over time, we should see as more electronic trading is adopted that, that number should certainly increase.

Maybe as a follow-up to that, I mean, there was a lot of excitement last year when Citadel talked about becoming more active in credit markets. Can you, maybe, broadly talk about, maybe not specifically about them, but just how automated traders are coming into this space and if credit trading is fundamentally changing or if it's still early days with that?

Yes. It's still early days. It's become quite big, and I don't think the growth in it is anywhere near topping out. It's a big focus for our business. We work with all of the systematic providers. It's a general category of what we call alternative liquidity providers, which includes ETF market makers, general credit arbitrage shops and systematic players. They can be set up as dealers, and Citadel is an example of that. Jane Street is an example, Virtu, firms that -- names that people are familiar with and are quite successful, those who are in this space already. And behind them are several dozen other firms that people have generally not ever heard about and are also very active on the system. And it's really having a positive impact on the ecosystem. It's great new sources of liquidity for traditional buy-side participants. It's a great business for us. We have a really significant focus on working with these firms, giving them the types of solutions that make it productive for them to operate. If they're a big shop like a Citadel that wants to establish relationships, direct trading relationships in credit, we have the ability to -- for them basically to leverage our sales force in helping to set up connections. All of the firms work with Open Trading as liquidity providers. And some of the smaller ones I mentioned, they continue to work anonymously. And one way I refer to this is we basically offer a solution that's like dealer in a box. If you want to operate as a market maker in credit, you can come on -- any firm can come on MarketAxess and be in the flow of virtually all the inquiry that comes in from our buy-side customers and dealers and be able to be a liquidity provider without the overhead of having to be a broker-dealer. Again, some choose to set up in that structure, particularly if they want to do some direct business. But this ability to get into the credit markets like this, it never existed before Open Trading came out about, about 10 years ago. And again, great for the buy-side. It's a really good business for us, a big part of our focus. It has implications when that credit arb becomes a little less active and, again, we see that in some of the market share. But the long-term trend of that is really positive for the market and positive for our business.

Now I think -- and I'm looking at the time here, we've obviously been -- and investors continue to be very focused on the U.S. credit business. But we should probably spend a few minutes talking about some of the other markets where you've, quite frankly, been fairly successful, probably not getting enough attention or credit for it. So EM looks really big. I think it's going to be big in revenue terms than high yields. If I'm looking at the current trends right now for this quarter, Eurobond looks mixed. I think there was some good trends earlier last year and then maybe flatten a little bit. But yes, maybe talk about what's going on in those other very important markets, both from a market share, from a competitive perspective, anything that you think investors should maybe focus a little bit more on.

Sure. We feel great about both of those businesses, and we had a great 2023 in our Eurobond business. The activity happening in the region there has been great. We have competition there. We always have, but we've done a nice job of winning that back. We have, in particular, an institutional focus that's been where we've made our place there in that market. Although recently, we've actually put a focus on private banking activity as well, with a front-end solution designed specifically for private banks. We call that one Axess IQ. You can think of it as analogous to X-Pro, which is designed for the institutional space. Axess IQ focuses on the unique needs of private banks, and we've captured some nice business that way as well. We feel great about emerging markets. That's an area where we feel we're quite ahead of the competition and continuing to grow it. Global in nature, of course. And we have operations in Lat Am in Europe, in Asia, capturing business there in emerging markets. It's a market where Open Trading has a big impact, and that's a real driver for us. Around 40% or so of our EM business is taking place in Open Trading, which is a great differentiator for us. So we felt really good about that one. Recent developments in emerging markets has been local market activity where we've been in that space for several years, just towards the -- in the second half of 2023, we introduced Open Trading for local markets in 4 of the key currencies allowing global investors to access local liquidity providers without having to have a relationship. So that's a real new addition to their liquidity needs when they need to operate in those markets. So a great space for us. We are very optimistic about the potential in that area. And right now, not the most competition compared to some of the other markets that we're in.

I have a couple more, which are on expenses and capital, which is not really your -- your day job. But I figured I should at least look at the room, as we have a few minutes left, and see if anybody has any other revenue type questions addressed. Not? I'll keep on going. Yes, I will. Everybody is ready for cocktails. So look, you did actually announce a new CFO hire, so maybe I should keep the expense question for her. But like I will ask you anyway. So like, look, you just obviously gave expense guidance for 2024. The feedback I've gotten was fairly mixed. Some people say like, hey, lower growth than in the past years, that's good. Maybe they're finally reacting to some of the slower growth environment that we've seen. Others actually came back and said like, well, maybe now they need to spend to defend their turf, which it looks like from a market share perspective, you need to. So how should we think about -- or how do you think about the expense growth targets?

Yes. So as you said, we put that out. I think we said about 7% or 8% on the organic front and 12% when we factor in our acquisition of Pragma. And my answer on it is that we are investing in all of the key strategic initiatives that are important to us. We have not taken our foot off the accelerator in that regard. We are looking to be a little more cautious in terms of the kind of corporate supporting expenses. We've invested quite a bit in the infrastructure of the company, let's say, over the past several years, and that's now in place. And we don't think that, that part of it needs to grow in the same way. But by no means are we skipping in any way on the strategic initiatives, in the capital investment that we make on software development. I mean that is the key part of our business, what drives the growth and no slowdown in that regard. We will do everything that we need to grow this business.

Perfect. Well, with 1 minute left, I'll ask one last one on capital allocation. Maybe latest thoughts from your perspective here, buybacks, M&A, anything we should be expecting on the M&A side, in particular. I mean are there still areas you look at where you say, there are some capabilities, some things that could rely fit well with MarketAxess? Yes, what should we expect?

Yes. No, just a quick answer on that, I would say. We're always on the lookout for particularly assets that help us from a technology perspective and can be accretive to earnings. We feel good about our organic business. We feel we can achieve our objectives in that way, but would be opportunistic when things present themselves. So clean balance sheet, no debt, it's easy for us to do things when the right opportunities present themselves and they are a good strategic fit and certainly bring technology assets like Pragma. It was a great example of something that is an attractive acquisition.

Excellent. Well, I see the red light. So I think a perfect way to stop. Rich, thanks again for making all the way down here. Safe travels back, and hope to see you again when we have this thing again in a year.

Terrific. Thanks, Alex.