TMX Group Limited (X) Earnings Call Transcript & Summary

Good morning, everyone. I'm Ari Ghosh, and I cover the U.S. exchanges here at Credit Suisse. For our next section, we are hosting a fireside chat with TMX Group to discuss the state of the Canadian markets and exchange trends. It's my pleasure to welcome CEO, John McKenzie today. John, I wish we were doing this in person in sunny Florida. But again, really appreciate you being here with us virtually. Thanks so much.

Thanks for having us.

My pleasure. So let's just jump right in. So 2020 was a disruptive year for global markets to say the very least, but the operational environment looks relatively improved early in 2021. So let's kick things off with what you're seeing from a customer engagement standpoint across some of your key segments? Have things returned to normal? Or are there specific areas where you're still seeing some pandemic-related pressures?

Well, first of all, I'd say that the customer engagement even all through 2020 was really remarkable when you think about how disrupted everyone's business models were. And we made a really strong point, and I know they did in the U.S. as well of ensuring the importance of keeping capital markets open and robust because, quite frankly, we're actually part of the solution on recovery, not part of the challenge. So for the most part, the engagement has been very, very strong. Certainly, where we saw one of the challenges was earlier in the year about companies being able to come to market and raise money when market volatility was so high. But not surprising, as we've seen in other kind of downturn trends in the past, with that low interest rate environment, with the renewed valuations in the market, we've seen a phenomenal opportunity for companies who raise money in the back half of the year that's continued into 2021. The areas where I would say in terms of where kind of some of those client challenges persist both through '20 and into '21 is when you're -- we're trying to do things that have a high client touch point. So we've been working on building out our Trayport franchise in the U.S. And while we've got great traction with our partner, Nodal, the ability to get in with clients and get engagement and get installs done, work with service providers, that's been a bit more challenging because everyone is actually just working to try to keep their businesses running. But I do see light on that in 2021, we're going to start to see more progress. Similarly, where we saw things difficult engaging is when you're trying to engage with international customers where you do want to get face-to-face, so in market for our expansion around Asia, I was worried about that in 2020, where we need to get back on the ground again. But we have got our folks back on the ground, and we're looking to get ready to go live for our derivatives trading in the Asian time zone in Q2. So very positive what that thing is going to be for 2021.

Got it. And we're going to hit on some of those points in a little bit. But let's start with your trading business and starting with cash equities. Volumes in the U.S. here were up 50%, driven in part by volatility and also greater retail participation. And that remains kind of elevated this year as well. You saw similar trends in Canada, so I'm really interested to get your thoughts on the level of retail activity that drove your cash volumes. And if you see this retail boom as sustainable?

So that's a great question. I'm sorry, I'm already parched today. The -- so we've seen participation from retail flow go from about 35% a year ago to 45-plus percent today across all our markets. And as you said, very strong upticks in volumes all through 2020 into 2021, it has continued to be very strong. And in some cases, even stronger, where our senior market, TSX, were up about 33% year-to-date. But our junior market, the Venture Exchange, which really does trend more to retail engagement is up over 80% this year, so really showing that demand for retail fuel activity. And we have hit multiple new record trading days for our Venture Exchange market through that period. When I think about the underlying trends, and it's not the GameStops of the world. It's the -- what are those fundamentals that are driving the opportunity for more retail participation. We've got a largely work-from-home culture right now, more disposable income for folks that are working. Retail access in a way they've never had it before in terms of both trading tools, access tools, disclosure and dissemination of information. So the ability for retail to participate is as high as it's ever been, and that's continuing. And then when you couple that with a very low interest rate environment, which means 2 things: one is the cost of borrowing or cost of credit is low; the ability to get yield in the debt market is not there, you've got to look to the equity markets; and the corollary, strong equity valuations make that market good to invest in. Those are all trends that are going to continue for the time to come. And while there are challenges with this kind of activity that we're seeing in some specific names, I don't want to forget the upside, which is the more retail participation we've got in terms of strong valuations, the more we can have small companies come to market because they're able to do really good equity capital raising with this level of participation in the market. And that's a good thing for market integrity.

Yes. No, that makes sense. And are there any specific company initiatives that you've undertaken to sort of capitalize on this growing retail segment?

It's more about the ability for us to support the market no matter what it's doing. So we've been working on about 1.5 years program around modernization of our equity platforms to really make a more robust, more resilient, able to handle larger swings in volatility and the messaging traffic that comes with this renewed interest. So that's our focus, ensure we've got all the infrastructure there to support whatever the market wants to do. The other area for us that it's more when we think about options, U.S. options has been on fire through this period. And while the Canadian option market has been growing, I think we're up about 20 points this year, it hasn't been as well embraced from a retail trading activity as it has in the U.S. throughout the years. And there's some structural differences around licensing of agents, around access to product. But what I hope to see here, we're going to continue to push on the education initiatives. The demand for retail, I think, will drive more dealers, more banks to provide access to these products to retail traders. And I think that will be positive for us.

Got it. I think that's an interesting point. We're going to touch on that next sort of moving to the Derivatives business. Maybe just starting with the outlook over the next 12 months for your interest rate derivatives, where the macro backdrop has improved a little bit versus what you saw towards the second half of last year.

Yes, certainly. And even in the back quarter of last year, we were starting to see that sequential growth happening again month by month. The -- we've been doing -- what we've been doing in terms of supporting the market but also adding product is what's going to help us long term here. So the interest rate market that was so depressed with this low rate environment always believe that, that -- while that can depress your short-term products, it doesn't mean necessarily it's going to depress your long-term product. So we've been focused on getting more product across the yield curve for traders to trade against. So we actually, in the middle of last year, in the middle of the pandemic, we actually relaunched our short-term 30-year product -- 30-day product. So a new short-term product that's got a better benchmark. We added a 2-year product in December of last year based on client demand to do that. So you can think about that. So even though the market has been depressed on the short-term curve, clients wanted to see us with a 2-year product on exchange. And so we were able to launch that in December. We've already got a very strong 10 that's been recovering really well. I think we're up another 20 points roughly this year so far. We've been getting strength in our 5-year product, which was the one we relaunched a couple of years ago, and we've got client demand for 30 years. So the client -- the demand indicators are there to provide support to that curve. And then the work, as I indicated earlier, that we're working on going to Asian time zone as well. We're already open from 2:00 a.m. so we trade European time zone. And that actually helped in 2020 because even though volumes were depressed, we got 6% to 10% of our flow coming out of that time zone trade that we wouldn't have had 2 years prior. So we actually got some offset to some of that pressure. So we are looking to get out into the Asian time zone in the second quarter, which will then kind of catch us up to the other global exchanges to be able to train virtually around the clock.

Got it. And I think that's a good segue into my next question, which is more on the broader derivatives industry and some of the trends that you see there. So across equity, index, rates, what's sort of the industry growth outlook for the segments as you kind of consider product maturity in Canada? And then when I think about these segments, are there particular spots where you see more growth opportunities either through product development, globalization of the base, for example? Or something else, to your point, with the auctions market seeming to be at different levels at Canada versus U.S. as well?

Yes. So globalization absolutely is going to be a growth driver for us. We've got about 40% of our flow coming from outside of the Canadian borders versus most global exchanges that are closer to 60. As I said on the time zone trade, we're doing about 6% right now out of the U.K. Mature platforms will have 15% to 30% of their flow coming outside their normal time zone, so those are all indicators of growth potential that we're trying to capitalize with the geographic solutions, which is not just time zone. It's actually time zone, access, clearing capabilities to make it easier for you to trade from different regions. So it's all in the plumbing that goes with it, not just the -- when you turn it on each day. As you indicated on the product road map, now that we've got all the different components that we're looking for on a yield curve, it's going to be about marketing those products to clients to get the liquidity built into them and then liquidity can beget liquidity to build them out and people will then trade across the curve. So there's some maturation that's going to happen to those products. We can't -- you don't just put them on the market and we're done. We need to build them out. On the other piece of the product curve, a couple of neat areas that we're focusing on product development. One is clearly around interest around ESG. So with our partnership with S&P, we have launched ESG Tilted indices for both the composite, the Canadian composite for the 60. We've got futures that we've launched on those now as well. We'll be looking for additional products in the future, and that gives people a different lens of the equity complex that they want to trade for Canada. And we're also looking at different types of products around the equity complex. So dividend-based futures, other futures on single names. We are one of the few markets that does single-name futures so we can -- when you've got either a stock or an ETF, it's very hot, we can put a future on that, so people can get future exposure to it. And those are all things that we continue to build out. One of the other areas that we've worked on and we think that will be part of our long-term focus is global product. So everything we've talked about has been Canadian-based product today. We've got an index product for global cannabis because that's a market that's starting to develop globally with different companies around the world. So we are going to look to that for where Canada can be a source of strength for a global index and then we can provide futures on that. And that will be easier to develop once we're also built out on the time zone trade so that people can trade these things around the clock.

Got it. Got it. And then some of these new products, especially cross-border and global, is that just new sort of first-to-market products versus a flavor of something that's already there? Or is it a mix of the 2? Because I would imagine that especially in the derivatives side, either you're coming up against already established products or exclusive agreements with investment providers, things like that. So is it primarily on the newer development of products when you think about non-U.S.?

Yes. It's on both because in some cases, we can see what products other markets have been successful on and create a Canadian version of it for the Canadian assets. So sometimes it's great when you actually can see what's already been successful in other regions to build from because you know there'll be investor demand. The other place that we do focus on is where do you see liquidity in the over-the-counter market that can be serviced by an exchange alternative. That's what we did with the 5-year fixed income. That's what we're doing in the 2-year as well. So you're looking at, again, where is there known client demand that we can solve a problem for.

Got it. And then maybe shifting gears to capital formation. You talked about how robust that was, again, a really strong year for you with listing activity sort of surging in 2020. I think you added 276 new listings across your platforms there. So curious what the pipeline looks like in '21, do you expect this momentum to sort of continue through over the next 12 months?

So I mean, I'm going to be careful about predicting 12 months to the future, but I don't mind predicting a few months at a time. Even coming into this year, I believe we've had 29 new listings already this year through January. So that trend has not abated at all, and it continues to be driven by a lot of demand in tech. We still have strong demand in mining as well in terms of both base metals and rare earth metal companies. Those are all exciting sectors that keep pushing ahead. Our team, we have 2 lenses in terms of pipeline. One is our sales and business development side, where we -- which is more of that long-term lens of the companies that we're curating over time that could be potential public companies in the future. And we've got an active pipeline of 1,500 companies there that we get into dialogue with, of which half are tech companies that could potentially access the market for capital in the future. But you can't definitely predict when they will want access to market. It's more about continuing to sell the benefits of the public market, so when they do need capital, they are thinking about the exchange as an alternative and not just the private equity market. In the short-term pipeline, we had good visibility to do it because it's our people that are working those files. So even though that this is a -- our people are actually all working remotely, we've actually digitized this workflow, so it can all be done through remote work tools. But we see that file load of companies that are coming to market, and they continue to be very robust. We've been adding resources as a team to help deal with the demand, and it's the heaviest demand we've seen in a decade plus.

Okay. That's helpful there. And maybe on that point, before we move on, I just wanted to -- I wonder if you could talk a little bit about the mix of companies that you've recently seen that have been active on the IPO side of it. Has there been acceleration more towards your venture and tech names, has there been a few over there in terms of the ones that came to market and the ones where you've seen market cap grow? And if so, I was wondering what the implications were for your -- in terms of business opportunities, either from new indices or corporate solutions, new business opportunities as a result of sort of this evolving landscape of active companies.

Yes, that's a great question. So from a sector standpoint, certainly, the biggest 2 drivers have been innovation companies and mining and resource companies. The largest 2 deals that we've done this year have actually been some of the largest in history for us as well. So TELUS International is the largest tech IPO we've ever done that went in January. Topicus.com was a spin-out. That's the largest venture listing ever. So we've actually been -- it's been broad-based in terms of both small cap on venture and large cap names as well. Tech sector is very strong, resource sector is very strong. Tech sector, for one, is one that we've been working on developing for a number of years. So it's -- yes, it's topical now, but it's something that the business development efforts have been there for a number of years, and we identified it as an opportunity in '16 that we wanted to see if we could build a tech franchise that was big as it rivaled our resource franchise that we were historically known for. And since that time, we've grown from about 5% of our mix in terms of TSX/TSX Venture companies in tech to about 14% today, and resource is about 19%, so real substantial closing of that gap. The one sector in the resource side that continues to be a challenge has been the energy sector. And that's been a global challenge around energy names. But we have seen some signs of light in it in terms of gas companies that have been able to raise capital through this period and other companies that are testing the market. So there's been some broad-based interest in that and industrials as well, but those have been the 2 sectors that have really driven it the most.

Yes. That's another good segue into sort of the energy side of it as well. So just moving to your Global Solutions and Analytics business there and starting with Trayport. I think there, again, revenues have been growing above your high single-digit targets. So despite the pandemic and some of the pressures you saw there, so again, like can you talk about sort of what's been driving the growth and the sticky demand here despite the pressures that we saw last year?

Yes. And certainly, last year, our concern was the energy sector under stress, what would that do to client health? Would you get the client renewals? Because this is a subscription business largely. And what has played out is it's been quite the opposite. The Trayport solution does such a good job of aggregating markets for clients and giving them full visibility that it really shows how indispensable it is for clients, so our renewals through 2020 all continue to be robust, clients that are renewing with us for multiple years, there's premium in them. And we're also adding new services to the clients at the same time. So the -- throughout 2020, we acquired 1, we built another new product, so we had an algorithmic trading solution that we acquired and then integrated into Trayport. We built an analytics solution. These are now premium offerings that we can push out through Trayport as premium subscriptions, and they increase that revenue per user and they increase the client experience as well with the platform because now you can do more data analytics on the tool in addition to the marketplace aggregation. All those trends are positive as we go into '21. So the continued demand for global natural gas, for electricity, particularly continued growth around renewable electricity has been part of the pieces that brought more traders into the community. And those demand curves continue strong. Those continue to be double-digit growth areas in 2021 in terms of the trading activity across those products. When we couple that with the things that we can do in terms of building out organically as well, we are looking to other marketplaces where Trayport can be a good solution. So this is the U.S. market that's got fragmented power and gas trading. Trayport is a good solution for it because it can bring that together on a single screen, so we're going to keep working on that build-out as well, and it will continue to help support that long-term growth target.

Got it. And yes, you've got a strong presence in Europe there. In terms of some of the secular tailwinds, I think you touched on a couple of them, but I wanted to just drill down a little bit on the secular tailwinds benefiting Trayport. I think from liquid natural gas to algo power trading, are there some of these longer-term secular themes that you're sort of positioned for? And how should we think about that? And then maybe if you can just remind us again, who are some of your largest competitors in the space as you think about growing the business and expanding it?

Yes. So like you said, the liquid natural gas, the -- one of the contracts we use as a benchmark for that is the TTF, the Title Transfer Facility, product. That volume, that one was up 27% last year, so continues to be growing demand for that. And we're going to continue to see more of that as LNG allows for pricing around the world to be benchmarked off of different regions. On the renewable side, the short-term power market, we look to a contract called the EPEX Spot because what folks may not realize in the power trading market, when you tilt your power trading to be more renewable, you need to be trading more in the short term of the curve versus the long term because the wind blows at different times and the sun shines at different times. So you need more spot trading solutions. So EPEX Spot trading is up about 14% over that period. So continued growth in demand for those products as well. The pieces around that make that interesting is that as you bring new traders into the mix, they don't just trade these things, they trade other things in the composite around energy as well. So what we're also getting is we're getting interest in demand for refined oil products on one end, where folks would like to see that on a liquid screen because a lot of that is treated bilaterally today. And we're also seeing demand for renewable energy and then renewable energy credits because it's the same clients that want to trade those things as well. So we are looking at other product opportunities to continue to expand. Now the latter part of your question around competition is it's interesting because it is a unique platform. So there isn't another platform like Trayport that aggregates all these marketplaces in terms of brokers and exchanges onto a single screen. Often what we're trading on or competing with is in-house solutions. So when we're talking to a broker about putting their product and their volume on our screen, it's about using our screen instead of doing their own. So it's in-house solutions. And on the other end, for highly liquid product, it's the ability for clients to go straight to exchange. And so that's an area where we don't really look to compete. So I'm not going to compete for WTI trading in the United States. That's well served by ICE and CME and aggregating that isn't going to create value. But I can create value by aggregating all those other different types of oil trading products that are more disaggregated and we could provide a central solution for.

Got it. Got it. No, that's really comprehensive. Maybe taking a step back and looking at the competitive landscape. Can you talk about whether the broader -- what kind of competitive pressures you're facing in the Canadian markets right now? If you're seeing either an uptick in pricing pressure or concessions that you offer as a result of new competition? And also as you continue to gain wallet share, so it works both ways as well, has there been any acceleration in either pricing pressure concessions that you've been having with customers?