Good afternoon, everyone. Let's get started. I'm Craig Siegenthaler from Bank of America. It's my pleasure to introduce Thomas Peterffy. Thomas is the Founder and Chairman of Interactive Brokers. Thomas founded the firm 43 years ago.
46.
46 years ago. Okay. is a pioneer of electronic trading globally. Interactive Brokers is a digital investing platform which spans multiple client segments. This includes hedge fund, prop trading, RIA, broker, and its largest segment, individual investor. It also expands around the world versus a lot of its peers, which really focus here in the US. Thomas, thank you very much for joining us today.
It's a pleasure.
We're gonna start off with technology, research and development, one of the areas that I think is a key competitive advantage for your firm. What makes your tech efforts so different, and why can't other e-brokers sort of replicate what you do and are able to expand globally like you've been able to do?
Interactive Brokers has a unique history, and that explains why the company is so different than others, and that includes our unique approach to building technology. Prior to founding IBKR with $200,000 of savings 46 years ago, I worked as a computer programmer for 10 years, and that experience have substantially determined my vision for the company. The company would basically be just a collection of computer programs that performed all the unique functionalities that the company has to do in an automated manner with as few people attending to these systems as possible. Initially, we were market makers at the American Stock Exchange. I first wrote a program that would be trading options, and as profits started coming in, I would hire other programmers to expand the system to more products and back office and accounting and management reports.
The next four decades were all about building this software and adding more people to building it. Accordingly, most managers of the company today are software developers. We do not start any new business up until we get it first completely automated. As to the international offering, why we are so unique and the only ones basically to do that. As option market makers by the late eighties, we had a fully automated system that would put out bids and offer quotations and receive executions, but on the execution end of the system, we had to employ human traders on the exchange floors who would execute the trades. Needing people to implement the trades was an impediment to efficiency and an unnecessary expense.
When in 1990 the first automated options exchange opened in Germany, we saw that as a huge breakthrough for us. They needed liquidity, I convinced them that if they let us hook up directly to the exchange's computers, we will stream live quotes to them throughout the trading day. That proved to be a great success. Other electronic exchanges, as they opened in Europe and Asia, we just replicated that same business model.
Pretty soon we had memberships and electronic connections to all the major exchanges around the world, except still not in the U.S., which was still open outcry. We had a computerized, automated global execution network. When we started Interactive Brokers in 1993 as a brokerage firm, we just put that on top of this network. This explains our international presence today. Of course, we. That was followed by years of building compliance and tax reporting software, for the individual unique requirements of each different jurisdiction. That, of course, still goes on to quite some extent.
Thomas, your business model, expands across so many different client segments today, and by geography, you know, across so many regions. You know, can you walk us through the key businesses that you offer today?
We have individual investors, we have hedge funds, we have proprietary trading firms, registered investment advisors, and introducing brokers. Now, introducing brokers are basically just brokers like we are, except they use our platform to do their business, so they in turn also have the same customer types, namely individuals, hedge funds, proprietary trading firms, and registered advisors. Our customers come from all countries, and territories because we are in 204 places, but there are only 194 countries in the world. That's where we are.
On December 15th, the SEC sent us an early Christmas present with 4 new proposals on equity market structure. What are your initial thoughts on the proposal?
I think the proposal, it's a well-intentioned proposal to save money for retail and institutional customers. I just worry that the savings may not be enough to justify the expense of building out a different infrastructure, and I'm somewhat worried about the unknowns that could emerge. I would prefer if the SEC left it up to the industry and the competitive spirit of the participants to deal with these problems.
What do you, what do you expect as the impact to the equity market structure in the United States? Also, you know, there's likely a negative impact of payment for order flow from the rules as they're written today. You know, what how do you think that plays out? Then also, what specifically is you think the impact on IBKR's business?
I don't think that payment for order flow will necessarily go away. Most brokers do not have their own order routing systems today. They will have to continue to use somebody else's, and they may as well use the current routing destinations of Citadel and Virtu and other similar companies. The changes are more likely to be on their end, not on the brokers' end, but on the execution side. They will have to go through different machinations to interact with the orders as the new rules will call for, and the interaction rate will probably decrease. The payment for order flow, they will decrease. Those orders that they are not interacting with they will route on behalf of the brokers just as a service.
That's what I think is going to happen. At Interactive Brokers, we offer a choice to our customers. We can choose IBKR Lite, zero commissions, and we sell the order for payment for order flow. We execute the orders within our routing environment, which includes our ATS, dark pools, and exchanges, and we charge a commission. 94% of our customers chose the latter. Much of our order routing and execution software revolves around getting the best price inside the NBBO. I cannot imagine that the new rules would make a substantial difference for us.
What do you think could come next from the SEC? I know you talked about potentially the options side, on the last earnings call. Do you think that could be next?
Yes. There could very well be a proposal to force option executions to go through different channels. Again, we just recently released our new option routing destination we call IBUSOPT. Here, customers can indicate the mid-price or a price back to the bid or offer or back to the best price as the price at which they want to execute. We will hold the orders up until we get an opposite side order against, so we can marry the two sides.
We will attempt to do that because all options must be executed at options exchanges. When we take the cross to the exchange, we at times get interference, which means that on one side we get a better bid or offer than we were contemplating where we had the two orders crossing. In that case, the other side gets a better price, which is great. We are already doing a version of what I think the SEC was going to do. Whatever they come up with, I think we will very easily be able to adapt to it, I'm not so sure that other brokers will be.
Let's change it up and move on to your Introducing Broker business. You've seen a nice acceleration in growth there. On the August earnings call, you talked about two very large potential wins in the pipeline. What's driving the re-acceleration of growth in the, in the Introducing Broker business?
I think I already gave you a glimpse of how complex execution systems are. Compliance is not any simpler, especially when all this must take place among many other different jurisdictions and regulatory regimes. This is an issue that many international banks and non-U.S. brokers are faced with today. These brokers want to make available to their customers U.S. products, where most of the action is today, in addition to the local products and sometimes also some international products.
They realize that to build and maintain a system that can do all that would probably cost a lot more than the revenues that they would derive from it. Especially since IBKR already offers that service at a very low cost in their country already, so they would have to compete with us. The ultimate issue becomes how should they compete with Interactive Brokers.
These financial institutions already have all these customers and offer other services to them, and we are happy to provide the technology and the service at a discount so that they would charge the same amount or just a little more than we charge, and they'll be running at a profit. We do not have to bother with getting the clients and providing the AML and the customer service. It's a win-win on both sides.
How does your pipeline for additional IBroker wins look like today? I don't wanna get ahead of myself 'cause you just launched, you announced two big ones. You know.
Right.
How does the forward pipeline look?
We are having conversations with several banks and brokers. Their customers will hopefully end up with us as their current providers become introducing brokers much sooner and for less expense than if they have tried to build it themselves. As I explained before, it doesn't make sense for them to build it themselves.
you also have Actually, not large, but you have a hedge fund prime business, that you're looking-.
Not large?
Well, large. We'll call it large. That's looking to compete against large banks out there.
Yeah, yeah.
Those large banks have a full suite of products that they can provide too. They also have very large capital bases, which is probably a selling point for them.
That's right.
How do you compete with them?
Hedge funds are our best customers, and that's because they must make a profit to stay alive on the long run. In order to be able to attract them, we must be able to offer our services on better terms than our competitors do. Superb quality of execution, low margin rates, high interest on excess cash, large and easily accessible short rebates, a versatile risk management software. These things are all extremely important to hedge funds. We can do all this because our very high degree of automation. Hedge funds are the ultimate sophisticated investors, and they are the ultimate proof that the best-informed investors choose Interactive Brokers.
As far as competing with the large investment banks, while we are very good at the services I just described, we do not do swaps, which are basically just margin loans against very thin collateral because we do not like the risk, and funds understand that. They understand that when a prime broker takes a risk on them, that prime broker probably takes a risk on other hedge funds too, and some of them turn out to be Archegos. When you're a hedge fund and you wanna be a very safe broker, your best bet is Interactive Brokers. We have $12 billion of capital, and we don't take any third-party counterparty risk.
We also do not provide capital introduction, although we do provide some on our website, as hedge fund can display their AUMs and returns and on our Hedge Fund Marketplace. And when the user clicks on it, they can provide other information and arrange for meetings. We do not sponsor these meetings or we do not sponsor meet and greet dinners or events. Most large hedge funds have two or three or even more prime brokers, and they use each one for the best of what they offer, and we fit very well in there.
How are you looking to, you know, grow your hedge fund business at this point, and how important is the capital base? I know a lot of us would like you to raise the dividend or, you know, buy back stock. We know how that works.
You can't have it both ways. You want capital base or you want dividend? No. We keep the dividend. I mean, we don't raise the dividends. We hold on to the capital. We believe that the market is favors growth at the expense of dividends, and we have similar sentiment. We are growing extremely fast in this space. We are currently number six. Next time Preqin comes out, they rate prime brokers annually. Next time they come out, we'll be number four behind Morgan Stanley, Goldman Sachs, and JP Morgan. Sorry, Bank of America.
Let's move on to your two commission models, IBKR Pro and your zero commission business IBKR Lite. You touched on them briefly, but how has the organic growth in this business changed from the 2021 bull market to the 2022 bear market? Do you see Lite or Pro as being the primary source of growth going forward?
No, no. Lite is negligible. It comprises only about 6% of our accounts and a much smaller percentage of our trades. Choosing Lite on our platform, which was built to provide the best execution possible, is probably not the best choice. There are some retail customers who insist on it, and so we let them have it, however reluctantly. Superior execution is the strongest feature of our platform, especially if we are successful in building our crossing mechanisms for stocks and options, as I just described. We would be remiss if we had not tried to guide our customers towards taking advantage of these features.
Where has your individual investor growth come from, in 2022 when you think about the different geographies? Did you see a big change in 2022 versus the prior years, the bull market years 2020 and 2021?
Our retail growth comes from individual customers and introducing brokers. In 2022, our growth was 28% and 16% respectively in these two groups. This year, so far, we are at 24% and 19%. We expect both sources to pick up strength as we go further into the year. Our high interest payment, currently 4.08% on idle cash, and our associated ad campaign around that is what will generate further growth in those sources. Of course, the more orders we get, the better our executions will become on both stocks and options, because we'll have a greater chance of being able to cross them near the mid-price. This will be our ultimate strength that we will emphasize throughout the years to come.
You just said that you expect retail growth to kind of re-accelerate towards the back half of this year. You gave us guidance in the call of long-term organic growth across the business, 20%-40%. We're close to the lower end now just 'cause we're in a bear market. What would it take to get back to those great levels we saw in, like, 2021, which were actually above the high of that range?
2021 and early 2022 were different times. It was the meme stock mania, which I hope will never return because a lot of people lose a lot of money. In my view, this is bad for the industry. It's not helpful for making people understand how the economy works and how capital market works and what the purpose of the capital markets is in the economy.
Interactive Brokers' high growth rate of new clients in that period was partly due, partly a by-product of the high growth of these accounts in the entire industry as many new, less sophisticated investors opened brokerage accounts, and we got our share. Our current and future growth is and will be due to unique capabilities we offer to customers so that it is not a result of industry-wide growth. Concerning institutional customers, our highest growth account, as I said, are the hedge funds and closely followed by proprietary investment groups.
I wanted to talk about lending for a second. You don't offer a lot of products there, but you have stock lending, margin lending. I wanted to figure out if these products are pretty well established across your platform or if there is a cross-sell opportunity for higher adoption rates with these products across your client base.
We do not look at this as cross-selling. We try to get all of our customers to sign up to our program of lending fully paid shares where we split the proceeds 50/50 with them. We also try to sell people on our very low margin rates that are just 50 basis points over the federal funds rate for larger amounts. We also try to showcase our online shortable inventory and display lending rates to everyone who is willing to look at it. This feature is becoming extremely popular among hedge fund customers. This is a unique feature in the industry because everywhere else you have to call the lending desk, the stock lending desk, and hope that they don't screw you for more than you expect them to. That's what happens.
Interest income has been a key growth driver and upside to earnings over recent quarters. It's benefited from higher interest rates. We wanna see if you could talk about your sensitivity to higher rates, especially on a go-forward basis.
At this point, every 25 basis points in federal funds rate adds about $50 million-$60 million to our bottom line. This is because the account holders whose account value is less than $100,000. We pay proportionally less than 50 basis points under the fed funds, and we pay no interest on the first $10,000 in any account. Accordingly, we have about $20 billion-$25 billion that you could say we pay nothing on. Well, it's the equivalent of having $20 billion-$25 billion that we pay nothing on. 'Cause overall, the cash holdings of our customers is $101 billion.
Thomas, your operating efficiency is kind of the envy of financial services. Your operating margins are in the mid-60s to even low 70s on a quarter-by-quarter basis. Is this, you know, are we essentially at a peak level or is your ability to even drive higher operating leverage from this point, especially with net interest income growing, which is a very high margin source of our revenues?
In the last quarter, our net pre-tax margin was 71%. It's hard to go much above that, but we will try to, and we'll probably hit 72% or 73%, but that's about it. It's difficult to go above that.
Yeah. You have to pay your people.
We are by high, by far the highest in that respect on the street or probably in any business.
What impact are you seeing with inflation today on your cost basis? With that margin, it doesn't look like you're seeing a ton to date.
Yeah. We raised compensation at the end of 2022 by about 8% on the average. This included merit and inflation raises. We are of course determined to compete for technological talent that helps us to continue to build out our automated technology as we expand to new geographies and new products. In addition, we have substantial new expenses associated with renting and furnishing new offices all over the world. As we build out to say a future of anywhere in any country where we get more and more customers, we decide to put in a local office. I think the local customers find that important, that association important, that they deal with a local broker rather than an American broker.
Thomas, we, you know, we hit on this a little bit earlier, you know, you continue to build capital. Is there a line in the sand or a certain point where you would say, "You know what? That's enough. Let's start returning capital to shareholders?
Just a few minutes before you asked me if we have enough capital for the hedge funds that have more capital. Yeah. I mean, no. As I said at that time, we are not going to return beyond the $0.10 quarter dividend that we are paying and have been paying for it seems like ever since we started.
I had a question on the GlobalTrader app. How has really early adoption trended for that? Does that offer crypto functionality today?
It does offer crypto functionality. But of course we do not custody the crypto. We have, I hate to say this, but we have Paxos custody the crypto, and SEC just announced investigation against Paxos, I think this morning. I mean, you know, customers are aware that we do not custody the crypto. Otherwise, the GlobalTrader is a very popular download, especially since we added 24-hour options trading capability. Almost 24, 23 and then something. People around the world who, especially who are on the other side of the globe and are sleeping when our exchanges are open, are very happy with this new functionality.
Thomas, we all enjoy you on the earnings calls and joining us at conferences. I'm gonna ask this one in a nice way, but, you know, New York City traffic is back. If you were, you know, if you were hit by a bus, what would happen to IBKR at that point?
That's exactly the reason I moved to Palm Beach. There are no buses in Palm Beach. But as many of you know, Milan Galik has taken over as CEO of the firm about three years ago. I think he's doing a terrific job, much better than I could do. He's only 56 years old. Only, mind you. He has worked at the company for over 30 years, and, having started as a software developer, he has a good 15 years left in him, I think. As a stockholder, I would much more worry about him getting hit by a bus than myself.
you know, I wanted your perspective 'cause we've, you know, we've seen some transactions in the past, I think more recent, Morgan Stanley E*TRADE. I wanted your perspective, 'cause your business is much more diverse than E*TRADE's, but do you think IBKR could make a good fit inside of a larger financial institution?
Definitely.
Yeah.
I think there'll be a large, globally integrated, highly automated financial services organization which will most likely be called IBKR.
Great. With that, we do have a few moments. Would you mind taking a question from the audience?
Sure. Sure.
All right, if there's any questions, please raise your hand.
I'd love to get your thoughts on the explosion in option activity, especially the daily options and also just single stock ETFs in terms of what that means for retail investors.
Slowdown in daily options?
In the growth and products.
The growth in daily options. Right. Okay. Daily options are attractive because they are bets that pay off at the end of the day if they do or, you know, if you won or lost. I think they do have a serious justification. I mostly see that as if you are an institutional trader and as many decide to buy a portfolio of stocks in the course of the day, that's very difficult to implement, especially if you have quite a number of stocks in that portfolio. It's very easy for you to pick up an S&P 500 option or 1,000 S&P 500 options because they are very liquid. Therefore you can put in the order for the portfolio as market on close. You will get the S&P closing price on all those stocks. That's exactly where your options will expire. So that's a very good way of implementing the trading of portfolios, whether you wanna buy them or sell them. Right?
With that, I think, we are out of questions and out of time. Thomas, on behalf of all of us at Bank of America, I just wanna say thank you very much for joining us.
Thank you very much.