Good morning, everyone. It's my pleasure to welcome Thomas Peterffy, Chairman and Founder of Interactive Brokers. Thomas founded Interactive Brokers in 1977 with a focus on leveraging technology and automation. It is uniquely positioned to capitalize on the move of global exchanges to go electronic. Today, Interactive Brokers is one of the highest quality, lowest cost, and most global brokerage firms with unmatched new account growth compared to U.S. domiciled peers. That's even as we've seen growth moderate from even faster levels earlier this year. We look forward to hearing Thomas's insights on the backdrop for the brokerage industry, as well as the strategic path for Interactive Brokers. Thomas, thank you so much for being here.
It's a great pleasure.
Thomas, I was hoping we could start with a question on some of the major events that we've seen for the last couple of years, the structural implications on trading in your business. We've had COVID, the meme stock boom, technology, zero commissions. There's been an increase of access of information for retail investors, all being general challenges for investor engagement. Against that, we've had volatility year-to-date, and a backdrop of higher interest rates. What do you think are the things that will last, or have a continued impact for the next few years, relative to what was temporary?
I think that perhaps the most lasting change over the past three years is the idea of working from home or from anywhere else other than the office. At least some of the time. While I do not think that this is a positive development for productivity and for the training of new employees, I think that it is an irreversible change that is positive for online businesses such as IBKR. Zero commissions will probably stay with us unless the SEC prohibits payment for order flow, which I do not expect. Higher rates, which are really not new, we have had them for most of the past 100 years, will stay with us, which is also positive for our business, and so is the tremendous expansion of options volumes in the U.S.
We are now seeing the early beginnings of increasing options trading in U.K., the EU, and Asian exchanges. None of these changes are temporary, with probably the exception of the meme stock craze, which I hope is going to be over soon. Buying stocks without regard to their fundamental value is stupid, and it gives a bad name to investing.
We have those sort of structural trends and also some geographic ones. As you think about the addressable markets of potential accounts five years or 10 years from now, what do you think the average investor is going to look like? Are they gonna be different from today, larger or smaller, older, younger? Do you think you'll have more institutions at IBKR, more introducing brokers, et cetera?
I think that as we move forward, there is going to be a growing percentage of the global population becoming interested in investing, as many of these people are initially quite new to investing, but they are hungry to learn and eventually going to become. Some of them are eventually going to become more sophisticated investors. There is nothing new about this. This is a long-term trend that we have been witnessing for quite some time now. These new investors tend to be younger, have less money, but I think this is a very positive development, and we welcome it. We build various educational facilities and design new products for them that makes this easy and fun to learn about how to think about the economy, the markets, and investing in general.
Got it. As you think about areas that you've seen as the fastest growth in your accounts over the past two years, I think a lot of that has been driven by individuals and outside of the U.S. Do you expect that to continue? What sort of impact is that having on how you're thinking about new products to drive increased engagement?
This younger crowd has been coming into the investment space in the U.S. and Western Europe for some time. Now it is happening at other parts of the world, such as Eastern Europe and Asia and Latin America. These countries are relatively new to capitalism and public ownership of companies. China, of course, remains a huge question mark in this picture. Very unpredictable. Unless war breaks out beyond Taiwan, whichever way China goes will not greatly affect the rest of Asia, I hope. As I said, these new investors tend to be younger and certainly have less money to invest. The average U.S. client of Interactive Brokers is 37 years old, while the average client outside of the U.S. is only 40. It is also the case that U.S. clients have about twice as much money as non-U.S.
On the other hand, we are very optimistic that these younger clients, since they tend to be the cream of the crop in the finance and investment space. We learn. We earn and learn to become great investors in the future, and we have long coat tails. This is the reason that our educational offering is so very important. We have a large number of small bite-sized courses about the economy in general, the various economic indicators and their significance, and demonstrations about products and trading and research tools on our website.
Got it.
by the way, we invite everybody to please look at them.
Over the course of the year, you've seen some months of very strong account growth. You've had some months where account growth has slowed, but still being solid. In your commentary from the last quarter's call, you suggested that we'll likely continue to see slower account growth outside of the introducing brokers. I was just wondering if you could help us think through the trends there and perhaps how long that could be sustained.
Yes. As far as number of new accounts are concerned, individuals outside the U.S. are our fastest growing segment, and I expect the trend to continue. This is the reason we have introduced GlobalTrader, which provides a simple way for people to open and fund accounts and to put on simple U.S. stock positions. From here, we figuratively take the hand of the new client and gradually introduce her to more sophisticated products and trading and research tools, all the while educating them about the various aspects of investing and trading. While traditionally we would require new clients to tell us what products they intend to trade and set up their accounts accordingly, with GlobalTrader, people are able to learn gradually and upgrade their accounts to trade in a larger variety of products very, very gradually.
For ESG-minded investors, we have our IMPACT app that seeks to align investors' portfolios with their values. In other words, we ask you about 20 questions about what you care more or less about, and we analyze your portfolio based on the stocks it contains as to how well it aligns with your values, and we may even suggest substitutions. This is attractive to many younger investors.
Understood. If we take it to the other side and look at the U.S. side of things, preaching that's only about 25% of your accounts, how would you describe them in terms of size for the new accounts that you're seeing coming to the platform? Are these new-to-market accounts, or are these people who are leaving other platforms to come to you?
As I said previously, new accounts are smaller and new account holders are younger and non-U.S. To underline the strength of this trend, accounts now represent non-U.S. accounts. I mean U.S. accounts represent only 21% of our total accounts. As a matter of fact, it's like 20.8%. Obviously non-U.S. growing faster than U.S. customers. While we are focusing on individuals, we should not forget about our hedge funds, proprietary traders and financial advisors. These customers are much fewer in numbers, only about 10% of our total accounts, but nevertheless represent 33% of our commission income. Since many of them use leverage on our first class stock borrow and lending facilities, which are automated and usually far less expensive than peers, they generate 37% of our interest income.
As a matter of fact, we are making quite a splash in the hedge fund space. New hedge funds joining our platform. This is the hedge fund space where our commissions are up 72% for the year in spite of commissions generally going down. This luckily counterbalances our declining commissions in the RIA and introducing brokers channels, which where the commissions have gone down due to markets going down.
Got it. Maybe sticking on that theme of outside of individual accounts, you've had two meaningful introducing broker wins this year. Can you give us an update on the transitions of these accounts, particularly given Interactive's strength in technology and automation? Maybe if you could give us some color on how you were able to win those accounts.
You know, introducing broker accounts as I previously mentioned, we have two very large introducing broker accounts that we are in the process of trying to onboard, but as you know, these larger institutions have many departments and everybody has to have their input in order to buy into the project. This has been just dragging on and dragging on and dragging on. That we currently expect to onboard them in the second and third quarter of next year. On the other end, this has some positive aspects from the point of view that we are learning more and more about what these large institutions are concerned with. The further ones are going to be much quicker and easier to onboard. What was the rest of your question? Sorry.
I was wondering how you were able to win the accounts. What stood out to them?
Well, you know, we have the most, the best automated platform out there. It's a no-brainer for when they try to find an introducing broker, it's a no-brainer for them to come to Interactive Brokers.
Got it. How would you describe the momentum overall in the introducing brokers channel? Do you see a path for more partnerships over the course of 2023?
Yes. There are more and more banks that are not as large as these two, private banks often, that have to, you know, have to do something about providing their customers brokerage services that up to now they have been doing manually, and of course, that is no longer satisfying to the customers, and it's too expensive.
Got it. Options and futures have increased meaningfully as a mix of DARTs for IBKR since early 2021. Some of this has been from a slowdown in stock DARTs, but we've seen quite a healthy increase in futures activity, maybe with the exception of recently. But options activity has been much more stable than stocks as well. I was wondering if you could help us unpack what you're seeing as the drivers of the increased use of derivatives, and if you think that trend is sustainable.
As for commodity futures, the greater volatility in energy prices focuses more interest on oil and gas futures contracts, so there is a lot of activity in oil and gas. The stock index futures markets are more liquid, and due to tighter spreads, trading costs are lower than for equivalent size trades in ETFs. When people want to express a short-term view on markets, futures contracts are a favored choice. For similar reasons, hedging long stock portfolios with S&P futures or NQ futures is cheaper and quicker than other alternatives. As for options... I became a market maker on the floor of the American Stock Exchange in 1977, so the option story is my very favorite one. Trading volumes have been growing more or less gradually ever since stock options started trading on the Cboe 49 years ago.
Yes, I'm very much looking forward to celebrating the 50th anniversary of exchange-traded options this coming year. Options, as you all know, are a wonderful, diverse instrument. You can express all kinds of different market views with different kind of combinations of options. Thanks to computerized trading platforms and the kind of educational offerings that you find on IBKR's platform, this is becoming ever more apparent to the investing public. While it is generally accepted belief that options are risky, but the fact is that vertical option spreads with vertical option spreads, you can take the safest limited risk positions possible in any market. This is unfortunately not yet apparent to the regulators and to some of the public, but we're working very hard to make this happen.
I believe options trading will continue to grow, not only in the U.S., but also in Europe and Asia and maybe even Latin America, where currently it is still small. As I said before, there are signs of this business increasing in the future.
Understood. your 3Q EPS increased nearly 30% relative to 2Q. A lot of upside came from higher interest rates creating meaningful tailwind. as Interactive Brokers is likely to benefit from that same tailwind in 4Q, how are you thinking about using the incremental free cash flow, and where are you planning to invest in that?
We are always working on establishing new brokerage subsidiaries in different countries, and they need their own capital base based on local regulations. This is our plan. In, you know, in the distant future, we currently are, I think, in 13 different countries. You know, in the distant future, that is going to rise to 20 or 30. We wanna be all over the globe, completely well-distributed.
Understood. Maybe on that point as well, the pre-tax margin in 3Q was 68% on an adjusted basis. As you continue to get some incremental benefit from rates, do you think there's more room for the margin to expand even with your investment plans?
Our employee cost will certainly rise this year in salary and bonus increases to keep up with improved performance and inflation. As you know, there is still a shortage of skilled workers in the software area where a lot of our reinvestment goes. At the same time, I think that margins in our fourth quarter will hit and probably exceed 70%.
Okay. Thomas, you've always been very focused on managing the risks of the business, making sure that there's capital to support your global operations. You just highlighted that. I was wondering if you could comment on your thoughts around the firm's capital base and if it's important for Interactive Brokers to continue to build capital.
A rock-solid equity base is important for us to attract more and more institutional clients. We are doing very well on this front and hope to do even better in the future. Our shareholders should not count on any dividend increase in the near future. I'm always asked about that, and my answer is always the same, "No.
Understood. Earlier this year, we had some commentary from the SEC about potential changes to equity market structure, including comments around payment for order flow, which you highlighted earlier. Recently, articles have suggested, it's unlikely the SEC will come out with anything outright to prohibit payment for order flow. I think it's left some investors wondering about what potential changes there could be, the probability, especially given the timeline that the SEC has. Are there any areas of market structure that you think have the highest probability of being addressed or changed by the SEC in the near future?
Definitely. A very likely change will be a decrease in tick increments for high volume, lower priced stocks, and potentially even for options. Parallel with that, we may also see an increase in tick increments for less liquid, higher priced stocks. We believe that these changes would lead to a more efficient market. We also expect to see new reporting requirements with respect to execution statistics. As you may be aware, we publish execution stats monthly on Reg NMS stocks. We compare all our actual executions to what they would have been if all are executed on the daily VWAP for each stock. For the past year, our execution cost, including commissions and reg fees and exchange fees, were 2.7 basis points by this measuring stick.
We would be extremely happy if all brokers had to publish the same statistics, and we could compare and brag about our execution quality. We also hope that there'll be changes with respect to reporting of short positions so that the kind of short squeeze disaster that took place around GameStop would be avoided in the near future. Few people realize that this situation almost brought down the entire system, but I hope so. We requested the SEC to give thought to this, and I hope they will. There is also some talk creating an exchange auction process for stock executions. There are currently many auctions held at exchanges for options.
What we do with options executions, we have currently, I think, 17 or 18 liquidity providers on our systems who are constantly listening, e-electronically of course, and whenever we have an option order, we show it to them, and they respond with a two-sided market. We agree with the best one as to the specific exchange where we will take that order and start an auction. Exchanges are know how to do these auctions currently for options. If there is no interference at that exchange, then the liquidity provider who run our internal auction will do the trade. This whole process takes just a second or two, and I can very well imagine that this similar process that we do in the second phase of our options currently could be dictated by new regulations for stocks.
At this point, maybe I can explain to you that within, still within this year, we are going to come out. Let me explain to you what we do with stocks. We have a number of, again, liquidity providers who give us resting orders for stocks that are packed to the mid-price one way or the other. In other words, you can either say that, "Well, for this stock, I'm bidding or offering, $0.01 under the mid-price or $0.01 or $0.02 above the bid," and so forth. And this is in our ATS. Whenever we get dark, it's IBKR Dark.
Whenever we get a stock order in that, from one of our customers, we immediately ping our IBKR Dark and see if there is a matching order, and if there is, we cross it. If there isn't, of course, then we go to other dark pools, and eventually we go to exchanges. This certainly enables us to give our customers a better execution, and many of the folks on the other side are getting the benefit of doing these trades without having to show a large order at the exchanges and driving the prices against them. Now, as I said about the options executions, these liquidity providers need complicated technology to continuously listen to our potential option trades and immediately respond to the request for a quote.
We are now going to announce within, as I said, still within this year, that we are enabling our customers, retail customers or retail, I mean, you know, depending on how sophisticated they are, they will listen to this idea that they can now participate in this option auctions. We are going to provide them with the technology of the liquidity provider technology, so that if you say you are looking at buying some very often trading like Tesla options, right? The likelihood is very good that if you would love to buy some, if you bid, well, you know, the spread is often $0.05-$0.10 in these Tesla options.
You know, if you wanna buy something and say you're willing to bid $0.01 or $0.02 under the mid-price, and you put in an order that the chances are very likely that you are going to get that trade from against one of our customers who wants to sell. So you can substantially improve on your execution costs, which is often quite a few cents or dollars per contract. I think, we are hoping to get some enthusiastic existing customers that are going to participate on the liquidity providing side of the options market.
Yeah. That sounds very interesting. I think if there are any questions from the audience, if not, I have a couple more questions to go.
Can you just talk a little bit about-
In India, where we have a large customer service installation in India, over 200 people. As far as getting customers in India, I tell you honestly, we are not very successful. We have spoken to a large number of brokers there. They all expressed interest. They have all signed up. We have most of the large Indian brokers as our customers, but we are seeing very pitiful order flow from them. I do not know why that is. You know, they all claim that their customers don't have enough money to trade U.S. stocks and they are more active on the Indian exchange. Of course, we are executing on the Indian exchange also.
You know, if an introducing broker wants to open an account with us for one of their customers, that customer is able to trade in India and in the U.S. and anywhere else in the world. The take-up is not very good.
I think we had another question over here as well.
I guess I'll just go. Your commission per trade has kept going up.
I can't hear, sorry.
I said your commission per trade, has kept going up, and I was wondering, is that due to a better product mix or do you get better commissions for your equity trades? Your options declined, but yet the commissions per trade went up. Are you seeing better unit economics per trade?
As the market's been going down, the individual traders' trading volume has substantially diminished. As I explained earlier, the hedge funds and the prop traders are making up for that. Their trades are larger. As you know, our commissions, you know, for larger trades are larger. The average commission per trade has been rising gradually as more and more of our order flow is becoming an institutional flow rather than a retail flow.
Hi. Thank you. You alluded to this for a moment, I think you've always mentioned desire to invest in U.S. assets for your global customer base has been partly allure of Interactive Brokers. I wonder if you could just speak to whether that's a persistent trend and if changing rate environment has changed any of that. Thank you.
Could you repeat that question for me?
Thomas, you've said before foreign investors' desire to own U.S. assets has been a draw to Interactive. Does that continue to be the case, and do local rates going higher in other markets change that at all?
Definitely it continues to be the case. I mean, obviously Europe is a mess, right? Basically everybody wants to invest in the U.S. Yes, that definitely continues to be the case. Rising rates in those countries, I don't think that has made an impact on this trend so far. As you know, those rates are still well under U.S. rates.
Okay.
The company has been offering crypto trading for about a year. We never offered custody. We always said that custody is with Paxos, which is a crypto company. We are charging very, very low commissions on cryptos, 12-18 basis points, which is much lower than other platforms charge. In spite of that, crypto trading hasn't taken off very well on the Interactive Brokers platform. What are my views? My personal view is that I'm long Bitcoin. I have been for about four years. I think that. You know, I believe that the value of Bitcoin depends on acceptance by the general public.
My belief is that crypto has reached a critical mass, Bitcoin has reached a critical mass in the general public as to enough people believe in it that it is going to stay with us for the duration. That isn't true for all these other crazy coins because everybody can, you know, just make a new coin and see their net worth rising like Sam Bankman-Fried has seen. Of course, it will collapse because, you know, there is no general acceptance in the mind of the public of these other coins. Maybe Ethereum, maybe. I am going to stick with Bitcoin personally.
I also think that the lending of these overvalued coins to other people who don't believe in them and want to short them, you know, you may short them and you probably will make some money. You never know. I mean, look at GameStop, right? You can also be taken to the cleaners, right? I would stay away from all the other coins, either side of the market.
Thank you, Thomas. With that, I think we're at time. We really appreciate all of your insights, and thank you for coming.
Thank you very much, everybody.