Good afternoon, everyone. Welcome to the 24th Annual Credit Suisse Financial Services Forum. This is Gautam Sawant, Credit Suisse's equity analyst covering US exchanges, and it is my pleasure to introduce Chris Gerosa, MarketAxess' CFO. MarketAxess is the largest electronic credit trading platform and has the deepest client network consisting of over 2,000 global active institutional investor and dealer firms. Chris, thank you very much for joining us.
Well, thank you for having me here today.
Chris, I want to begin the discussion with your economic outlook. Can you give us a sense of how credit spreads, volatility, and duration are changing?
Yeah, we're very optimistic about the current view of the economy and where we're going with our business model. Just to hit upon the latter point of duration. Duration has a direct impact on some of our fee plans. The good news there is we've seen stabilization with duration through the bond index. The economic activity, particularly in the fixed income market volume perspective, we've seen very strong year-over-year growths in market volumes for credit. You're starting to see a positive return of emerging market and Eurobond market volumes. Just to put a pin on what we're seeing in one of our flagship products in high grade. The investment grade market volume so far in February are up 30% year-over-year.
A very good sign to see that there's a return of the redeployment of cash into fixed income, which is notable given the current interest rate environment. You're actually making a better return on bond investments than you were three or four years ago.
How do improved themes for fixed income investing, including higher interest rates, how do they complement MarketAxess growth initiatives? What products are you most excited for in 2023?
Well, emerging markets is an early stage product for us. We've been in it for a while, we're very excited about expanding our emerging markets into local markets that we're not in today. As I mentioned last year, the emerging markets, the market volumes weren't performing at the same level that we'd seen in 2021. We see a return to that market opportunity, and it's just a tremendous growth opportunity for us on the products that we're offering on the platform, where if we had to guess, our overall market share in the global emerging market space is probably a mid-single digit. It's hard to put an actual number on that because not all of the local markets are required to report locally. We're using our best estimates of what sizing up the total market share.
Can you speak to market share trends so far in January and how you evaluate the strong volume growth relative to overall market share?
Yeah, the market share performance in January was still strong across all of our composite products, with the exception of high grade. As we've talked about in the past, high grade doesn't tend to do well in a very active new issuance calendar, and it's exactly what we saw during the month of January. Longer-term, more new issuance is better for the secondary market. We think of our share gains across all the products on a long-term perspective, where we believe that we continue to generate 150-200 basis point share gains across all of our product sets.
Within the U.S. market share and high yield accelerated to 21% in December, in line with high grade. What dynamics accelerated high yield market share growth?
Yeah, high yield it's a very actively traded product within Open Trading. Over 50% of the high yield activity is consummated in the Open Trading platform. It gets back to the value we're delivering to our clients. When you come to MarketAxess and trade on Open Trading, you're trading with the breadth of our client network, which is up to 1,700 credit trading clients on the platform, and it's getting that best price of execution. Particularly in November and December, you saw elevated levels of volatility, credit spreads, and that brings the value proposition to getting the best price of execution on the platform, where the traditional dealer liquidity may step away from those distressed assets, that our client network knows they can come to Open Trading and get a best price of execution.
When you look at U.S. high grade, how do you feel the platform is positioned for future volume and market share growth?
We're benefiting from the stat I called out earlier. The market volumes are up over 30% in February, up over 25% in January. This return of the inflows into fixed income is a very good development for our business model. We haven't seen bond yields at these levels since pre-crisis. What differentiates us from the business model we had pre-crisis to where we are today, we didn't have the Open Trading network. The dealers were supporting the trading of fixed income investments pre-crisis, where a rough estimate of $300 billion was managed on the dealer balance sheets. With all the regulatory developments post the crisis, that's more around $7 billion-$10 billion. The opportunity to trade fixed income credit is available in Open Trading.
Growing international revenues and trading volumes has been a successful strategy for MarketAxess. Within emerging markets and Eurobonds, can you speak to the growth trajectory and target addressable market penetration for the firm? Can you also speak to the complementary growth between the firm's local and hard currency offerings?
Well, the emerging markets, particularly for certain local emerging markets, a very delicate assessment of where we wanna introduce Open Trading, which again, Open Trading is our competitive moat, where we provide that network effect for getting the best price of execution. We assess what the local regulatory requirements are and what the investment means for us to enter certain markets. Because what we're ultimately measuring is the ultimate ROI we're returning to our shareholders. It's a very delicate matter where every local emerging market is almost its own asset class, and we're selectively deciding which markets we wanna introduce Open Trading. It's a very compelling opportunity for us, but we wanna make sure we do the math and understand what the fee model looks like and what the expense commitment is so we're generating a return for our shareholders.
Going back to Eurobonds and emerging markets, it's the breadth of our liquidity pool, the increased volatility, the widening of the bid-offer spreads. They're getting a better price of execution within Open Trading because they're dealing with a much broader universe of clients that are offering an attractive bid offer.
Within municipal bonds, the firmest market share grew to 7% in January from 5% in January 2022. Can you share how the challenge of electronifying muni bonds compares to other products? Why is MarketAxess positive on this specific opportunity?
Yeah. Muni bonds is early days. We're mid-single digits a year ago. We got to 7%, as you pointed out, in January, which is a record share for us. We're benefiting from the acquisition we made a year and a half ago, where we're fully integrating the MuniBrokers platform to introduce us to new community of Muni bond trading, where that flow is gonna be redirected into Open Trading. For Muni bonds, it's a generational thing. There's a network effect of phone trading that's taking effect within the Muni bond universe, and we feel that as the Muni bond community gets more comfortable with our pricing and the attractiveness of our pricing in Open Trading, you'll see a migration of the traditional phone trading into Open Trading like we've seen in our other product sets.
Dialing into the growth of specific protocols, can you give us an overview of Open Trading, Portfolio Trading, Mid-X and Live Markets? What are these protocols for investors newer to the MarketAxess story?
Portfolio Trading has been a very popular storyline over the last two to three years. One of the competitors was successful being the initial launcher of Portfolio Trading, which is a protocol that does extremely well in a benign environment. I think we're quick to react in the second quarter of 2021 to introduce a very comparable protocol. It's the same dealers, it's the same institutional clients that trade on both platforms, they're plugged into our network. We're continuing to add record share on our portfolio trading momentum. I think we've caught up on that front.
In a more volatile environment where you're putting one price on a basket of bonds with bid-offer spreads and volatility whipsawing around and you see increased levels of volatility, it's gonna be that much more expensive to conduct a portfolio trade, where certain clients or certain participants will pay the price because it's a very efficient means to rebalance a portfolio or transfer risk. Right now you've seen it stabilize to about 5% or 6% of TRACE, which is where we said we would think it would be over the longer term. Live Markets, Mid-X, very early protocols for us. They're not being a major contributor, but we've made the investments, the functionality's there. To the extent that we see demand increase for those types of protocols, we have them in place, and we're ready to provide that to the clients.
across the platform, where are you extending these protocols today? I know you mentioned Open Trading going to EM, but are there any other spaces?
Yeah. Talking about the protocols, what the next stage for us is algo trading and continued investment in our automated trading solutions, where we want light touch, no touch activity for our clients to make it a much more efficient user experience of trading within our ecosystem. That gets back to we're rolling out a new interface this year in terms of what we're excited about for 2023. We have a new user interface which is gonna improve the user experience of trading on MarketAxess. We're gonna take a block trade in from the client, and we're gonna push it through the ecosystem where they're not gonna know which protocol it's being affected on. At the end of the day, they're gonna know that they get the best price of execution through our automated trading solutions.
How does the combination of Auto-X and Composite+ improve trader workflows, and how is it helping increase efficiency for the buy side?
The CP+ product is a very valuable intraday pricing tool that fuels our automated trading solutions, where they're getting an intraday benchmark to ensure that they're getting the best price of execution. That's a very important component of the auto engine behind our automated trading solutions. The price savings that we're proving is available in transaction cost saving analysis reports that we show to our clients. Getting the behavioral change where our clients are comfortable containing information leakage when they're posting big block trades into the platform, they're concerned about the information leakage aspect.
That's a behavioral change that as they get more and more comfortable with the automated trading solutions, that there is no information leakage trading within the Open Trading Network, that there's not gonna be any impact on the pricing, and they are getting the best price of execution.
Can you speak to how average trade size compression could positively impact near-term automated and electronic trading?
It gets back to making it a much more efficient process. With smaller, more trade sizes, you want automation, that's sort of how MarketAxess originated 20 years ago, was Rick saw that there was a lot of manual intervention with small trade tickets, and we came up with a solution that made it more efficient for the smaller trade ticket execution. That's evolved where you're seeing our continued increase in larger block trades across all of the product sets that we have to make it a more efficient user experience for the clients, so they can focus their attention to more complex trade initiatives or strategies that they'd like to employ.
Looking ahead, do you expect the notional size of automated and electronic trades to grow over time? Should we expect block trades to be conducted over platforms in the future?
Yeah. The idea of the automated trade solution and algo trading is to dismantle those large blocks into smaller blocks, feeding it through the ecosystem and getting best price of execution on Live Markets, Mid-X, even maybe Portfolio Trading or Open Trading. That's the auto routing system that we've built using the CP+ to get the best price of execution. By naturally by that effort, you're gonna have smaller trade sizes coming through the platform.
Can you walk us through how fee capture works across the MarketAxess platform? Where do you get the highest fee per million, and which products are growing the fastest, and how does that kinda compare to the overall mix?
The highest fee capture product that we have is high yield, which averages around $300 per million. What you saw in Q4 is we had a very heavy mix of high yield volume, which helped support our fee capture for total credit. The next in line is high grade and EM, which our high grade fee capture had an exit rate of around $140 per million at the end of December. High grade fee capture, as we all know, is directly impacted by the duration of the corporate bond index. It's the spread protocol and the market convention and how that product trades. What we've pointed the investment community to is if you track the corporate bond duration index in Bloomberg, it's been relatively stable coming out of November, December, January.
That's a good indicator that our high grade fee capture has stabilized. Emerging Markets averages $150 per million, and there's going to be a dynamic shift there. As we have more success in local markets, they're much more like a government-issued bond that has commanding a lower fee capture. Overall, it's a win-win for us because we'd have additional revenue that's coming onto the platform that we didn't have before. Eurobonds is averaging $115-$120. The Eurobonds, Emerging Markets, and high yield, they're all price-based product sets, so they're not sensitive to the duration such as high grade. The other products, US Treasuries, it's a government issue product, so you'd expect a much low fee capture on that rate business. That's around $4 per million.
With the success that we've had in muni bonds, expanding the volume into tax-exempt munis that has lower fee capture, on average, collectively, our tax-exempt and our taxable is anywhere from $250-$300 per million.
Maybe what about the protocol mix? How do those kinda compare in terms of, you know, which are the higher fee capture protocols on a relative basis to RFQ?
Yeah. The portfolio trading is the one that's actually lower. It's roughly around 60% of the standard fee that you would charge across high grade, high yield. Getting back to dynamics of what could fluctuate fee capture, the more success that you have or the more activity you have around portfolio trading, there's gonna be a lower capture rate that you recognize. It's the same with Live Markets, roughly 70%, but it hasn't been very active at this point. Those are the two types of protocols that, in terms of trading functionality, provide for a lower fee rate than what you see on the standard fee card.
As we think about high grade fee capture, it seems to be stabilizing here as we enter 2023. Where is corporate bond maturity trading presently relative to history?
Yeah. The average years to maturity have been just under nine years, as we pointed out in the fourth quarter and what we've continued to see in Q1 of 2023. I know people look back five or six years and when we bottomed out at a much lower level of duration, I think there's a key difference in terms of the overall pie of investment-grade bonds, where newly issued bonds that were issued in 2020, 2021, 2022, issuers were going out much longer on the curve. The dynamics of the average maturity of what bonds actually trade and TRACE have a longer-dated maturity profile, which has elevated the duration.
Can you walk us through the outlook for expense growth of $418 million-$446 million in 2023? Where is MarketAxess investing for growth?
We're investing, and I pointed this out in our guidance slide, 65% of the year-over-year increase in OpEx is focused on the investment in the platform, which requires technology investments in IT personnel, investments in customer-facing roles. Wherever we can invest to generate revenue, that's a primary investment for us. Coupled with the balance of we've got a step up in our intangible asset amortization expense, which is a little bit of noise around the M&A activity that we've done over the last two to three years. The balance of the increase year-over-year is really recognizing some slight inflationary costs of salary adjustments we needed to make. The overall investment theme, 65%, is investing in technology and customer-facing resources.
How is MarketAxess positioned to expand the client network going forward now that you have over 2,000 clients on the platform?
Yeah. The 2,000 is a big number, and the reality is we got the largest fixed income players already on the platform. I think for us, it's about improving the user experience, making it easier for them to trade fixed income. We may add small clients over time. 2,000's a lot of liquidity. It's a very wide net of fixed income bid offers that are available on the platform. If you're asking can it go to 3,000, maybe, but they're gonna be much smaller institutional players and mostly probably coming from the local emerging markets that we're entering into that we're not in today.
You've mentioned enhancements to U.I. a few times. Can you talk about how that's gonna improve nimbleness on the platform going forward?
The new user interface, it's not just the look and feel of what you're seeing on the screen. We've made a lot of changes on how the technology stack is being developed and delivering new functionality to our clients. Where we're going with the new user interface, it's on a new technology stack, so our ability to be nimbler and quicker for delivering new functionality to our clients, we'll be able to do that much quicker than we were on the old technology stack.
What is the firm's ETF and index strategy, and can you speak to the firm's growing end-of-day revenue opportunity?
The ETF and the index is early days. We announced the partnership with Virtu on the RFQ-hub consortium, and that's our opportunity to build out a fixed income ETF product. You talked about the end of day, and this is where I get excited in my seat as a CFO and a treasurer, recognizing that today our client base and our data product offering has really been focused on the trading community, and that's being recognized as a very valuable intra-day fixed income pricing engine.
That product we can evolve and focus on getting it into the end-of-day market close, where that introduces a completely new client base into controllers, corporate treasurers, that at the end of the month, when they're valuing their corporate bond portfolios, if there's an alternative pricing solution, such as the end-of-days BondTicker CP+, you know, that's something that the treasurer and controller community will pay for. It's gonna take time because you need to build the team. You need to have the controls in place. It's not something that we think about in terms of a 2023 revenue opportunity. Longer term, I'm excited about that because it opens up the wallet to a client base that we're not in today, and it's beyond the 2,000 financial institutional clients. We're talking about retail clients.
What you're looking at in terms of the inflows into fixed income, in this type of interest rate environment, recognizing the type of yield you can make on investment-grade fixed income investments, there's that buildup of the stockpiled AUM that's building the wallet for where that end-of-day pricing could be used.
Can you talk about the evolution of Auto-X? How has that tool evolved over time to kinda help traders minimize or maximize what they can do in any given workflows?
Yeah. The Auto-X is setting the parameters for where they wanna trade. It's light touch trading in terms of relying on our CP+. If you wanna hit a price close to where our intra-day CP+ is, it's allowing them to do that without focusing on that trading all day and monitoring the screens, which gets back to my earlier point, where they can redeploy their resources and time to focus on more complex trading. It's the stepping stone into the algo trading of no-touch trading, where it's the evolution of the automated trading strategy. It's one of those early-stage protocols that's just getting the fixed income community comfortable with automated trading solutions. We've seen the success of Auto-Responders. If you looked at our earnings deck, we're seeing the increase of the size that's actually getting executed within those automated trading strategies.
It gets back to the point of our solution for addressing blocks is through this automated trading solution.
Maybe taking a step back and thinking about electronification as a whole in credit. As Auto-X grows, do you think that electronification can go to 100%, or do you think it's something that caps at about 60%-80%? How do you think about the mix of electronification if Auto-X is able to continue growing?
I think you'll have different views internally, where some of my colleagues have seen this evolution in the equity and foreign exchange markets, where they feel it can get closer to 90%-100%, and some of us think it could get to 70%-80%. Either benchmark that you hit, you still got tremendous opportunity for growth. Euro bonds is at the highest of 60%, where we estimate it to be trading electronically. Investment grade's around 40%. The other products are rounding out to around 20%. Tremendous opportunity for growth.
I think we can pause here for questions. If you have a question, please raise your hand, and we'll bring forward a microphone. Just as we get that squared away, there are a few industry initiatives, like central clearing, bringing all-to-all to the U.S. Treasury market and ATS registration. Can you speak to how MarketAxess could be impacted by these dynamics?
Well, we know what it means to be regulated in terms of the discussions around ATS and the exposure and leakage into being a regulated broker-dealer. We are one, we comply with those rules on a daily basis. We are a self-clearing broker-dealer for a majority of our credit business. We know what the responsibilities and capital requirements and the liquidity needs are for clearing a business with DTC. It's something we've been doing for two and a half years now, we're very well accustomed into that. The all-to-all network effect of U.S. Treasuries moving into that environment, you've seen the success of credit having an all-to-all solution when we suffered the liquidity challenges in the early days of the pandemic.
Our Open Trading penetration ballooned in the month of March of 2020 because there was no real venue to trade credit other than Open Trading. We see similar characteristics around the Treasury market, where volumes just collapsed. We're working towards an all-to-all solution for our institutional clients to trade outright US Treasuries.
As you think about the capital deployment or maybe capital initiatives at MarketAxess, where do you see yourself deploying capital over the next 12 months? Is it growing the dividend, repurchases? Are there opportunities for M&A?
The priorities remain the same: invest in the platform, deliver the functionality and the needs to our clients. That's the number one priority because it's generating revenue and expanding our operating margin. M&A is very opportunistic. There's not a lot of assets on the market, but we've demonstrated that we can succeed on acquiring small assets. We've done three deals over the course of the last three years. Collectively, on average, $250 million of total cash, which is less than our trailing 12 month free cash flow. It's getting back to: How do we return capital to our shareholders? We just announced that slight increase in our quarterly dividend as part of the guidance for 2023. We were very aggressive in 2022 with our share repurchase program.
The share repurchase program is more or less meant to offset equity dilution from new equity grants. We accelerated two years of dilution through that repurchase program in 2022, and we still have a remaining balance of $100 million in authorization to the extent that the price gets to a level where it makes sense.
Maybe coming back to where MarketAxess is investing, where are your margins today, and where do you see margins going maybe over the next five to 10 years?
The EBITDA margins are very healthy, and I point to EBITDA initially because it strips out the noise with respect to the M&A activity that we had. Not only the M&A, but moving into a self-clearing model in 2020, we had elevated professional and consulting costs. If you're going back and looking at our operating margin performance and our operating expense year-over-year growth rates from 2020 through today, there's a lot of items in there that, I should say, events, that elevated that expense growth rate. You had self-clearing in 2020. You had LiquidityEdge in 2020 with the integration and the professional and consulting fees.
You had some professional and consulting fees in 2021 around the Regulatory Reporting Hub acquisition of the contracts, then MuniBrokers in 2021, which all that now is baked in. We're fully integrated mostly on all those fronts. You're not gonna have that step-up in whatever professional and consulting expenses you needed for the integration, you're also gonna have the intangible amortization expense naturally come down over time. You'll see that margin expansion as we continue to maintain expense discipline.
Coming back to data and technology, you mentioned CP+, you know, the end-of-day revenue opportunity. Are there any other future opportunities you could pursue that you're excited about?
Well, just circling back to the end-of-day price that we're gonna make available for valuing a portfolio of bonds, we also have another very valuable attribute within our data product set, which is the liquidity score. The liquidity score would enable an asset manager or corporate treasurer to construct and build an investment portfolio that if they want a particular characteristic of that portfolio to be very liquid, I don't know of any other liquidity score available within fixed income that would allow them to decide which ISINs or CUSIPs of an issuer are actively in liquid in the market. That's a differentiator for us in terms of another valuable data set that we're offering within the data offering. Emerging markets, as I mentioned, very excited about where we are in the positioning of our share today relative to what we think the opportunity is.
Just the overall market conditions in terms of credit volumes in the market, where they are today and where people think they're gonna go as there's this return of investment into fixed income, just an absolute level of where the current interest rate yields are today relative to where they were two or three years ago.
As you think about the marketplace as a whole, can you walk us through where client segmentation is? All-to-all clearly wants to be the bridge between dealers and clients and clients and clients. How do you think about this evolving over time? Do you think of the proportion of trading that's client to client should grow tremendously over the next three to five years?
You've seen a slight mix shift in the dealer to dealer and the institutional client makeup of trades. I'm talking about high grade because that's where we have the best reporting. Two or three years ago, I think it was 20% round numbers dealer and 80% institutional client. The beauty of MarketAxess is we're a true all-to-all network where we see dealers and institutional clients participating in our Open Trading network. We feel that we are offering a true all-to-all network to our client base. That mix shift has slightly changed in the last year, where you've seen maybe 20% go to 25% or 30% dealer. For us, it doesn't matter because we're providing liquidity to both the dealer and the institutional client community.
With that, I think this is a good place to pause. Chris, thanks again for joining us.
Thank you. Nice one.
No problem.