MarketAxess Q3 2022 Earnings Call Transcript

Quartr
Provided by Quartr
October 19, 2022

Key Takeaways

  • Record market share gains: In Q3, MarketAxess posted its second consecutive quarter of top‐quartile share gains across almost all products, setting new records in high yield, municipal bonds, Eurobonds and emerging markets with nearly 2,000 active client firms.
  • Open Trading cost savings: The all-to-all trading protocol generated $260 million in estimated transaction cost savings for clients—double year-ago levels—with record penetration of 37% overall and 53% in high yield.
  • Automation momentum: Automated trading hit a record $52 billion in Q3 volume (up 36% year-over-year) and over 290,000 trades, representing 18% of trade count, driven by rising adoption of AutoX, autoresponders and dealer algorithms.
  • Fee capture headwinds: Average fee per $1 million in U.S. high-grade bonds was pressured by an 18% drop in bond duration and a stronger U.S. dollar, reducing Q3 revenue by about $8 million on high-grade products.
  • Expense and capital focus: Full-year expense guidance was narrowed to $390–$398 million (implying ~9% growth), 2023 expenses are expected to grow ~10%, capex was cut to $48–$52 million, and the company plans to balance platform investment, opportunistic M&A and shareholder returns.
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Earnings Conference Call
MarketAxess Q3 2022
00:00 / 00:00

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Operator

Ladies and gentlemen, thank you for standing by. Welcome to the MarketAxess Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. At that time, if you have a question, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. As a reminder, this conference call is being recorded on 19th October 2022. I would now like to turn the call over to Steve Davidson, Head of Investor Relations at MarketAxess. Please go ahead, sir.

Steve Davidson
Steve Davidson
Head of Investor Relations at MarketAxess

Thank you, Brent. Good morning, and welcome to the MarketAxess Third Quarter 2022 Earnings Conference Call. For the call, Rick McVey, Chairman and Chief Executive Officer, will provide a strategic update for the company. Chris Concannon, President and COO, will review the progress we are making on our growth initiatives, and then Christopher Gerosa, Chief Financial Officer, will walk you through the financial results for the quarter. Before I turn the call over to Rick, let me remind you that today's call may include forward-looking statements. These statements represent the company's belief regarding future events that, by their nature, are uncertain. The company's actual results and financial condition may differ materially from what is indicated in those forward-looking statements.

Steve Davidson
Steve Davidson
Head of Investor Relations at MarketAxess

For a discussion of some of the risks and factors that could affect the company's future results, please see the description of risk factors in our annual report on Form 10-K for the year ended December 31st, 2021. I would also direct you to read the forward-looking statement disclaimer in our quarterly earnings release, which was issued earlier this morning and is now available on our website. Now let me turn the call over to Rick.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Good morning, and thank you for joining us to review our third quarter results. We continue to execute our growth strategy and delivered the second consecutive quarter of record market share gains across nearly all of our products, strong increases in trading volumes, and significant execution cost savings for clients through our unique all-to-all trading protocol, Open Trading. Our dealer and institutional investor clients are facing very challenging credit market trading conditions, and our focus is delivering value for them to help navigate through elevated market volatility. Through these challenging markets, our leadership position in global credit continues to expand beyond just U.S. high grade with record estimated market share in high yield and municipal bonds in the US, record share in Eurobonds, and accelerating share gains in emerging markets. The breadth of our global market share gains continues to expand in this volatile market.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Engagement of institutional investors and dealers on our platform continues to increase with a record of nearly 2,000 active client firms and a record number of active traders. We have seen especially strong growth in our international business with nearly 1,000 client firms now active, including strong growth in Asia. As traditional sources of liquidity have become scarce, the importance of our diversified liquidity pool increases and further enhances our leading market position. It is encouraging to see institutional clients and dealers leaning into MarketAxess across so many products during a period of challenging liquidity. We are also making excellent strides in developing new growth cylinders with another record quarter in municipal bond trading volume and a record quarter in portfolio trading volume.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

In U.S. Treasuries, there were 226 active client firms trading on the platform, up from 122 in the prior year, as we continue to gain traction with investors in our unique all-to-all Treasury solution. U.S. corporate and emerging markets debt outstanding in the market has been growing at three-year compound growth rates of approximately 4% and 9% respectively, which when combined with higher rates, sets a strong foundation for trading growth in the institutional client e-trading space. In summary, the breadth of our business has never been stronger with accelerating growth in trading volume, new market share records, increasing momentum in new product areas, and a growing addressable market opportunity. Slide 4 provides an update on market conditions.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Just one year ago on our earnings call, we stated that central bank tapering would lead to a more normalized yield levels and volatility in the bond markets around the world, and that is exactly what has happened. In a very short 10-month period, we have moved from massive central bank quantitative easing to the current state of central bank quantitative tightening due to the elevated levels of inflation. We have seen a rapid increase in yields around the world, and investment-grade bond indices are down a remarkable 22% year to date. While current trading conditions are extremely volatile, we believe higher bond yields create a better investing and trading environment. We maintain our view that bond trading velocity will grow in the years ahead due to growing bond market participation and increased adoption of trading automation.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

What we did not predict was this historically rapid rise in interest rates driving one of the steepest declines in corporate bond duration, dropping 18% year-over-year. This reduction in duration has had a negative impact on our high-grade fee capture, which is the only bond product that institutional investors trade in yield instead of price. At the same time, the U.S. dollar index moved to 20-year highs in a short period of time. Despite these short-term revenue headwinds, our overall revenue growth trends have improved materially in the last few quarters, and we would expect both the duration and FX revenue headwinds to diminish in the future as market conditions stabilize. In the very early weeks of Q4, total credit and rates average daily volume is running similar to September levels and well above last October.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Slide 5 shows the strong year-over-year increases in estimated market share and the magnitude of our share gains since the pre-pandemic period. This is the second consecutive quarter of top-quartile market share gains as compared to our long-term average year-over-year share gains. All but one of our primary products were in the top quartile of historical data for year-over-year quarterly growth versus the past 10 years. We focus on the longer-term trends, and as illustrated on this slide, we have grown market share by almost 550 basis points per product since the third quarter of 2019, which equates to an annual increase of approximately 180 basis points across products. These growth rates reflect the strength of our franchise and underpin our confidence in our ability to capture the market opportunity in front of us.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Slide six illustrates the tremendous growth opportunity that is driving our approach to investing. The strong market share gains we delivered this quarter only serve to reinforce the sizable revenue and earnings opportunity that we have ahead of us. We have a unique position in large and growing global debt markets. We are leveraging our global client network and technology to grow share in existing products and add new product areas to the platform. As we grow market share, our data and content become even more valuable, which makes us even more excited about the many ways that we are pursuing the data and ETF opportunity. We believe we can capture this opportunity and deliver superior returns to our shareholders. Now let me turn the call over to Chris Concannon to provide more detail on the significant progress we are making with our investments in new initiatives.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Thanks, Rick. Slide 8 provides an update on Open Trading. The benefits of Open Trading are coming through in the form of significant increases in execution cost savings for our clients. The importance of all-to-all trading is clearly shown in the record percentage of our global trade volumes benefiting from price improvement. Open Trading price improvement generated $260 million in estimated transaction cost savings delivered to our clients in Q3, double the savings levels from one year ago. We believe that the market is moving in our direction because of the benefits of all-to-all trading. We are also innovating and bringing this model to the U.S. Treasury and municipal bond space. One of the largest fixed income asset managers in the world, PIMCO, recently released a viewpoint piece suggesting that the entire U.S. Treasury market would benefit from a shift to all-to-all trading.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

We agree with their view. A record 1,800 unique firms, or over 90% of our active client base, executed at least one trade through our Open Trading network during the quarter. This dynamic is clearly shown by the data with record overall Open Trading penetration of 37% and record high yield Open Trading penetration of 53%. Slide nine highlights the increasing momentum we are seeing with automation in credit trading. Automated trading increased to $52 billion in volume and over 290,000 trades in Q3, reflecting continued strong adoption during a period of heightened volatility. This speaks to the increasing comfort that dealers and investor clients have using our tools and their confidence in our CP+ data feed. Today, AutoX represents 18% of total trade count and 7% of our credit trading volume.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

We are also seeing record Auto-Responder trading volume where our clients are optimizing their execution quality. Additionally, the use of dealer algorithms is continuing to grow on the platform with approximately 6 million algo responses in the third quarter, up 33% from the same period last year. The impressive 3-year CAGRs shown on this slide reflect the strong long-term growth of our trade automation suite. As the use of automation tools increases, we believe we will see an impact on trading velocity over time. Slide 10 illustrates our growth in portfolio trading. The third quarter was another record for portfolio trading with total volume of $25 billion. We delivered this strong performance through continued international diversification. Eurobond's portfolio trading volume doubled in the quarter, and EM portfolio trading volume was up over 20% sequentially.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

EMEA-based clients executed approximately 30% of our portfolio trading volume in the quarter. Estimated high-grade and high-yield portfolio trading market volumes have remained relatively flat at around 5%-6% of secondary trading over the last several quarters. Slide 11 is an update on emerging markets, where we continue to see strong growth in local markets and market share. We achieved 8% growth in emerging markets trading volume during the quarter, 12% growth on a constant currency basis. Local markets trading volume of $60 billion increased 33% on a reported basis and 47% on a constant currency basis. We continue to onboard new clients with record 1,376 active clients trading EM on the platform, and we traded in 28 of our 30 local markets.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

80% of the emerging market opportunity is in local markets, which is a huge and growing market for us. Now, let me turn the call over to Christopher Gerosa to provide an update on our financials.

Christopher Gerosa
Christopher Gerosa
CFO at MarketAxess

Thank you, Chris. On slide 13, we provide a summary of our quarterly financials. Third quarter revenue was $172 million, up 6%, driven by strong growth in trading volume and record market share gains, but was negatively impacted by the lower duration of U.S. high-grade bonds traded and a strengthening U.S. dollar. Excluding the impact of foreign currency fluctuations, revenues would have increased approximately 9%. All else equal, and assuming the same level of trading volume, we estimate that the change in U.S. high-grade duration lowered our third quarter revenue by approximately $8 million. Information services revenue was up 1%, or 10% excluding the impact of FX. We continue to expect our full year 2022 information services revenue growth rate to hit our historical growth levels of around 10% on a constant currency basis.

Christopher Gerosa
Christopher Gerosa
CFO at MarketAxess

Third quarter post-trade revenue included the negative impact of approximately $1.7 million on a strengthening U.S. dollar compared to the prior year quarter. Excluding the impact of FX and one-time revenue activity in the quarter, the year-over-year growth rate would have been approximately 8%. The increase in other income was principally due to higher investment income of $1.3 million as we are benefiting from a more attractive interest rate environment and a $900,000 gain on our equity investment. We expect other income in the next few quarters to increase slightly as we plan to benefit from higher investment yields on our cash and deposit balances.

Christopher Gerosa
Christopher Gerosa
CFO at MarketAxess

The effective tax rate was 24.8%, and we are reconfirming that we expect the full year effective tax rate to be at the upper end of the previously stated range of 24%-26%. On slide 14, we provide more detail on our commission revenue and our fees per million. Total commission revenue increased 7%. Our growth in total credit and total rates commission revenue was driven by healthy increases in our trading volume and estimated market share, but was partially offset by lower average fee capture across U.S. high-grade. The lower high-grade fee capture was driven principally by higher bond yields. The weighted average years to maturity of bonds trading U.S. high-grade has remained stable year-over-year on the platform. On slide 15, we provide you with our expense detail.

Christopher Gerosa
Christopher Gerosa
CFO at MarketAxess

Third quarter expenses increased 9%, driven principally by investments to enhance the trading system and our data product offering. Excluding the impact of FX, expenses would have increased 13%. Employee compensation and benefits increased $4 million on an increase in headcount, mainly in technology and customer-facing roles to support revenue growth initiatives. Technology and communications expense increased $4 million on higher software subscriptions, cloud hosting expense, and technology licensing fees. Professional and consulting expenses decreased $3 million, driven by lower acquisition-related consulting expenses and lower recruiting fees.

Christopher Gerosa
Christopher Gerosa
CFO at MarketAxess

Given the progression of operating expenses and the impact of FX fluctuations year-to-date, we are refining our full year 2022 expense guidance range to $390 million-$398 million from the previously stated range of $385 million-$415 million. The new midpoint would imply 9% growth year-over-year. On slide 16, we provide an update on cash flow and capital management. As of September 30, our cash and investments were $352 million, and our trailing twelve-month free cash flow was $239 million.

Christopher Gerosa
Christopher Gerosa
CFO at MarketAxess

We are refining our full year 2022 CapEx guidance range of $58 million-$62 million to a range of $48 million-$52 million, mainly due to a transition from purchasing to leasing fixed assets and the FX impact on our international investments. During the third quarter, we paid out $26 million in quarterly dividends to our shareholders. Year-to-date, we have repurchased 280,000 shares for a total of $88 million. $100 million remains on the outstanding repurchase authorization. Our board of directors declared a regular quarterly cash dividend of $0.70, which was based on the financial performance of the company. Now let me turn the call back to Rick.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Thank you, Chris. In summary, we continue to execute very well against our growth strategy and are pulling all the levers within our control.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

We delivered record levels of market share and enhanced our competitive position in the institutional client e-trading space, both in the U.S. and on the international front. Our global footprint continues to broaden and deepen as we diversify our product offering and achieve record growth in active clients. The market is increasingly turning to our unique Open Trading solution for liquidity and significant price improvement, and the market opportunity before us continues to expand. Now I would be happy to open the line for your questions.

Operator

At this time, I would like to remind everyone, in order to ask a question, press star followed by the number one on your telephone keypad. In the interest of time, we request that you ask one question and one follow-up. Your first question comes from the line of Rich Repetto with Piper Sandler. Your line is open.

Rich Repetto
Rich Repetto
Research Analyst at Piper Sandler

Yeah. Good morning, Rick and Chris and Chris. I guess the first question is on the market share gains in U.S. high yields. Some significant gains, you know, really starting probably last quarter. I guess, Rick, the question is, can you characterize what's driving that? Is it similar to the U.S. high grade market volatility and market share gains you saw at, like, early in the pandemic? Is it a similar situation of liquidity demand?

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

It certainly is, Rich. If you look at our high grade and high yield bid-ask indices, they are approximately double where we were a year ago and already at about 80%-85% of where they were in March of 2020. The liquidity conditions are incredibly challenging, and as a result, clients are leaning on the all-to-all trading model that we have developed in high yield for diversified sources of liquidity and price improvement. It's obviously a completely different model that we run in all-to-all trading. The consistency of delivering price improvement is what's driving high yield clients and dealers to execute more of their volume with us on the platform.

Rich Repetto
Rich Repetto
Research Analyst at Piper Sandler

Got it. One follow-up, Rick. This is on the Treasury market and regulatory proposed changes to central clearing. If I had to sum up, and you correct me if I'm wrong, but the proposed rules from the SEC would require central clearing of Treasuries from a wider audience, including proprietary traders and hedge funds. What do you see as the impact on the Treasury marketplace, you know, if that was to occur? Do I have it correct, I guess, to sum up the proposal?

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Chris, do you want to take the first cut at this?

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Sure. Rich, I have to say, you're reading the proposal like a lawyer. That was an accurate summary. You know, the way we view the SEC's proposal is the policy goals of the proposal are sound. The market will benefit from centralizing clearing at DTC of Treasury activity, because of the net settlement benefits that DTC provides and the guaranteed settlement that DTC provides. Organizing the market to have more centralized clearing is favorable to the overall market. I think the key piece of the proposal is how we get there. There are steps, the way the proposal is structured, because it's really a rule change that supports the clearing agency's proposed rule changes.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

There are some benefits embedded in the customer protection rules that the SEC are proposing for clearing firms to allow them to have more favorable capital treatment if they're clearing on behalf of other broker-dealers, particularly the proprietary trading firms. I do think we're at least a year or two away from the final implementation of the clearing agency rules. Remember, the SEC has to approve the rules, and then the clearing agencies have to file their own rules to comply with the proposed rule. A few steps away. There's still obviously some discussion around the repo proposal that the SEC incorporated into the overall clearing proposal. Again, the policy benefits are sound. It's really the steps that we get that we use to get to the final outcome.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

there are some impacts, but I do think we are a ways away from the final implementation of the goals of the proposal.

Rich Repetto
Rich Repetto
Research Analyst at Piper Sandler

Got it. I'll take that lawyer comment as a like a positive. I'm usually suspicious of any lawyers or those with lawyer degrees, Chris.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

I always think highly of lawyers, just try not to be around them as much.

Operator

Your next question is from the line of Chris Allen. Your line is open.

Chris Allen
Chris Allen
Managing Director and Senior Analyst at Citigroup

Morning, guys. Thanks for taking my question. I want to talk a little bit about fee per million, which has been obviously a bit of an overhang on the stock. Wondering if you could maybe give us some color just in terms of how fee per million progressed over the course of the quarter, specifically around high grade. Are you starting to see some stability there? Any other dynamics, whether it's in EM, that's going on, local versus hard currencies? What was the thought process on pulling back on the disclosure there in terms of breaking it out between the different products?

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Hey, Chris. I'll get into the technical discussion of the sequential, it was stable, relatively speaking, for total credit. Then the charts that we provide in the deck, I mean, we provide the view of what the years to maturity and bond yields look like from a 3Q perspective. On slide four of the deck, there was some pressure on high-grade fee capture, given the movement in the years to maturity was down slightly, and bond yields were up slightly. Just to remind you that the technical metrics to that, it's every 100 basis point move in bond yields is around a $4 impact on fee capture, and every one year to maturity is around $14-$15.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

There were movements, and there was slight pressure on high-grade fee capture, but, relatively speaking, it was stable to the Q2 exit levels. What we're seeing so far in October is around the same. Of the $16 decline in total credit fee capture, roughly 60% of that was due to the duration impact from high grade, and the balance of the 40% was due to product and protocol mix. So high grade was a bigger impact, but there were other variables that were contributing to that as well. That was a year-over-year comparison, Chris. I know you asked about the sequential, but I just wanted to hit the year-over-year decline. On the second half of your question, Chris, a couple of thoughts and responses there.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

One, in one way, we've increased transparency on fee capture because we have started to provide the total credit fee capture on a monthly basis rather than quarterly, so we think that will be well-received by investors. Secondly, it's one of many examples where we were providing a lot more granularity on fee capture than the rest of the market. We think by going to total credit fee capture, we've aligned ourselves with what we see elsewhere in the industry. Thirdly, as we've said, the vast majority of the high-grade fee capture change was all due to the increase in rates and duration. There is a publicly available data point that I would point all of you to that will show you what's going on with duration and corporate bonds, and that's the corporate bond index duration.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Anyone that wants to follow it more than monthly, or try to dissect high grade versus other products, there is a way to do that with the public data on the corporate bond index. All three of those factors drove the decision to shift to monthly and go to a full credit fee capture per million. Chris, you mentioned EM, so I have to obviously answer that question as well. Our EM volume in the quarter is up about 7.7% over Q3 last year, and that's in the face of market volumes being down. But as you mentioned, local market ADV is up 32% year-over-year. Obviously, super exciting for us to tap into that local market.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

It obviously has a slight impact on capture, as you noticed. Overall, EM volumes continue to grow. We're super excited about that local market piece because it's up so large year-over-year.

Chris Allen
Chris Allen
Managing Director and Senior Analyst at Citigroup

Got it. Appreciate the color there. I guess I just wanted to follow up a little bit kind of on the environment. You gave some color just on high-yield, just in terms of some liquidity challenges there. But maybe more so on high-grade, where the commentary we've kind of heard is spreads are widening out. Why isn't trading activity better? Is it a function of clients waiting for a firmer picture of the economy? Are there other factors involved? Is there outflows impacting activity? I'm just trying to think about what's the potential catalyst ahead to improve the environment from specifically on the high-grade side.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Yeah, you know, the high-grade market volumes are actually holding up reasonably well year to date, given the extreme volatility in the market and the challenges with liquidity. You actually see the market volume challenges more clearly in the international products, and a huge part of that is just the FX translation back into dollars in our reporting. But there, you know, in EM in particular, you have a risk-off environment. You clearly have had outflows in bond funds. I don't think most investors are used to these kind of price changes in corporate bond mutual funds and ETFs. It's not anything I've ever seen in my career. In fact, in the last 20 years, if you look at the high-grade index, the worst year we've had was down about 4%.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Here we are down 22% year to date. It has driven some outflows as well. I think all of those factors are at work. We still feel very strongly that debt in the world is going to continue to grow as it has been. We really feel that the increase in participation and automation over time will increase velocity. There are a number of factors that are contributing to some challenges in the very near term on market volume growth.

Chris Allen
Chris Allen
Managing Director and Senior Analyst at Citigroup

Thanks, guys.

Operator

Your next question is from the line of Gautam Sawant with Credit Suisse. Your line is open.

Gautam Sawant
Gautam Sawant
Research Analyst at Credit Suisse

Hey, good morning. One of the key differentiators of the MarketAxess platform is value-added data. Can you speak to recent enhancements to your data and analytics capabilities and if there's been any pricing changes to your offering?

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Sure. On the data front, obviously we have our premier product CP+ and Axess All, two products that are obviously used by a large community of both dealers and clients. We continue to see high demand for both products, but particularly in CP+ because we've rolled out additional product for CP+. Not only do we have CP+ for U.S. corporates, but we also have it for euro bonds, EM. We've now launched a CP+ for Treasuries and EGBs as well. We see growing demand as we grow market share, as well as we roll out additional products. You know, we're looking at future launches in municipals as an opportunity as well, and working on that.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

The other area that has been growing interest from a data perspective by our clients are what I'll call portfolio construction data. That's really how we help our clients to select the right bonds based on liquidity and activity in the market when they're constructing their portfolio. An example of this is used in our MarketAxess 400 index, where we select bonds, 400 bonds in the investment-grade space that are the most liquid bonds across our platform. We use that data to construct the investment-grade index, the MarketAxess 400. It's now been launched into an ETF, LQIG, in partnership with State Street. We're super excited about being able to take our data on our platform and to convert it into portfolio construction.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

We're seeing higher and higher demand from our clients around that unique data that they can use on a daily basis to help construct the most liquid portfolio, particularly given the liquidity challenges that we're seeing in the market, in this time.

Gautam Sawant
Gautam Sawant
Research Analyst at Credit Suisse

Got it. Just as a follow-up, as you consider the narrowed expense range, excluding some of the FX benefits, where are expenses coming in below your initial estimates? Could you expect to see any of those expense benefits carry into next year?

Chris Concannon
Chris Concannon
President and COO at MarketAxess

The rationale behind tightening the range was really driven by the FX impact, and we provide good disclosure in our 10-Qs in the market risk liquidity section, where every 10% move in exchange rates, particularly around the sterling and the euro, is gonna be around a $10 million impact on operating expenses. It's not as if we've pulled back the investment strategy. We're continuing to invest in the platform and changing our investment philosophy from leasing as compared to purchasing, but all that's doing is just shifting our spend across the income statement. The FX was a headwind for us, and we just felt it was appropriate to tighten the range for the investment community.

Gautam Sawant
Gautam Sawant
Research Analyst at Credit Suisse

Got it. Thank you very much.

Operator

Your next question is from the line of Alexander Blostein with Goldman Sachs. Your line is open.

Analyst at Goldman Sachs

Hey, guys. This is Michael on for Alex. Maybe just following up on that, there was a meaningful step up in tech and communication spend this quarter. I think the press release referenced enhancements of trading systems as well as, you know, higher subscription and licensing costs. Where are you guys making incremental investments? Should we still think about 10%-12% over the next few years? Or, you know, and what extra investment are required to support that growth range? Thanks.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Yeah. We called it out. It's around our cloud investing licensing for our platforms that support our U.S. Treasury business. IT security is a big investment area for us. As we think about the 2023 expense guidance, we're in the early days of our budget planning, but the preliminary outlook is that we're gonna see around 10% year-over-year growth in operating expenses, and that's assuming, of course, that we're looking at an exchange rate around today's levels, so that's subject to change depending on where the foreign currency markets take us. I would just say in terms of our, you know, what's driving our desire to continue investing is what we see in client behavior and adoption of all the new products and protocols that we're delivering to the market.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

In addition to our core business market share gains being well above average, we're really encouraged with the progress that we're making in municipal bonds and government bonds, and clearly now have a competitive offering in portfolio trading as well.We're super excited about the share gains that we see internationally and how big the emerging markets and euro opportunity is.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Our view is that we're getting all the right signals, that our clients want to automate more of their fixed income trading around the world, and we have an opportunity to continue to do more with existing products and also add additional products in the years ahead.

Analyst at Goldman Sachs

Great. That's helpful. Maybe shifting gears a little bit. Can you help us understand how much of the high yield revenue might be coming from ETF market makers, specifically in the quarter and, you know, maybe how that's changed versus 2021? Thanks.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Obviously, ETF market makers are an important part of our overall market across all of our products. Not just high yield. Our Open Trading record open trading market share penetration of 53% is certainly reflective of seeing alternative liquidity providers stepping up and filling the gaps of liquidity in the market as other traditional liquidity providers are more challenged from a balance sheet perspective. We don't give out overall statistics on any one segment, particularly our ETF market makers, but they are a strong partner to us and strong partners in the liquidity that they provide to our clients. I would expect ETF market makers to continue to grow on the platform.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

If you look at the growth of the ETF market and the new product offerings being delivered to that market, we would expect higher correlations as more products come into market. We would expect higher correlations of ETF market makers being part of our market. The other thing to point out is all of the large investment banks have sizable ETF market making presence.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

There's really no way to discern what is ETF market making anymore and what is separate type of investment bank traditional client to dealer business. It's everybody's in the ETF space, including some of our hedge fund clients. To try and, you know, triangulate what that really is is quite difficult to do.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

You know, I just would remind you, and you see in high yield that over half the volume is going through Open Trading. There are three main sources of that liquidity, and they are all growing. One is what we call the alternative market-making community, and a lot of those are ETF market-making participants. The second is just allowing more dealers to compete for order flow efficiently.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Those are dealers anywhere in the world that have market-making businesses that may not have counterparty relationships with clients that are utilizing our platform, but they can compete for order flow here. The third, and I think the most interesting long-term, is that in environments like this, when liquidity is challenging, we're seeing more opportunistic investors leading with price and being the price and liquidity provider.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

All three of those different segments are contributing to the diversification of liquidity that we see. The best example of that, as you point out, is in our high yield marketplace.

Analyst at Goldman Sachs

All right. Thanks, guys.

Operator

Your next question is from the line of Daniel Fannon with Jefferies. Your line is open.

Daniel Fannon
Daniel Fannon
Managing Director and Senior Research Analyst at Jefferies

Thanks. Appreciate the time. Just wanted to follow up again on high yield, just thinking about sustainability of some of the share gains and what you were just talking about with some of the momentum. Looking at the comparison to the beginning of the pandemic with high grade and the benefits your platform sees, and then it normalizes as you know, spreads come back to more normal territory. Would you anticipate some normalization in your market share if and when, you know, kind of activity in the high yield you know, kind of slows down and spreads tighten a bit?

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

I do think you see fluctuations depending on the liquidity conditions in the market. The overall trend and Mike, that's actually why we provided a three-year view on share. You can see, even though we went through that extremely volatile period in 2020 with the spike up and then some reversion in 2021 when market conditions were very stable, when you look at three-year growth, the trend is pretty darn clear. I do think the direction of travel on share overall is positive.In the short term, you know, quarter to quarter, we will certainly see impact based on market conditions. Quite honestly, when I look out to 2023, my own expectation is that it's likely that volatility is going to remain high.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

This is a very delicate balance for central banks around the world to try to control inflation without sending the economy into recession in a significant way. It sure looks to me like they're going to be dealing with that challenge all of next year. Our outlook on volatility is that it's likely to favor our model going into 2023.

Daniel Fannon
Daniel Fannon
Managing Director and Senior Research Analyst at Jefferies

Okay. Appreciate that. Just to follow up on capital return, it looks like buybacks were kind of halted this quarter after three quarters of relatively stable levels. Just curious on your outlook for share repurchases here.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Yeah. Our capital management strategies around share repurchases has been to offset dilution from employee equity grants. We spent a lot of money this year, almost $90 million repurchasing 280,000 shares, which essentially accomplished two years of offsetting equity dilution from the awards we give to the employees. What's different today, Dan, is we're in a much more attractive investment yielding environment. When we're thinking about deploying cash, returning value to our shareholders through higher returns on our cash balances is something that we think about as we think about our capital management strategy going forward.

Daniel Fannon
Daniel Fannon
Managing Director and Senior Research Analyst at Jefferies

Okay. Thank you.

Operator

Your next question is from the line of Michael Cyprys with Morgan Stanley. Your line is open.

Michael Cyprys
Michael Cyprys
Managing Director and Equity Analyst at Morgan Stanley

Hey, good morning. Thanks for taking the question. Just want to circle back to some of the commentary around trading automation. I think you mentioned the automated trades are about 18% of trades, but 7% of volumes. I was hoping you could talk a little bit about some of the initiatives to expand automated trading to larger trade sizes and expand usage across your customer base. Maybe you could talk about some of the hurdles and how you're working to overcome them.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Sure, I'm happy to answer that. Obviously, as we mentioned, automation continues to grow across the platform. If you take a step back and look at the macro challenges of our clients, particularly in 2022, with falling AUM, which obviously cuts their revenue, there's a need to outsource trading solutions. We're feeling that demand from our clients to help them solve automation solutions that they need for their trading. We're seeing that obviously in the growth with seeing record automation at $52 billion in the quarter up, you know, 36% over the year. The demand continues. The areas where we're seeing heightened interest, it's really two areas. It's the basic workflow, small execution sizes continue to grow.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Also the no-touch region, which is really an API solution where there is no trader involved. The orders come in directly, and they're processed. I would say Auto-Responder, and I mentioned this in my remarks, Auto-Responder, where clients are able to capture spread through an automated solution and be working an order in the market.That's where we're seeing heightened demand, particularly given the spread levels in this current market. They're all very comfortable with our data feed. It's controlled by CP+, and obviously the adoption rates, even in this volatile market, has been high. The other exciting area of growth for us is in the muni space.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

In the quarter, we executed our first Auto-X in municipal bonds, and we see heightened demand in that area. Again, very small ticket sizes in munis and a lot of workflow associated with the muni market. We're super excited about what we can do, not only in high grade, high yield, Eurobonds, and EM, but also in the muni space.

Michael Cyprys
Michael Cyprys
Managing Director and Equity Analyst at Morgan Stanley

Great. Thanks. Just to follow up with the, on the balance sheet side, $325 million cash position. How do you think about deploying that here, prioritizing maybe buybacks, or investing organically in the business, but also M&A? Where might that be helpful in terms of filling any gaps or accelerating growth in certain areas?

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Yes. I'll just repeat the investment priorities. Invest in the platform, potentially some opportunistic M&A, and return capital to the shareholders. You know, of that $350 million, when we think about cash, we also think about the investment line items. Round numbers, it's $350 million. You know, roughly $250 million is supporting our Open Trading business, and $100 million is balanced for our working capital investment needs. That $350 million today is earning around 3%, which is representative of Fed Funds.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

As we are working through our capital management strategy for 2023 in connection with our budget, we're recognizing the opportunities we have on the investment yield front and balancing that with how we're gonna return capital to our shareholders through dividend and repurchase programs.

Michael Cyprys
Michael Cyprys
Managing Director and Equity Analyst at Morgan Stanley

If I just follow up just really quickly there. Does that imply about $100 million of excess cash then, cash and investments?

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Yeah. As of 9:30 A.M.

Michael Cyprys
Michael Cyprys
Managing Director and Equity Analyst at Morgan Stanley

Okay. Thank you.

Operator

Your next question is from the line of Simon Clinch with Atlantic Equities. Your line is open.

Simon Clinch
Simon Clinch
Research Analyst at Redburn Atlantic

Hi. Appreciate you taking my question here. I was wondering if we could circle back to the high-grade market. Just help me understand sort of the market share trends. I mean, this is the one area where obviously the market share trends haven't been as other segments for you. Just wondering how to think about why that should be the case, given the volatility we've seen of late. You know, what's it gonna take for that to really accelerate?

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Yeah. I think if you look at it, a lot of it is the market shock that investor clients have gone through this year with the significant drop in corporate bond price values and indices and the outflows that they are experiencing. I do think if you still look at the institutional client space, we have a meaningful lead on our competitors there.We have lots of interesting things going to add to what we've done so successfully around RFQ. The growth in portfolio trading is clearly very relevant to us. We have not historically been competitive in the D2D space that's actually growing as dealers use electronic trading more to move inventory more quickly through the market.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

We have some ideas there that we think could be successful around how to compete more effectively in D2D. As I said, the automation tools in our mind are likely to increase both usage and velocity for trading on the platform. It's a strong leadership position in the institutional space today, and we think we have many ideas to continue the market share gains in the years ahead.

Simon Clinch
Simon Clinch
Research Analyst at Redburn Atlantic

Okay. Thanks for that. Just as a follow-up, though, on the portfolio trading side, I know you said that, you know, the share of portfolio trading is sort of flatlined at about 5%-6%. Actually, if you look at the numbers, it's still creeping higher. I was kind of expecting portfolio trading to maybe retract a bit from share of volumes in a higher volatility environment, given that, you know, it just becomes much harder and much riskier price for, you know, for participants there. Should we just expect that figure to keep creeping high regardless of the volatility environment?

Chris Concannon
Chris Concannon
President and COO at MarketAxess

You know, creeping higher is, I think, a good explanation of the trends in portfolio trading this year, and the growth rates in the prior two years were significantly higher. Some of the analyst expectations on growth were much higher than what we've observed this year. Yes, we think it's going to be used selectively for situations where large portfolios can be moved mostly through the dealer community. I think you will see that volatility does impact pricing in portfolio trading, and it's becoming more concentrated too. When there was no volatility in the market, we observed more dealer market makers winning portfolio trades on MarketAxess one year ago than we do today, where that liquidity has become concentrated around thre or four dealers that do portfolio trading very well.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Yes, our expectation would be exactly that it will probably creep higher in the years ahead, and we think we have continued opportunities to continue to take share.

Simon Clinch
Simon Clinch
Research Analyst at Redburn Atlantic

That's great. Thank you very much.

Operator

Your next question is from the line of Rich Repetto with Piper Sandler. Your line is open.

Rich Repetto
Rich Repetto
Research Analyst at Piper Sandler

Yeah. I just have two follow-ups on questions that were asked earlier. Chris, on this Treasury regulation, central clearing is good for a number of reasons, but it also requires margin, and I know it's not gonna be until whenever you said it was, another year plus down the road. Could it impact trading of these proprietary traders or hedge funds if they're required to put up margin in a centrally cleared environment?

Chris Concannon
Chris Concannon
President and COO at MarketAxess

The way, obviously they're trading today, they have favorable margin treatment as they're clearing outside of the central clearinghouse. Two things I would think would happen as you organize more volume in the central clearinghouse. Obviously margin offsets do get created as you're netting down more of the activity that's cleared away.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

But also the fees that are charged, if you grow that clearing volume dramatically, and there's a sizable portion that clears outside the central clearinghouse, I would expect fees to be reflective of the overall volume coming into the central clearing. It's not clear that the margin impact will be dramatic for all of the proprietary traders.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

One of the key elements, as I mentioned, is that we've seen a number of clearing firms that clear on behalf of others, step out of the market over the years 'cause of the challenges around capital treatment for that clearing of Treasury business. They're really trying to create a benefit for those clearing firms, so we'd see more clearing firms step in to clear on behalf of others, clear on behalf of those proprietary trading firms that you mentioned. There are solutions, and the SEC is well aware of some of the capital impacts for bringing that volume back into central clearing.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Again, there's a lot more detail that has to be worked out, both on the proposed rules, as well as when we see the clearing agencies actually draft their rules that comply with the SEC's rules. It's a complicated step by step process, and there's a number of opportunities to create favorable capital treatment for the proprietary trading firms.

Rich Repetto
Rich Repetto
Research Analyst at Piper Sandler

Got it. Thank you, Chris. Then Rick, I guess this is the last question is, I understand the pros and cons of the disclosures and comparing to what your peers do and what you've done. But I guess the question surrounds like as market share in U.S. high grade has been more stagnant lately, as well as the pressure on the fee capture, that you know, is U.S. high grade the more mature market? Is that any proxy for the way other credit markets can go over time, and therefore, investors don't have the disclosure? Or, like, I think you're still pretty positive on the opportunities in U.S. high grade as well, you know, that you spoke about on the call. I guess.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Well, positive on the market environment, the market opportunity, and our transparency. I haven't had anyone challenge our view that we're the most transparent e-trading platform in the space in terms of the granularity of detail that we provide to analysts and investors. We think we've added some important information with the monthly disclosures, and we're happy to point you to the duration factors that you need to see shifts in duration that are impacting fee capture in that product. We continue to have a view that fixed income is going to follow other asset classes. I think the demand for automation with investors, Rich, are noticeably higher today than they were a year ago because of the drop in asset values across asset classes.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Our expectation is that our investment in automation and the clients' need for it will continue to drive the share levels across all fixed income product areas in electronic trading higher in the years ahead. I think when we look back five to ten years from now, we're going to see it's landed in a similar place to other asset classes with 70%-80% of the volume taking place electronically. Rich, I would just add, if you really think about the growth of MarketAxess today and in the years to come, it is breadth of product that we are growing. There's not a one product.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

We're putting up records across our product categories, and we want our disclosure, which is, as Rick mentioned, far more than most of the platforms in the space. We want that disclosure to recognize the breadth of product that we're offering, not just an investment grade capture rate. We've made this adjustment. We've actually become more transparent on a monthly basis than most platforms in this space. If you look at the overall records across the product categories, we wanna make sure our disclosure reflects that breadth of products, not just one category.

Rich Repetto
Rich Repetto
Research Analyst at Piper Sandler

Got it. Thank you very much.

Operator

Your next question comes from the line of Kyle Voigt with KBW. Your line is open.

Kyle Voigt
Kyle Voigt
Managing Director of Equity Research at KBW

Hi. Good morning. Maybe if I could just ask a question on the Eurobond business and the significant share gains there. Can you just give us an update on how much of that total market you estimate to be electronic? From a competitive perspective, you know, we can obviously see your share and Tradeweb share. I guess the question is, do you believe that Bloomberg is still ceding significant share in that market, and how much electronic share is left on their platform? You know, I'll ask my follow-up with this one. Are you seeing Bloomberg do anything strategically to catch up in terms of investing in their offering or developing protocols in that market? Should this kind of continuation of ceding share, should investors expect that to kinda continue near term?

Kyle Voigt
Kyle Voigt
Managing Director of Equity Research at KBW

Thank you.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Yeah, happy to comment. Of course, I think the environment has been favorable for us given the all-to-all trading benefits that we drive to Eurobonds and also EM for EMEA market participants in a very challenging market environment. I think that is the core competitive advantage that we have that you see coming through in our Eurobond and EM market share. You know, unfortunately, Kyle, it's hard to get at the number of what the true electronic share is in Europe today because I believe I'm correct in saying that both of our competitors include pure processing volume in their e-trading numbers. When dealers get their reports, they're seeing the processing volume mixed in, and that's the way we see the public reports coming out.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

We've decided to stay true to providing only our fully electronic volume in Europe and elsewhere around the world. When we look at it, we think that the electronic share in Eurobonds is probably around 45% of the total market, so there's plenty of room yet to grow. I think when you look closely at the trends and you include just the fully electronic volume, you'll see that we're not only gaining share on an absolute basis, we're gaining share from competitors.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

I would just mention there's a sizable opportunity in the Eurobond market in terms of electronic block trading. We continue to see our record share. Average trade sizes are still small relative to the block market, but we are gaining block market share as well. I think there's a huge opportunity in the Eurobond market to increase the electronic trading of blocks. Obviously, the dealers are quite comfortable providing pricing for large-sized trades, and we think that opportunity is quite sizable in the Eurobond market.

Kyle Voigt
Kyle Voigt
Managing Director of Equity Research at KBW

Thanks. If I could just squeeze in one more question. Now the call's running a little bit long here. Just in terms of the Mid-X protocol, I think that launched at the end of last year in the U.S., and there was some, you know, enthusiasm, I think, around what that uptake would be throughout this year given the kind of pure all-to-all nature of that protocol. I guess, are you still seeing good levels or high levels of client interest around utilizing that in the U.S., and maybe just kind of an update on the uptake there?

Chris Concannon
Chris Concannon
President and COO at MarketAxess

Yeah. I think the way we approach the dealer-to-dealer business, and Mid-X is really a dealer-to-dealer offering. We have that offering live in Europe, and we continue to see demand for it. In the U.S., we're seeing higher demand for our dealer RFQ platform, where dealers can come in and use Open Trading anonymously and request price from other dealers. We continue to see growth in the dealer-to-dealer business, both globally in terms of Mid-X as well as the dealer-to-dealer RFQ business, across U.S. and Eurobond market. I think the offerings that we are certainly growing is that dealer-to-dealer business. They look at things like live markets, RFQ, as well as a mid-market session-based trading.

Chris Concannon
Chris Concannon
President and COO at MarketAxess

In this environment with heightened volatility, those mid-market sessions are a little bit more difficult to manage, 'cause dealers are typically looking to move out of their inventory more rapidly than waiting around for a mid-market section. We see heightened demand for dealer RFQ over any of those mid-market solutions.

Kyle Voigt
Kyle Voigt
Managing Director of Equity Research at KBW

Great. Thank you very much.

Operator

Again, if you would like to ask a question, press star followed by the number one on your telephone keypad. There are no further questions at this time. I will turn the call back over to Mr. Rick McVey.

Rick McVey
Rick McVey
Chairman and CEO at MarketAxess

Thank you for joining us this morning, and we look forward to catching up with you again next quarter.

Operator

Ladies and gentlemen, thank you for participating. This concludes today's conference call. You may now.

Executives
    • Chris Concannon
      Chris Concannon
      President and COO
    • Christopher Gerosa
      Christopher Gerosa
      CFO
    • Rick McVey
      Rick McVey
      Chairman and CEO
    • Steve Davidson
      Steve Davidson
      Head of Investor Relations
Analysts
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