CME Group sees record performance in Q3 2024

Our management team, including Lynne, is available to answer questions following our presentation. Our outstanding performance in the third quarter highlighted the increasing demand for risk management on a global scale. We achieved the highest quarterly average daily volume in CME Group’s history, with a 27% increase compared to the previous year. Our growth was widespread, with year-over-year increases in volume and open interest across all asset classes for the second consecutive quarter. Financial product volume grew by 28%, and commodity sector volumes grew by 20%. Our success was supported by the effectiveness of our volume tiers, particularly in the interest rate complex, which saw a 36% year-over-year growth. Despite no changes in fees or incentives, we saw significant growth in trading volume, leading to lower RPC and incremental earnings growth. Our SOFR complex continued to perform well, reaching record levels of trading volume and open interest holders. The geopolitical environment and the upcoming US election further emphasize the need for liquid and efficient markets to manage risks across asset classes. International business also saw record volumes, with strong growth in all asset classes, particularly in interest rates and equity products. Financially, we achieved record revenue, net income, and earnings per share, with a strong operating margin and effective tax rate. Our focus on product innovation and market liquidity has driven consistent demand for our products, leading to continuous growth in trading volumes and financial performance. We are committed to providing our clients with the tools they need for risk management and delivering value to our shareholders. Regarding the return of capital to shareholders, we are constantly monitoring it to ensure we are acting in the best interest of our shareholders. Our dividend policy has been successful in a zero rate environment, but with changing rates and global events, we continue to assess it at each board meeting. As for M&A activity, we are open to opportunities that make sense, but we are currently focused on monitoring rather than taking action. In terms of efficiencies provided to customers, our portfolio margining program is saving clearing members an average of $7 billion daily, with $1 billion in savings from the cross margining program. New customer acquisition has been a focus, with growth in both retail and institutional clients. Our efforts have resulted in significant increases in new clients and traders, with a focus on expanding globally. And this is a crucial aspect of our strategy to drive NCA in this sector, collaborating with them on education and marketing content. The success of our distribution partners directly impacts our success, attracting new traders to CME with our products. We anticipate this trend to continue in the coming year.

In terms of the potential impact of retail trading activity on our P&L, it is difficult to predict future volumes. However, it is important to note that changes in pricing and the client base can affect the rate per contract. We have tailored our pricing based on the value added for our clients, rather than solely on the size of the contract. Our focus remains on revenue and earnings growth, rather than just RPC growth. So, when it comes to acquiring new clients of any kind, our focus is on driving growth in both the top and bottom lines. We are not fixated on the RPC line specifically, but rather on the overall picture and level of growth.

Terrence Duffy: We don’t have a special formula for success, and that’s because every market and client is unique. The pricing change we made in micros was not based on a standard basis, and that’s the direction we’re heading in as we consider our client base.

Ben Budish: That explanation makes sense. On a more detailed note, there was an increase in licensing fees this quarter. Can you provide insight on what drove this increase and what we can expect from this line item in the coming quarters?

Lynne Fitzpatrick: The rise in licensing fees was expected due to high volume levels and growth, particularly in our equity complex. Additionally, existing OTC clearing programs saw growth leading to an impact on Q3. There were no new license fee programs related to SOFR or treasury complexes. The main drivers are overall business growth and existing OTC clearing programs.

Mike Dennis: The growth in futures and options continues to strengthen our OTC IRS business, particularly in US dollar swap activity. The majority of portfolio margin savings are in US dollar swaps, showcasing strong client engagement in this area. Other CCPs have different collateral levels, but they do not offer the same margin savings for SOFR and treasury products as CME does.

Terrence Duffy: Introducing Mike Dennis, our new head of rates franchise. Thank you, Mike.

Ben Budish: Thank you for your insights.

Operator: Next question from Ken Worthington at J.P. Morgan regarding the impact of Bitcoin and ETF launches on CME’s futures business and the potential for further growth in the digital platform.

Terrence Duffy: Tim McCourt will address this question. Tim highlights the positive impact of ETFs on the futures complex, leading to significant growth in volumes. The futures market plays a central role in the crypto ecosystem, enabling various trading strategies and providing efficiency in creating and redeeming ETFs. CME remains a leader in this space, offering a regulated and transparent futures market. Ken, when it comes to the perpetual market, it’s important to note that the comparison is not easy because perpetuals exist on more crypto native platforms that are not regulated outside of the US. However, we are committed to engaging with customers to provide them with the necessary tools to manage risk in these uncertain times, whether it’s in cryptocurrencies or other products. At CME, we ensure that our crypto products are offered in a trusted, transparent, and regulated manner.

As for the competitive landscape in rates and the recent launch of SOFR futures by a competitor, we are closely monitoring the situation. While volumes have been modest, it is still early days. We remain focused on delivering efficiencies to our clients and maintaining competitive bid-ask spreads. Our bid-ask spreads in SOFR contracts are tighter compared to our competitors, which ultimately benefits our clients in terms of cost. We are also focused on growing our interest rate products and ensuring that our offerings are cost-effective for market participants.

In terms of treasuries, we continue to advocate for the importance of US Treasuries being cleared in the US under US laws and regulations. We believe that having US Treasuries cleared overseas with resolution authority overseen by a foreign regulator poses risks that could be detrimental to the US financial system. We will continue to advocate for the importance of maintaining US control over the clearing and resolution of US Treasuries. Recently, there has been speculation about potential responses to FMX launching, including rate cuts. However, with the value provided to customers and record interest rate ADV for the third consecutive year, it may be misguided to assume that rate or price increases in the rates complex are off the table. The company adjusts tiers and strategies regularly based on market dynamics, not just competition. The energy business is also experiencing growth, particularly outside the US, with record revenues and new customer acquisitions driving global participation. The physical flows of US benchmarks to Europe and Asia are attracting new customers, especially in natural gas markets. This growth is fueled by market shifts and increased options trading due to challenging hedging conditions. Overall, the company is well-positioned to capitalize on structural changes in the energy market. I believe we are also observing a longer-term trend where the ability to liquefy natural gas for export is a limiting factor on the Henry Hub side. However, we are seeing ongoing build-out of multiple liquefaction facilities, with many expected to come online in the next couple of years. This increase in capacity for exporting could potentially benefit our business as more international customers may look to hedge back to that export point.

Terrence Duffy: Thanks, Lynne. Thanks, Derek. Alex, did that address your question?

Alex Kramm: I think it did. Great insight. And I have a quick question about the tax rate. It seems like international growth is positively impacting it. If this trend continues into 2025, do you think a tax rate around 23% is a more accurate estimate to use?

Terrence Duffy: I assume you are referring to energy, Alex. On the tax rate, we have adjusted it based on the significant international growth we are experiencing. We will provide tax guidance as part of our outlook for the coming years. While we have seen strong growth for several years, there are various factors at play, including potential changes in administration and political dynamics that could impact taxes. It is premature for us to determine a specific future tax rate at this point, but we will provide updates on this.

Operator: Thank you. Our next question is from Kyle Voigt with KBW. Please go ahead.

Kyle Voigt: Thank you for taking my question. Can we discuss pricing in a broader context? In recent years, you have announced pricing changes in the fourth quarter that take effect in the first quarter of the following year. For example, in 2024, you guided to a 1.5% to 2% pricing change assuming constant volumes. How are you currently evaluating future pricing changes, and should we consider 2024’s pricing change levels as a baseline for 2025?

Terrence Duffy: Pricing is evaluated throughout the year for the following year, and it involves more than just a blanket increase of 1% or 2%. We focus on providing value to our clients when adjusting pricing, considering factors like our investments in technology such as the Google transition. We do not make pricing decisions based solely on historical patterns, but rather on the value we can offer to our clients. We assess pricing continuously before making final decisions in consultation with our board. Lynne, would you like to add anything?

Lynne Fitzpatrick: Yes, Kyle, the 1.5% to 2% you mentioned was specific to clearing and transaction fees. We consider various factors when evaluating pricing changes, including fee schedules, incentive programs, data components, and collateral fees. In 2023, we guided for a 2.5% to 3% total revenue increase due to changes in these fee lines, and we have been tracking towards that goal this year.

Kyle Voigt: Thank you. And a follow-up for Lynne regarding expense trajectory. In 2023, there were $56 million in cloud migration expenses, expected to grow by $15 million in 2024. Can you confirm if this migration spend is still on track, and how should we anticipate these expenses in 2025 and 2026, considering the impact on depreciation and amortization?

Lynne Fitzpatrick: The total migration spend for this year is on target with our guidance of $90 million, including the $15 million increase. As we are in year three of the migration process, we expect to continue incurring incremental costs related to migration in the next year. There may be additional expenses in the following years as well, but we are managing this within our overall financial strategy. I would like to point out that our overall expense guidance already included the expenses related to Google. Therefore, the 3.9% implied by our expense guidance did encompass the Google spend. This trend has been decreasing as we are beginning to see the advantages of rolling off the on-premises operating expenses. To clarify, when looking at futures and options on futures products at CME Group, they are efficient from a tax perspective as they are Section 1256 contracts with a blended 60-40 capital gains tax. This tax advantage is index-based and not available for ETFs. The distribution of these contracts through partners like Robinhood is important for traders to manage risk and access the market. In Q3, CME Group’s futures outperformed ETFs at a 15-to-1 ratio, showcasing their capital efficiencies. While CME Group currently does not offer political event contracts, they remain open to future opportunities after evaluating market maturity and regulatory considerations. The focus is on offering event contracts that leverage existing futures contracts and engage with market participants for feedback on potential new products. In terms of expenses, there may be true-ups for incentive compensation throughout the year, reflecting operating leverage and performance-based compensation rather than direct headcount increases. I believe you are beginning to see the benefits of that model playing out this year.

Owen Lau: So should we anticipate a larger adjustment in the fourth quarter based on the model?

Lynne Fitzpatrick: No, the adjustments happen throughout the year. Any outperformance or underperformance will be reflected in each quarter, so there won’t be a significant adjustment in the fourth quarter. Our compensation expectations are already factored into our expense guidance for the year.

Terrence Duffy: We are growing revenue with the same resources and costs due to our operating leverage model.

Owen Lau: Understood, thank you.

Operator: Next question is from Mike Cyprys with Morgan Stanley.

Michael Cyprys: Regarding treasury futures clearing, what level of receptivity are regulators showing to your arguments? And what actions might be taken? Also, if a competitor were to set up a US clearinghouse for treasury futures, what would be the implications for netting benefits?

Terrence Duffy: The derivatives market is significant, and regulators are starting to understand its importance. There have been inquiries and responses indicating that they are taking this matter seriously. The implications of a US clearinghouse for treasury futures in terms of netting benefits would not be as significant as they might expect.

Suzanne Sprague: Achieving offsets between clearing houses in different jurisdictions is costly and regulators typically require full capitalization in each location. This is due to resolution regime concerns, and the need for domestic regulators to oversee the resolution of each clearinghouse.

Michael Cyprys: Thank you for the detailed response. Can you provide further information on interest rate swap clearing and the $40 billion margin of swap collateral mentioned? Just curious about the proportion of US interest rate activity in your swap clearing business and the growth you’re experiencing. How much does this contribute to your overall business? It seems like a potential growth opportunity, especially with larger clearing houses overseas. What steps are you taking to convince customers to move their swap clearing business to you and how can you make the process more seamless for them?

Terrence Duffy: Lynne and Mike, can you address this question?

Lynne Fitzpatrick: The majority of our margin requirement comes from US dollar swaps, around 75-80%. The efficiencies gained in our portfolio margin program are a key driver of swap activity. Capital efficiencies in this space have been a focal point since the clearing mandate for swaps. We are also focusing on offering efficiencies across different asset classes within the interest rate complex.

Mike Dennis: We are actively engaging with dealers to highlight the margin efficiencies between SOFR futures, treasury futures, and swap portfolios. Clients are showing renewed interest in sending portfolios to us for portfolio calculations. We see this as a good area for growth.

Terrence Duffy: Thank you, Mike.

Operator: Thank you. Our next question is from Bill Katz with TD Cowen. You may go ahead.

Bill Katz: How do you think about expenses and operating margins going forward, considering your high level of profitability? Is there a natural limit to your margins or would you reinvest in growth opportunities?

Lynne Fitzpatrick: Our fourth-quarter expenses typically increase due to marketing events and cloud migration expenses. We don’t have a target operating margin; our focus is on driving earnings growth and investing in new opportunities. We have enjoyed nice margins but prioritize driving growth over maintaining a specific margin level.

Bill Katz: Can you share insights on the growth potential from retail clients already on your platform? How much volume growth do you typically see from these clients, and how does it contribute to your total ADV?

Terrence Duffy: Julie, can you provide some more insights on retail growth?

Julie Winkler: Yes. As Terry mentioned earlier, predicting revenue is challenging, especially considering the diverse nature of our distribution partners. Some partners focus solely on futures, while others offer a wider range of products, including CFDs. Additionally, each partner targets a different audience in terms of account size, making it hard to provide a one-size-fits-all projection for Average Daily Volume (ADV) growth.

To address this complexity, we are dedicated to attracting new traders to the market through education and content initiatives. We collaborate closely with our 100+ distribution partners worldwide to tailor our offerings to their preferences. This includes organizing joint events, both online and in person, and working with third-party influencers to promote trading strategies.

Our diverse product portfolio also plays a crucial role in driving volume. For example, when equity volatility is low, we shift focus to products like WTI and Micro Gold, which have seen a 35% increase in volume year-on-year. Looking ahead, we are exploring new product opportunities in the retail space to further enhance our offerings for next year.

Overall, the recent quarter was marked by growth across all six asset classes, reflecting a robust performance across the board. We appreciate your participation in today’s call and look forward to keeping you informed in the coming months. Thank you, and stay safe. following sentence:

The cat chased the mouse around the house.

The mouse was chased by the cat throughout the house.