Welcome to another issue of Front Month, a newsletter covering the biggest stories in exchanges every Friday. If you have questions or feedback, please reply to this email or find me on Twitter. If you like this newsletter and want to follow the exchange industry with me, please hit the Subscribe button below & be sure to share with friends & colleagues:
Nasdaq Reports Q3 Earnings
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This week saw the first peek at Q3 earnings in the exchange space - Nasdaq reported on the morning of 10/21.
Nasdaq’s results beat expectations as revenue grew +13% and EPS surged +20% vs. Q3 2019. Index revenues helped drive the impressive result with 54% year-over-year growth as Nasdaq-100 Index futures & ETFs linked to Nasdaq indices saw stellar demand during the quarter.
Index outperformance made up for a rather lackluster Market Tech showing. Revenue shrank -1% organically as non-recurring business hurt otherwise solid growth in recurring SaaS revenue. Nasdaq management mentioned the pandemic as a continued reason for Market Tech softness:
As we stated earlier in 2020, service implementation, change request projects, new order intake levels and funding for new market initiatives have been adversely impacted by pandemic-related factors. We continue to expect to see in the short term mostly logistical growth headwinds that underpin the risk of Market Technology being below the bottom of our medium-term growth objectives for the current year.
Nasdaq touched on some other important topics during its earnings call:
Retail engagement in the equity markets is extremely high, bolstered by brokerages moving to $0 commissions. This trend may not be a long term one, but Nasdaq does expect elevated industry volumes to continue into 2021.
In response to questions about the New Jersey transaction tax, Nasdaq mentioned they don’t physically own any of their data centers, and moving states would be a forgone conclusion if new taxes were levied.
Nasdaq consistently looks at selective M&A opportunities in the market technology & data space, and will provide more guidance on their strategy in an upcoming investor day scheduled for November 10.
Overall I’m impressed with Nasdaq’s results and competitive position - they’ve undergone a multi-year strategic review that’s transitioned them from a macro-dependent transaction business (ahem, CBOE…) to a long-term data subscription business that benefits from the rise of passive investing & advances in technology. When markets do become volatile like we’re seeing in 2020, Nasdaq enjoys the best of both worlds.
(Q3 2020 revenue growth & medium-term outlook - source: Q3 earnings presentation)
CBOE Buys BIDS
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CBOE announced on 10/16 that it plans to buy BIDS Trading, a US & European equities block trading network, for an undisclosed sum. The deal completes the CBOE-BIDS partnership after jointly launching a European block trading service in early 2017 that showed modest success in the following years.
Block trading networks like BIDS are popular among large buyside participants because they can be used to trade in secret without broadcasting a position’s size & the trader’s intentions to the public. If exchanges like BATS or the NYSE are places where traders stand in the public square and shout their offers to the world, think of BIDS as the small side-room where big traders whisper orders behind closed doors. BIDS handled ~0.5% of US market volume in 2019, and made ~$42 million in revenue over the last 12 months.
CBOE purchased a similar dark trading venue MATCHNow from Virtu earlier this year. MATCHNow is the largest dark pool in Canada, with ~65% of off-exchange market share in Canadian equities.
To me, CBOE’s recent dark venue M&A suggests they’re worried about market volume leaving public exchanges permanently. The rise of retail Robinhood trading and new competitors has pushed volume off-exchange and has put pressure on legacy exchanges to keep market share. CBOE’s response seems to be using its balance sheet to follow the volume - or, to put it differently, moving to the dark side…
SOFR’s Big Bang & LIBOR’s Swan Song
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Did you hear that? That’s the sound of $80 trillion in derivatives changing benchmarks. Over the weekend of 10/17 - 10/18, the Secured Overnight Financing Rate (SOFR) replaced the effective Federal Funds rate in valuing interest rate swaps in the US. Bloomberg has done good reporting on this topic, first with the European transfer to the Euro Short Term Rate (ESTR) and now changes in the US.
The benchmark transition process began in 2012, when the Financial Times published an article by a former trader alleging LIBOR rigging scandals at the big banks stretching back to 1991. At the time, LIBOR was administered by the British Banking Association (BBA) and was calculated by essentially polling banks for daily lending rates they were seeing in the marketplace. This discovery of wrongdoing led to shaken confidence in LIBOR and calls for a transition away from the benchmark. In 2014, the BBA handed LIBOR administration duties to ICE, and regulators set timelines to transfer markets away from the benchmark altogether. Those timelines are now coming due - by the end of 2021, LIBOR is set to be fully obsolete.
I find this narrative important for two reasons. First, the global dominance of central banks can be seen even here - as LIBOR fades away, new benchmarks (SOFR, SONIA, ESTR, etc…) will now be administered by the ECB and the Fed, rather than ICE or the BBA. Second, benchmark transition takes a lot of work to accomplish, as CME, LCH and others prepare for & manage the shift of their markets from old benchmarks to new ones. These moves not only bring about execution risk (will these firms be able to transition without a tech glitch or cyber breach affecting their markets?) but strategic risk as well (will exchanges keep their product market share or lose business to competitors as benchmarks change?).
As a reminder, CME’s largest contract - Eurodollar futures - uses LIBOR as the underlying, and ICE’s Euribor & Sterling futures leverage LIBOR as well. I recommend the book The Spider Network for those interested in more reading on the topic.
Euronext Suffers Outage
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It was more than just another manic Monday for Euronext-owned exchanges this week. On October 19, the European exchange group suffered not one, but two separate tech glitches that disrupted markets at the beginning and end of the trading day. Trading was halted across nearly all asset classes and closing auctions didn’t take place in the afternoon, all during earnings season as many European companies report Q3 results.
While this is not the first time an exchange has halted trading due to a technical glitch, the mishap comes at a challenging time for Euronext & exchanges more broadly. ENX just announced its purchase of Borsa Italiana from LSE as regulators keep a close eye on anti-trust threats - tech glitches could raise concerns that one exchange system is the single point of failure for too many markets. Exchanges may face margin pressure down the road as technology needs grow, along with fines or other guardrails put in place by regulators.
Honorable Mentions
The NY Post reported that Bill Ackman & Mike Bloomberg were in talks to take part of Bloomberg LP public via a SPAC, but the company denied any plans were in place.
FactSet acquired ESG data firm Truvalue Labs for an undisclosed sum. Truvalue uses AI to create deeper & higher quality ESG datasets.
Moody’s announced their CEO Raymond McDaniel would be stepping down at the end of 2020 and be replaced by COO Robert Fauber. They also acquired KYC analytics & real-time news firm Acquire Media for an undisclosed sum.
MERS, a subsidiary of ICE in the mortgage technology space, announced record registrations on its eRegistry this week. The news signals strong macro demand for mortgages and adoption of new technologies to make mortgage origination more efficient.
Goldman Sachs has signed on as a market maker to MarketAxess’s Open Trading platform for investment grade corporate bonds. The news is meaningful as it drives more bond trading to electronic platforms where MarketAxess has a huge lead over competitors.
Chart of the Week
CME made $4.9 billion in 2019 revenue, with a whopping ~35% contribution from interest rate futures & spot markets through NEX. Rates volumes are highly correlated with current & forward expectations for rate hikes, particularly in the US. From late 2015 - 2019, CME’s Treasury & Eurodollar futures markets roared as interest rates rose & traders grappled with hawkish guidance from Jerome Powell & the Federal Reserve.
Then, COVID hit. To offset the sudden pandemic demand shock, the Fed quickly cut rates to near 0%, sucking the life from CME’s top markets. Below plots rates open interest against the Federal Funds rate - 2020 has seen a dramatic drop in OI as traders scale back positions with little need to hedge against future rate hikes that are many years out:
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