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Marketaxess Holdings Inc
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Ladies and gentlemen, thank you for standing by. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference call is being recorded, January 30, 2019.
I would now like to turn the call over to David Cresci, Investor Relations Manager at MaretAxess. Please go ahead.
Good morning and welcome to the MarketAxess' fourth quarter 2018 conference call. For the call, Rick McVey, Chairman and Chief Executive Officer, will review the highlights for the quarter and provide an update on trends in our businesses. And then Tony DeLise, Chief Financial Officer will review the financial results. Chris Concannon, President and COO also joins us for the call today and we’ll make some brief remarks.
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. Company’s actual results and financial condition may differ materially from what is indicated in those forward-looking statements.
For 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 31, 2017. I would also direct you to read the forward-looking statements 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.
Good morning and thank you for joining us to discuss our fourth quarter 2018 results.
This morning we reported strong fourth quarter results, driven by record market share across our core products and record Open Trading activity. Overall trading volume of $442 billion was up 24% compared to Q4 2017. Our estimated U.S. high-grade market share reached a record of 19.3%, up from 17.6% last year. Estimated high-yield market share shows especially strong growth and reached a record of 10.9%, up from 6.3% in the same period last year.
Open Trading had a record quarter with a volume of $118 billion, up 96% year-over-year. Fourth quarter revenue of $112 million was up 14% compared to Q4 2017. Operating income for the quarter was $54 million, and diluted EPS was up 38% to $1.21.
According to Greenwich Associates' Institutional Investors Survey published in the fourth quarter, MarketAxess maintained its leading position in U.S. credit electronic trading with an estimated 85% market share.
Before we move into further review of our results, I am pleased to share two exciting new developments. Chris Concannon joined MarketAxess last week as our President and Chief Operating Officer on the same day we moved into our new corporate headquarters in Hudson Yards. We believe that Chris brings a unique set of skills to the company, and he will join us later in the call today.
Slide 4 highlights our full-year results and continued strong growth rates. 2018 marks the 10th consecutive year of record trading volume, revenue, and operating income. Full-year 2018 revenue with a record $436 million, up 10.7% from 2017 and diluted EPS was a record $4.57 up 17.5%.
Commission revenue for 2018 was up 10% year-over-year to a record $391 million as overall trading volumes reached a record $1.7 trillion up 17.5%. Estimated U.S. high-grade and U.S. high-yield market share both reached records as we experience strong volume growth across core products.
These gains in market share were driven in part by the growing number of client firms active on the platform. In 2018, more than 15,000 institutions were active on the system with 850 firms trading three or more products.
Finally, our 2018 results continue to show attractive long-term growth with five-year compound growth rates of 13% for revenue and 20% for EPS, creating superior returns for market access shareholders.
Slide 5 provides an update on market conditions. Fourth quarter market conditions were favorable for our business. Credit spreads widened and credit spread volatility increased. New issue activity was lighter than normal and investment managers experienced outflows.
Secondary liquidity was challenging and dealers and investors both relied on MarketAxess for a higher percentage of their trading needs. Our expanded liquidity pool with open trading is especially valuable in this kind of environment.
We have seen a stark reversal of market conditions in January, as investor sentiment has moved back to risk-on. The new issued calendar is active, fund flows are positive, order flow has shifted predominately to offer-wanted, and both high grade and high yield credit spreads have tightened significantly.
In this environment, average daily trading volumes on market access month-to-date are still higher than both Q1 and Q4 2018 levels, but high grade and high yield market share is significantly below Q4.
Slide 6 provides an update on Open Trading. Open Trading experienced an exceptionally strong fourth quarter. Adoption accelerated during the quarter with volumes up 96% to a record level of $118 billion.
Average daily open trading volume surged to $1.9 billion and average daily open trade count was 5,600 trades. Open Trading represented 27% of our volume in Q4, up from 175 last year. Over 344,000 open trading transactions were completed in the fourth quarter, up from 168,000 in Q4 2017.
Open Trading liquidity providers or price makers on the platform drove approximately 1.7 million price responses, representing a 1285 increase in activity in the fourth quarter. During the quarter, approximately 790 firms provided prices through open trading. This significant increase in client and dealer trading activity translated into increased transaction cost savings for market participants.
Liquidity takers saved an estimated $57 million in transaction costs through Open Trading on the system, up 175% from the fourth quarter last year. Participants benefited from the average transaction cost savings of approximately 2.5 basis point in yield when they completed a U.S. high-grade transaction through Open Trading protocols.
On annualized basis, Open Trading liquidity takers saved $163 million, an 82% increase from 2017. Open trading volume is growing rapidly across all four core products as dealer and investor clients embrace Open Trading as an important source of new liquidity.
Slide 7 provides an update on our international progress. Our ongoing investment in international expansion continues to show returns with international client volume of 20% to $456 billion in 2018. Growth over the longer term has remained strong with a compound five-year annual growth rate of 45% in international client volumes.
The increase in volumes in 2018 was driven by the more than 740 active international client firms trading on the system. Our emerging market product continues to perform well with five-year compound growth in trading volume of 32%. We are seeing especially good results in the 26 EM local markets available for trading with five-year compound growth over 100%.
Eurobond volumes were up 31% for the year which we believe is driven by healthy market share gains. Our preparations for all Brexit scenarios are on track and our new office in the Netherlands is staffed and up and running. We are pleased with our progress internationally and continue to invest in the significant growth opportunity outside of the United States.
Now, let me turn the call over to Tony to discuss the financial results in greater detail.
Thank you, Rick.
Please turn to Slide 8 for a summary of our trading volume across product categories. U.S. high-grade volumes were up 20% year-over-year to $241 billion for the quarter due to a 1.7-percentage-point increase in estimated market share coupled with a 9% increase in estimated U.S. high-grade TRACE volumes.
In spite of weak market volumes, our other credit category trading volumes were up 32% year-over-year. We estimate that market volumes across the emerging markets, U.S. high yield, and European corporate bonds were down around 10% in the aggregate. The standout this quarter was high-yield bonds where higher volatility in spreads and loan new issuance resulted in an estimated 4.5-percentage-point increase in market share and a 66% increase in trading volume.
On Slide 9, we provide a summary of our quarterly earnings performance. Overall revenue was up 14% year-over-year. The 24% increase in trading volume resulted in a 15% uplift in commissions. Information services revenue was up 4% on a quarterly basis and 9% on a full-year basis. Post-trade services revenue was up 6% on a quarterly basis and 38% on a full-year basis.
The step function increase in post-trade services revenue in 2018 was principally due to a combination of new MiFID II services and new customers. In 2019, we expect information services and post-trade services revenue will grow in the low-double digits.
Expenses were up 18% year-over-year and operating income was up 11% year-over-year. Excluding duplicate rent expense recognized during the build-out phase of the company's new corporate offices operating income was up 15%. The effective tax rate was 18.3% for the fourth quarter and 20.7% for full year 2018.
During the quarter, we recognized $1.9 million of excess tax benefits related to share-based compensation awards. Our diluted EPS was $1.21 on a stable diluted share count of 37.8 million shares.
On Slide 10, we have laid out our commission revenue trading volumes and fees per million. Total variable transaction fees were up 17% year-over-year as the 24% increase in trading volume was offset by lower overall fee capture.
On a year-over-year basis, lower duration resulted reduction in our U.S. high-grade fee capture, and revisions to the Eurobond fee plan enacted in early 2018 resulted in lower Eurobond fee capture.
That said, we're seeing little movement in our U.S. high-grade fee per million over the past four quarters. Years to maturity of bonds traded on the platform was unchanged sequentially and there was no significant change in the percentage of volume in each trade-sized bucket.
Our other credit category fee per million increased by $10 on a sequential basis. A higher percentage of volume in the other credit category was derived from high yield in the fourth quarter driven by 31% sequential growth and high-yield trading volume. There was little change in the fee capture at the individual product level during the quarter.
Slide 11 provides you with the expense detail. Compensation and benefits costs accounted for the most half of the $3.4 million sequential uplift in expenses. An increase in the variable incentive accrual which is tied directly to operating performance and the impact of additional headcount and higher share based compensation drove the growth in compensation and benefits costs. We experienced sequential increases in several other expense categories.
Most notably, higher clearing cost was due to the 33% sequential increase in Open Trading volume, higher trade show and promotions drove marketing expense up and higher general and administrative costs was largely due to a successful emerging markets charity day donation.
On Slide 12, we provide balance sheet information. Cash and investments as of December 31st were $486 million and free cash flow reached $175 million in 2018. Dividend and share repurchases aggregated $95 million. Capital expenditures in 2018 were $48 million and include $25 million related to the build-out of our new Hudson Yards office space.
Our recurring quarterly dividend is an important element of our capital management strategy. With the announced 21% increase in the quarterly dividend to $0.51 per share, we have doubled the dividend level in the past three years.
During the fourth quarter, we repurchased a total of 30,000 shares under our share buyback program. Our board authorized the new $100 million share repurchase program to replace the plan expiring at the end of March. As it’s been our practice, the principal purpose of the repurchase plan is to offset dilution from employee equity grants.
On Slide 13, we have our 2019 guidance for expenses, capital expenditures, and the effective tax rate. We expect the total 2019 expenses will be in the range of $224 million to $256 million. The midpoint in that range suggests an approximate 12% year-over-year increase in expenses which will be similar to our growth rate over the past three years.
2019 capital expenditures are expected to range from $25 million to $30 million of which roughly half relates to software development costs. We expect that the effective tax rate of full year 2019 will range from 20.5% to 22.5%. The guidance range incorporates an estimate for excess tax benefits related to share awards of approximately $6 million which would be similar the amount recognized in 2018.
Now, let me turn the call back to Rick.
Thank you, Tony.
We are pleased with the strong market share gains in the fourth quarter and for the full year in our core products. Open Trading growth is accelerating and rapidly becoming an essential pool of liquidity for investors and dealer clients. Business expansion is on track internationally and we are investing for the future.
Now, I am happy to introduce Chris Concannon who will make some brief remarks about the opportunity he sees ahead for market access.
Thanks, Rick.
It's great to be here and it's great to be part of this amazing team that you’ve dealt. I’m very excited about the opportunity. While it is only day 7 on the job, I’d like to share some exciting early observations about the company and the opportunity ahead.
First, I’m pleased to say that I’ve finally graduated from the minor leagues of equities to the major league called fixed income, the largest asset class on the planet. MarketAxess sits in the middle of this giant market. And that market is in the early stages of a transformation to electronic trading. MarketAxess is the clear leader in that space and it is still early days of a multi-year transformation.
Second, Rick mentioned the client cost savings on the company’s Open Trading platform. That execution quality that MarketAxess is delivering is an opportunity to drive more business to the company’s platform as clients become more educated about the superior execution quality. The prices that clients are achieving are setting the standard for best execution in the fixed income market.
Finally, I am very excited about the market data opportunity that the company has. Both our real-time pricing information and our historical pricing information is a gold source of execution quality in a corporate bond market, and provides us with a wonderful revenue opportunity.
So Rick thanks for letting me join the impressive team, and I think we’re ready to take Q&A.
[Operator Instructions] Our first question comes from Rich Repetto from Sandler O'Neill. Please go ahead.
So I guess the first question is on Open Trading. Great increase the 27% of the market, and I know Chris has capabilities and knowledge in this - in the sort of the market that's more liquid and faster trading. So, I guess the question is how do you plan to grow - you’ve been growing systematically, what drove, besides I guess volatility, you’re up to the 27%? And then what new things do you have Rick and Chris in mind to go grow further in 2019?
Thanks, Rich. I'll start on that one. It was a great quarter. And as you know, liquidity was challenging in credit markets throughout the quarter, which is one of the reasons that our clients were leaning on MarketAxess and Open Trading was more valuable than ever.
Part of it is just client trading behavior and adoption, and this is especially the case for investment managers. It's pretty easy for them to include MarketAxess, Open Trading in their inquiries and take advantage of the system as a liquidity taker.
The bigger challenge, but also the bigger opportunity, is to see more of them move toward the liquidity provider side. And that is a big change in the trading process that involves changes to their order management and compliance systems and utilizing data engines in real time. But we are seeing this - starting to see a movement in that direction. And in my opinion, that will be one of the bigger opportunities in the years ahead.
The other piece that we’re seeing is that, by opening up the market in credit, we are enabling new competitors to enter this space and commit capital for market making. So, liquidity pool is in fact growing and quarter in and quarter out we’re not only seeing new entrants the ones that are coming in continue to do more business. So that liquidity pool continues to get larger and as a result the competitiveness of open trading continues to improve.
We will continue to invest as well, as you point out, in new training protocols. We continue to benefit from leveraging RFQ trading so far. But we think that there are opportunities to participate in other parts of the market to trade with faster protocols.
So, this is one of the many reasons that we're pleased that Chris is here is that he has seen so many different protocols and knows the pros and cons of all of them during his many years of experience in the equity and foreign exchange markets. And it sure feels like fixed income is starting to move in the same direction and you will see investment in new protocols as part of the open trading strategy as well.
And, Rich, I’ll just add. As you know, the managed fund industry is certainly very focused on cost and it's not only cost of their own infrastructure but it’s cost of trading and trading cost generally. And when you look at the statistics that we shared today on savings that was delivered by the open trading platform that's a pretty attractive enhancement to returns and much reduced trading costs for the average managed fund.
So, I think certainly the open trading platform is finding a lot of new clients as well as what I'll call same-store sales with current clients given the cost savings that they're experiencing.
And I would assume, Rich, that the additional liquidity provided you're talking about more will be like I'd say liquidly providers you’re talking about are more be like I’d say it will be electronic liquidity providers, market makers. Is that fair?
Yes. There's I think that there are three pockets of liquidity. Well, I know there are three buckets of liquidity under the hood of open trading. One is the alternative market makers who are experienced with electronic market making and other asset classes and a subset of those from ETF arbitrage strategies that are now in place in credit.
The second is extending the dealer community available to investors on their electronic order flow and the third is buy side asset managers that are able to take advantage of matching opportunities.
And I guess just one last follow up would be on expenses and to Tony. And given the range up – I think it’s 9% of 15% I believe is the full range. But if you sort of look at that midpoint and I know you had to pay the signing bonus here for the free agent. But even taking that into account you also had some decrease expenses for the duplicate rent and I guess what I'm saying it seems like where we expected it to a little bit to offset, maybe a little bit increase. But are you investing or expanding the investment at any other initiatives I guess is the question?
And Rich - we continue to invest here and we’ve – you heard from Rick a little bit here on changes and enhancements. And we have demands from clients around technology and automation. We continue to expand our geographic reach and we’re expanding our addressable market. We’re supporting new protocols, we’re addressing a Brexit and other regulatory changes.
And we’re also investing in senior management and Chris is an example of that sitting here. I mean of course I’m trying to slice and dice the expense increase here but and this isn't to be isn’t to be self-serving but to just help you know bridge the difference.
If you look at Chris coming on board, there are other - we had a long-term employment agreement for Rick they were both AKs so it’s both public knowledge. There's other senior management investments we think the time is right and we're at we're at an inflection point but if you just look at the investment just humor me look at the investment in it the senior managers, it's somewhere in the $8 million to $9 million range, and if you just carve that out, you're looking at an expense increase below 10%.
So I don't think it should be a surprise given those investments particularly in senior management, but we're also investing you know we are investing for the future, so we a big part of that investment as around headcount it’s across the board, there's a big investment in technology resources anticipated.
So you know we're not shy about the expense increase and again we think the time is right to continue on that investing path.
And I just to add to that. We've mentioned in prior calls but the demand for automation and credit trading has never been higher. So what we are seeing is that investor clients that are trying to reduce trading and transaction costs are increasingly moving toward automation and auto execution especially for the smaller trade sizes and dealers as we know have been trending toward algo market-making for a greater percentage of their credit trading.
So, we're responding to those demands and we are highly confident that the long-term returns on those investments are going to be very attractive for our shareholders.
Our next question comes from Chris Allen from Compass Point. Please go ahead.
Good morning, guys. Just want to talk a little bit about the environment. I mean, you guys know that January volumes since you weigh up, market share kind of came in. Maybe the issuance levels were basically nonexistence for most of the month. Is this kind of a function of people just kind of prepaying for issuance until the market is kind of came back or just any color on that would be helpful?
Sure. New issuance is actually been pretty decent this month. It’s not at last January’s levels, but the capital markets have been open and the inflows have been helping to support new issues at tighter spreads. But similar to the equity markets, if you really look at the trend in credit spreads, there was consistent widening going on for four months toward the end of 2018. And literally in three weeks, we reversed half of that move. So this went completely the opposite direction with respect to risk on.
And in addition to new issues being far higher than they were certainly in December, you do see asset managers that have seen significant inflows, we hear anecdotally that many of those inflows are coming from international sources including Asia. So there is intermediation of those flows that we are often times don’t see.
And there also have been an increase in story bonds that have been a big part of TRACE where there’s high volatility in issuers like Pacific Gas that we’ve seen through the months. So I think the core flow business that where we excel continues to perform very well in January, and we have some ideas on how to participate more fully in other pockets of activity.
But I think probably the right way to look at this is if you took the average of our December and January market share, you'd probably get a truer reflection of the long-term trends because December and January are both unusual months in terms of the flows that are reported into TRACE.
And then just one more for me, just distribution fee, have you seen any changes in kind of - I mean, people shifting in terms of pricing plans? Kind of what's the outlook there moving forward? Anything on the horizon? How should we be thinking about it through 2019?
Chris, I wish I could tell you with complete clarity. We give dealers the choice of plans, and some have a distribution fee, some are all variable or have an execution fee. So, it's tough to predict. I'll tell you, just looking at the fourth quarter, when you look at that small change for U.S. high grade in particular, we did have one dealer migrate to the distribution fee plan in the fourth quarter. So, that gave rise to about a $400,000 increase in distribution fees.
I'm cautious about giving the – put forward guidance just because it's difficult to predict. Even things like unused minimum fees, it depends on activity and activity for those individual dealers. So, it can bubble around month-to-month.
I'll give you one thing, though, just in terms of what we have clarity on today. We do have one dealer in the first quarter, one dealer effective January 1st, that is moving from the high-grade distribution fee down to the all variable fee.
So, all things being equal, lots of things in the mix, but all things being equal, that one dealer migrating would cause a reduction in distribution fees of about $0.5 million in the first quarter. But I do caution. There's a lot of moving pieces in the – even the distribution fees.
Our next question comes from Kyle Voigt from KBW. Please go ahead.
Rick, maybe you can start just with the hire of Chris. Obviously, it was a big hire for MarketAxess. It deepens your senior leadership team significantly. In terms of the company’s and the board's motivation to go out and make this hire just wondering if you could speak to two things. One, Chris have extensive experience in M&A in integrating large businesses at Bats and Cboe, was that experience viewed as valuable and a necessary addition to the experience you already have within your leadership team?
And then secondarily, I know you signed an employment contract through 2025, Rick. But can you speak a bit to about whether succession planning by the board was also a key consideration in the hire?
Sure. No. I'm happy to talk about both of those. And just…
Are you sure you don't want me to answer?
…on the first question on M&A, of course, that was one of the many skills that Chris has that that I, in particular, was attracted to. We have built the company as you know almost entirely through organic growth. And we're in a great position to think both about the next wave of organic growth but also be able to be opportunistic about M&A opportunities.
And Chris has been very successful with various M&A strategies in a variety of different companies that he's worked for in the past and we're excited to have him lead our corporate development effort.
I would say though it doesn't address either of the two questions that you asked but equally important is the skill set around trading automation that Chris brings to the company that are clearly showing real traction now in credit.
So, it is really just in the last two years that dealers have moved to algo trading, high frequency trading firms have shown up in credit. Investors are moving to auto execution so the litany of experiences and knowledge of trading protocols that Chris has, we think is ideally timed for the changes that are taking place in credit. And we couldn't be any more pleased to have those skills around the table as well.
And of course, we are now a much larger company than we were four or five years ago and the board has responsibilities at all levels of the management team around succession planning. So that was also one of the key things that that we were seeking to accomplish with bringing Chris on board. So from my perspective, he checked a lot of boxes and we’re really excited to have him here working both with the management team and the board.
Second question is really some on the growth in high-yield in the quarter is exceptional and we can see that Open Trading was nearly half the volume there. I know ETF market makers are very active in that market and their activity can really depend on the flows and volume and some fixed income ETFs and funds.
Just wondering if you can comment on how much of your high-yield volume this ETF market makers drove in the fourth quarter versus a more normalized quarter? And I'm really just trying to understand whether we're seeing similarly strong growth from your core institutional clients in that market as well.
So it’s Tony here. On the ETF side, you’re exactly right, they are important components who are high yield trading. And while the fourth quarter, the percentage of volume represented by the ETF community was up it was not up appreciably. And what that tells you is that we had growth from traditional long-only clients and from the ETF community. And just to put in perspective it was around 30% of the high yield volume.
But I would tell you at other points in time in the past that percentage for example when energy blew up back in the fourth quarter of 2015 that percentage was closer to 40%. It's been bubbling in the around 25% or so. So not an appreciable change growth across all clients.
Last one for me is really just around – similarly you touched on earlier maybe streaming price protocols. Rick, I think you maybe alluded to this but is that going to be a significant area of investment when you talk about investing in new protocols. I know that's probably a wide array of things but is that a key component of that? And I'm wondering where you see the opportunity for streaming price protocols to become more frequently used? Is there subset of more liquid bonds or is the opportunity a lot larger than that?
Yes. I would point to two things and, yes, it is one piece of a much broader strategy. And an important part of the investment budget that Tony talked about earlier is technology developers and greater output in terms of new protocols available for our clients. But there are two places where I think faster protocols including streaming protocols make a lot of sense.
One is on newly issued bonds. And as you know we don't participate all that actively on the first week or so of trading following new issues and we do think that there are ways for us to participate more fully through quicker protocols than streaming prices. The second is really in the retail space, and we do think we have an opportunity to invest organically in retail and private client business and have a bigger impact in that client segment.
Our next question comes from Patrick O'Shaughnessy from Raymond James. Please go ahead.
So, I was hoping that you could elaborate a bit more on that market data opportunity that Chris spoke to in his prepared remarks. Historically, you've used your data as a means to attract order flow and hopefully increase transaction revenues. Is that philosophy going to change going forward?
Patrick, it’s Chris. That's correct. I'll take that. No. There has to be a healthy balance between attracting new clients and new business and not overcharging for that entry or charging too much of an entry fee, but there is really a wealth of data within the current platform.
And if you look at the growth of Open Trading, the data on debt and liquidity, which is a key factor in the cost of trading a fixed income instrument so that the more we can distribute that data, the more we can – it's not just a price increase game. It's also a distribution and being smart around the data that we are sharing or haven't shared just yet.
So, I think the opportunities both in the form of new products as well as in fees that are smart but don't damage the growth of the product.
And then one thing I would add, Patrick, is that when we look at our peers that have more developed data businesses, oftentimes they are doing that in partnership with the large data companies Often times they are doing that in partnership with a large data companies for distribution. And that is something that we really have not done much of in the past, but we are going to test some new distribution channels in the New Year. We’re optimistic that that will also help them in creating better traction in data revenue.
And then I guess speaking of initiatives that Chris is going to be tasked with. So regarding M&A, how broad of a net would you guys think of capping here? And what types of deals do you think might hit your radar going forward?
The big picture here is that nothing has changed in our enthusiasm for the global credit opportunity. It’s an enormous market and we think we have unique competitive advantages. So our focus is squarely on continuing to deliver returns in that very, very large market opportunity. It doesn’t mean that we wouldn’t look at alternative asset classes including other areas of fixed income, but our focus today continues to be on credit.
And I think what we said in the past is still true today. We are interested in product capabilities that would extend our offering to our institutional clients whether it be data offerings, trading offerings or post rate. And we think there could be interesting opportunities in all three of those. So nothing specific to comment on today, but we’re excited to have Chris here to really ramp up our thoughts and our creativity around corporate development.
And maybe one last quick one for me for Tony. So you kind of gave the commentary around what ADV was compared to previous periods and talked about market share, can we actually get the month-to-date ADV that you guys have seen across new products?
Is it on January, Patrick?
Yes.
We've got two more days left here. And Rick gave some comments in the prepared remarks where ADV’s running ahead of both the fourth quarter of last year and the first quarter of last year. So be a little patient, but we'll have the numbers out on Monday.
Our next question comes from Jeremy Campbell from Barclays. Please go ahead.
I think you mentioned that that broader kind of liquidity taker option in the more volatile markets during the fourth quarter is part of the uptake in open trading usage. Historically, do those clients tend to stick with open trading after your volatility maybe dies down a little bit or do they kind of back off of that at some point?
Well, we've seen nothing but them sticking with open trading and increasing their activity. So, sequentially, we've had a pretty consistent track record of seeing open trading adoption virtually every quarter. And as you know in a quarter like last quarter where the price improvement percentages were growing for liquidity takers and the level of price improvement on average per trade was higher it's a powerful reinforcement of the benefits of having orders into the MarketAxess system.
So, we are seeing a continuation of that trend in January even though the market conditions are very different. But as I mentioned our view is that open trading was especially valuable in the fourth quarter during challenging liquidity times.
And then, Chris, congrats on the new role from us equity analyst still toiling there in the minor leagues but I know I know it’s super early days here but Rick and Tony, I mean is there any kind of current initiatives that MarketAxess has had going on but you think, Chris can really kind of accelerate across the goal line in 2019 and then Chris, I know day seven here but you listed a kind of bunch of areas of focus here but is there what would be the top of your hit list as far as kind of rolling up your sleeves here at MarketAxess?
Well, we just talked about Open Trading and that opportunity is just a phenomenal opportunity as I think about the buy side experiencing a transformation of electronic trading and what has been a you know a largely much more manual market, they need a lot of assistance from the market that's forming price.
So when we think about order types and enhancements to the trade platform, I think that's an important area that I can help. I've seen transformations in both the foreign exchange market as well as the equity market and there's things that the end user needs that helps them execute their trading activity and to follow on to Rick’s point on Open Trading, I just think you know when these clients experience the Open Trading execution quality, they continue to come back.
So it's kind of like eating a Chick-fil-A, once you had one you keep adding more and more to your diet.
Our next question comes from Alex Blostein from Goldman Sachs. Please go ahead.
A question around distribution plan especially at high yield. So I know you guys made some changes last year with a handful of dealers moving over. But is that part of your liquidity pool continues to growth and it sounds like participation from ETF market makers has also been a meaningful contribution. How should we think about more of the participants switching to the distribution plan over time within high yield?
We haven't had from when we adopted that new plan, August 1st of last year, August 1st of 2017. We haven’t had any migrations. You’ve seen more of that in the high grade plan. So we’re not tracking anything right now. Those dealers do enjoy seeing the disclosed order flow. Even with the increase in Open Trading percentage, the disclosed dealers are also increasing their participation on the platform.
So, again, we're not tracking anything there and unlike on high grade where it does tend to swing around a little bit.
And then I heard your comments obviously around expense for 2018 with some incremental uplift here as well. But I guess bigger picture when we take a step back, how are you guys thinking about the tradeoff between growth and expenses versus market share gains and maybe just a little bit of a near to medium-term outlook on expense growth?
We're going to continue to invest out. And we oftentimes do talk about operating margins and where margins are running. I look at over the past four years now margins have been hovering around 50% and yet at the same time we've been investing heavily and again to expand the addressable market and add new protocols and address Brexit.
And now with the senior management hires, it's– we would do anything we could to increase market share. And our view around the table is now’s the time to invest, and if that means that margins, at least in the near term, if margins are kind of flat-lined at 50%, that's not a terrible outcome.
It's tough to look out. If we had a crystal ball, even that it's tough to look out beyond the next year or so, I think there is leverage in the margin, in the business. I think it's more about growing the top line. It's more about growing market share, adding new products, monetizing more on the data side. That's where we'll see the leverage come through, and market conditions are supportive, and Open Trading is a bigger piece of what we're doing. That’s where we’ll see the margin expansion coming through.
And, Alex, it’s Chris. I’ll just mention, all of our new hires are expected to grow top line.
Our next question comes from Hugh Miller from Buckingham. Please go ahead.
Just have a question. You guys obviously have historically from quite a deal of trading seen a difference between the spread widening versus tightening scenarios in terms of the hit rate. I was wondering, as we think about growth in Open Trading, does that play a factor in that type of scenario with client-to-client trading in terms of the hit rate for buying versus selling or is that still similar to what we've seen in client-to-trade trading?
Hugh, I can't say there's been a big change in overall hit rates, whether it's on the offer side or the bid wanted side. You know we have this the dynamics. We typically the hit rate is higher on the bid wanted side versus the offer wanted side. That trend or that difference has continued to play through.
So, of course, the more price responses that we get in, the better chance of getting a trade executed, the more value we’re delivering, drives more order flow on the platform. That’s the model. But I can’t say looking over the past several years, you’ve seen an appreciable change in that hit rates whether on the bid side or the offer side.
And then just in terms of the opportunities in 2019, can you talk a little bit about dealer to dealer trading, what you’re seeing on the platform in terms of adoption and how you see that as a channel for growth in 2019?
Sure. I’ll take that one Hugh. But fourth quarter was interesting because the level of spread widening I think caught the market by surprise during the quarter. And there was a fair amount of interest in reducing credit risk by investors and dealers. So we did see a nice uptick in dealer-initiated Open Trading order flow.
And I think what you’re starting to see is that this is becoming a very attractive liquidity pool for the dealer community. And the breadth of liquidity that we have both investors and other dealers on the platform is a great alternative for dealers when they’re looking to reduce balance sheet and shed risk.
So when they’ve tested the system, they’ve had good results and that has caused them to increase activity, especially in strained market environments like the one that we had in the fourth quarter.
Do you have a sense as to kind of what percentages of the overall trading that would represent in Q4 or historically?
Yes. So if you looked at pure D2D in the fourth quarter we would have stayed over 5% market share pure D2D. And, of course, what Rick is saying around the activity level and the increase in our dealer-initiated orders that’s up appreciably year-over-year.
Thank you for the color there. And I think in the prepared remarks you guys had mentioned, obviously, you gave some color in terms of the benefits from open trading from a dollar standpoint. But I think you mentioned that you're seeing roughly about a 2.5 basis point benefit in open trading for U.S. high grade relative to trades not through open trading. I was wondering is that a correct way that I have that? And as well how has that changed over time from the onset of open trading?
So yes. That's what Rick in the prepared remarks mentioned the 2.5 basis points, and just to put that into dollar terms on average every basis point in yield is somewhere around $750. It's a rough number. So 2.5 basis points you're looking at about $2,000 per million in savings.
Rick didn't talk about the high yield number. That was closer to $0.28 or $2,800 per million notional trade in the fourth quarter. Across the board the fourth quarter and the reason why you saw that big jump in the savings not only were OT volumes up but the capture or the savings or the price improvement across each product was also up in the fourth quarter.
And that undoubtedly had a lot to do with where spreads were going so across both high-yield and investment grade you saw spreads widening and just the delivering more cost savings in OT in that environment.
Our next question comes from Chris Shutler from William Blair. Please go ahead.
So Rick, correct me if I'm wrong on this but I think you rolled Auto-Ex capabilities maybe a year ago or so. Can you just talk about the uptake so far on Auto-Ex and you know any stats or kind of trade volumes that you're doing today that are Auto-Ex or algo amongst both buy side and dealers.
I don't think we have the exact stats at the ready this morning Chris but happy to follow-up with you on that but sequentially we have seen attractive growth in both a number of clients using Auto-Execution in Europe and the U.S. as well as the percentage of their trades they’re going through Auto-Ex. It's early days in credit but the trends are very clear and we'd be happy to come back to you with the exact percentage increases that we're seeing.
And then in Open Trading, I guess the percentages of Open Trading today that's buy side to buy side I know it's a pretty small percentage but any color there and trends?
You know it's I wouldn't call it small, It's as there has been in past calls there are the three main pools of liquidity that are coming through Open Trading the alternative market makers, the expanded dealer community participating in orders and then the buy side. But the trends have been pretty stable in terms of buy side participation in Open Trading liquidity provision and it’s still important source that it’s running around a quarter of the volume that is done on the system.
And then lastly for Tony, the tax rate guide that was a little below expectations again. Just walk us through kind of how to think about the normalized tax rate and how much longer you'd expect to enjoy this lower tax rate?
It's a good question and the 2018 tax rate full year was just a shade under 21%. And you're right there are lots of things that go in the tax rate. There's the mix of income by jurisdiction. There's permanent items and credits and then there are these discrete items like the excess tax benefit. If we pull out the excess tax benefits from 2018, the rate would have looked more like 23.5%. And I think what we're guiding to right now if you pull out what I said again the prepared remarks around $6 million in excess tax benefit, you're going to get back to that that mid 23.5%.
The second part of the question just on how long can this last. What’s the future look like for these excess tax benefits. We are sitting on around $16 million of excess tax benefits coming into 2019. Tough to tell where it's going to end up because it's depending on the stock price when options are exercised, restricted stock best.
And also we don't know the timing of when the exact timing of when the options will be exercised but I'll give you in the near term 2019 and 2020what we’re tracking right now based on when restricted stock has to vest and when auctions actually expire, we’re looking at about the same number, of about $6 million this year, about $6 million next year. That could move, but that’s what we’re looking at right now.
Our next question comes from Rich Repetto from Sandler O'Neill. Please go ahead.
I promise I'll keep this short here, but as I listen to all the questions on the Open Trading, and the one thing that occurs - it's still a request for quote even though it's sort of an automated open-to-all request for quote. And I guess the question is, and this follows on to the automated execution, someone referred to that, I know you build on the liquidity side with the electronic liquidity providers, but do you also have to get the buy side here to also buy in and move more to the automated execution if you really want to grow Open Trading volumes? I guess that would be the question.
I’ll take the first crack at that, Rich. But I think that this is the first in a series of steps that the buy side is likely to take with automated means of trading and credit. And this is the most obvious where they're taking the smallest tickets with the base of real-time data that is now available to them, and they're setting parameters within which they're willing to execute the trade with no manual intervention.
When you think forward, that ability to be able to price a transaction without trading intervention is a precursor to being able to be more responsive in Open Trading as a price provider.
So, I think the buy-side as you well all know is under tremendous cost pressures. They're always interested in transaction cost savings that will improve portfolio returns and this is the beginning of what I think will be a multiyear investment in automated trading tools by the buy-side and ultimately those tools will make them better equipped to be responsive to matching opportunities on the system.
Our next question comes from Kyle Voigt from KBW. Please go ahead.
Just one follow-up. Just for the open trade continue to grow rapidly. I was just wondering if you give us an update on your clearing and operational plans to that part of the business? I know you’ve built out the risk management functionality to kind of support that volume growth. But are we closer today to maybe heading in a different direction from an operational standpoint just given the size and the pace of the growth there?
We are benefiting from tiered pricing with our settlement partner currently. So, you're seeing the cost of settlements trend down, which is obviously a great thing for us. But we’re in early stages of reviewing our long-term settlement strategy. There are lots of scenarios that that could evolve over the next three to five years.
But we've increased the level of automation that we have in our settlement process to improve the risk controls, and we're benefiting from lower pricing because of the discounts that take place at higher ticket, average daily ticket counts with earnings. So in the near term nothing specific, but we do think there are opportunities there down the road.
Our last question comes from Patrick O'Shaughnessy from Raymond James. Please go ahead.
Thanks for taking my last question here. Curious about your block market share in the fourth quarter and whether your fourth quarter market share gains were across both blocks and non-blocks.
So on the market share side, the gains were pretty much across the board. Now, on the block side, we ended up right around 9% for the quarter. If you look over a longer term basis, over full year 2018, block share was up close to 1% close to 1 percentage point. You look at it overall, we are up a little more than 1 percentage point overall for all of the U.S. high-grade market share. So it was across the board over the span of the full year.
And if you look longer term, absolutely, the trend looks similar to our market share growth overall. When you look at longer term or what happens with block trading as well. So it was pretty much across the board.
This concludes our Q&A session. At this time, I would like to turn the call back to Rick McVey, Chairman and CEO for closing remarks. Please go ahead.
Thank you for joining us this morning and we look forward to talking to you again next quarter.
Thank you, ladies and gentlemen for attending today's conference. This concludes the program. You may all disconnect. Good day.