MarketAxess Holdings Inc (MKTX) — Q4 2016 Earnings Call Transcript

Good morning, and welcome to the MarketAxess fourth quarter 2016 conference call. For the call, Rick McVey, Chairman and Chief Executive Officer will review the highlights for the quarter, and will provide an update on trends in our businesses. And then, Tony DeLise, Chief Financial Officer, will review the financial results. 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 conditions may differ materially from what is indicated in those forward-looking statements. For a discussion of some of the risks and factors that could affect the Company’s future results, please see the descriptions of risk factors in our Annual Report on Form 10-K for the year ended December 31, 2015. 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.

Good morning, and thank you for joining us for the fourth quarter and full year earnings call. Fourth quarter trading volumes matched the record levels of the second quarter, and were up 35% year-over-year. Quarterly average daily volume records were set in U.S. high-grade, emerging markets, and Eurobonds. This is an extraordinary outcome given the normal seasonal factors impacting the quarter—a combination of strong market volume growth post the U.S. elections and continued gains in market share contributed to the results. On the back of the growth in trading volumes, revenues for the quarter were $94.4 million, up 23%. Pre-tax income of $50 million was up 36%, and EPS equaled our record quarter at $0.88 per share. Based on our estimates of market volumes during the quarter, combined aggregate market share of our core products, including high-grade, high-yield, emerging markets, and Eurobonds, we see new record highs during the quarter, which was up a full 2 percentage points from year ago levels. Slide four highlights our full year results and continued strong growth rates. Revenue and earnings growth for the full year in 2016 shows an acceleration of our long-term growth rates. Full year 2016 revenue was a record $317 million, up 22% from 2015, and diluted EPS was up 31% to a record $3.34 per share. Both revenue and earnings growth in 2016 were well above long-term growth rates. Commission revenue for 2016 was up 25% year-over-year to a record $332 million, as overall trading volumes reached a record $1.3 trillion, up 34%. We are beginning to see returns from the increased investment in both our U.S. and international business. We estimate that the five-year compound annual growth rate for aggregate market volumes across our core products was 1%. Comparatively, our trading volumes show a five-year compound annual growth rate of 20%. This means that market share gains continue to be the primary driver of volume and revenue growth. In light of our strong results and our outlook, the Board of Directors approved a 27% increase in the regular quarterly dividend to $0.33 per share. Slide five shows our volume and client growth by products. Our year-over-year volume gain of approximately $330 billion was by far our largest ever. The growth in trading activity was driven by share gains with existing clients, as well as the ongoing addition of new clients. Combined U.S. high-grade and high-yield volume of $879 billion was up 27% from 2015. We now have approximately 900 client firms active in these product areas. We are especially encouraged by the growing momentum in our international business with both emerging markets and Eurobond activity reaching new annual records. Eurobond volume was up 77% year-over-year with more than 400 firms active on the trading system. Emerging market volume was up 54% from 2015 with approximately 800 client firms trading. We believe our growing global client footprint and the breadth of our trading capabilities create a strong foundation for future growth. Our history of cross-selling success also gives us confidence in our ability to develop new marketplaces, such as municipal bonds and leveraged loans. For the full year 2016, we had 727 client firms trading three or more products on MarketAxess, up from 429 in 2012. Slide six provides an update on Open Trading. Open Trading experienced another record year with average daily volumes up 86% from the fourth quarter of last year. Approximately 125,000 Open Trading transactions were completed during the quarter compared to 58,000 in Q4 2015. We continue to be encouraged by the increasing number of unique liquidity providers or price makers on the platform. The fourth quarter saw 660 firms providing liquidity, up from 469 in Q4 of last year. This expanding tool of participants helped drive a 223% year-over-year increase in Open Trading price reached bonds; clients taking liquidity on the system saved an estimated $29 million in the fourth quarter due to the expansion of the liquidity pool. The profile of Open Trading liquidity providers continues to be fairly evenly split between dealers, investors, and alternative market makers. The ETF community is increasingly active, and we are investing in additional trading functionality and ETF analytics for this growing client segment. Over 18% of combined U.S. high-grade and U.S. high-yield volume on MarketAxess now takes place through Open Trading, up from approximately 13% a year ago. Participants benefit from average cost savings of approximately 3 basis points in yield when they complete a U.S. high-grade transaction using Open Trading protocols. Open Trading technology enhancements will remain a key focus area for investment in 2017. Slide seven provides an update on the global regulatory landscape. Regulatory change continues to have a meaningful impact on our clients and on our business. In the U.S., we are monitoring the regulatory landscape as it unfolds under the new administration. Our current understanding is that it's unlikely that we will see any proposals to reduce bank capital requirements. Higher bank capital requirements have led to balance sheet constraints for market making. However, it is widely expected that we could see changes in implementation or delays in more controversial aspects of financial regulation like the Volcker rule. There is also much discussion on potential corporate tax reform. MarketAxess would benefit from lower overall U.S. tax rates. However, some proposals on lower taxes, such as the repatriation of foreign earnings or reduction in the tax deductibility of corporate interest payments, could have a negative impact on the pace of growth of new debt issuance. It is far too early to speculate on the outcome of potential tax changes. In Europe, we are focused on the opportunities presented by MiFID II in relation to clients’ increased preference to TRACE on regulated venues that can help them fulfill their new obligations under MiFID II. We expect that the new regulatory focus on demonstrating best execution will lead to increased demand for electronic trading, as well as data products to allow market participants to compare transaction prices such as Axess All. In sum, we currently believe that the likely regulatory and tax changes will be net positives for the Company, but it is too early to predict the outcome with any degree of certainty. Now, let me turn the call over to Tony for a more detailed look at our financial results.

Thank you, Rick. Please turn to slide eight for a summary of our trading volume across the product categories. U.S. high-grade volumes were $185 billion for the quarter, up 29% year-over-year. The increase in volume was evenly split between an improvement in market share from 15.1% in 2015 to 17.2% in 2016, and an estimated 14% increase in TRACE volumes. Volumes in the other credit category were up 49% year-over-year. Emerging market bond volumes increased 59% due to growth in estimated market share, and an increase in estimated market volumes. Gains in our Eurobond and high-yield trading volumes were almost entirely due to a pick-up in estimated market share. In January, we are seeing year-over-year market volumes across our core four products up an estimated 10%. We expect that our overall average daily trading volume in January will be above the fourth quarter levels. With five trading days remaining in January, estimated U.S. high-grade market share demonstrated a decline from the December and fourth quarter levels beyond this typical seasonal movement, and reflects the impact of the record pace of new issuance early in the year. On slide nine, we provide a summary of our quarterly earnings performance. The 23% year-over-year increase in revenue was primarily due to the uplift in trading volumes, and resulting 27% improvement in quarterly commission revenues. If the dollar versus sterling exchange rates held constant year-over-year, overall revenue would have increased by an additional $2.7 million. On a constant exchange rate basis, information at postpaid services revenue increased by 14% on stronger data sales. Total expenses in the fourth quarter were $44 million, up 11% year-over-year and up 15% on a full-year basis. We continue to invest in our business, and at the same time, deliver improved operating margins. For both fourth quarter and full year, pre-tax income increased by 30% or more, and the operating margin percentage for full year 2016 reached 52%. The effective tax rate was 34.1% for both the fourth quarter and full year 2016. Compared to 2015, the 100 basis points reduction in the full year effective tax rate reflects the higher percentage of income attributable to lower tax rate jurisdictions, and a reduction in certain statutory foreign and state tax rates. Our diluted EPS was $0.88 on a diluted share count of 37.7 million shares. On slide 10, we’ve laid out our commission revenue, trading volume, and fees per million. The 36% increase in total variable transaction fees was entirely due to the increase in trading volumes. U.S. high-grade fee capture declined by $4 per million on a sequential basis. There was no appreciable change in the average years of maturity or trade size bucketing between the third quarter and fourth quarters. We expect that first quarter 2017 U.S. high-grade distribution fees will be similar to the fourth quarter of 2016. Our other credit category fee capture increased by $12 per million on a sequential basis, primarily due to a fee plan change for European bonds. Dealers were given the choice of adopting one of several standard plans, consisting of varying minimum monthly commitments. Under the new plans, distribution fees are eliminated and fees per million traded deferred based on maturity. The overall Eurobond fee capture now looks similar to our U.S. high-grade figure. For the fourth quarter 2016, Open Trading revenue was $11 million, more than double the fourth quarter of last year. And Open Trading protocols were responsible for 15% of overall trading volume. Slide 11 provides you with the expense detail. On a sequential basis, expenses were slightly above the third quarter level. Higher Open Trading related advertising costs were offset by lower variable bonus accrual and employer taxes. On a year-over-year basis, higher compensation of benefit costs accounted for the largest variance, reflecting a rise in headcounts and greater variable bonus accruals. We closed out 2016 with a headcount of 383 compared to 342 at year-end 2015. The year-over-year growth in professional and consulting fees was driven by implementation efforts surrounding several important infrastructure projects. Higher Open Trading related advertising costs accounted for the bulk of the market and advertising expense increase. On slide 12, we provide balance sheet and capital management information. Cash and investments as of December 31st were $363 million, and the 2016 free cash flow reached a record $136 million. Dividends and share repurchases aggregated $63 million or approximately 46% of free cash flow in 2016. Our current quarterly dividend is an important element of our capital management strategy. The 27% increase in the quarterly dividend follows the 30% increase in 2016, and 25% increase in 2015. We've now increased the dividends for seven consecutive years. During the fourth quarter, we repurchased 63,000 shares at a cost of $10 million under our share buyback program. As of December 31st, approximately $51 million was available for future repurchases under the program. We are increasing investments in our trading platform, new protocols, and infrastructure and view this continuing investment spend as a competitive advantage. Through our existing cash positions and strong cash flow generation, we have the flexibility to fund our investment priorities and return capital to shareholders. On slide 13, we have our 2017 expense capital expenditure and income tax rate guidance. We expect that total 2017 expenses will be in the range of $192 million to $208 million. The midpoint in that range suggests an approximate 12% year-over-year increase in expenses, which would be slightly above our five-year compound annual growth rate adjusted for the Trax acquisition in 2013. For purposes of generating the expense guidance, we've assumed that the sterling to dollar exchange rate holds at 1.25:1. We expect that 2017 capital expenditures will range from $25 million to $30 million. The midpoint in that range reflects an increase of approximately $9 million over the 2016 level. The majority of this increase relates to a new datacenter build-out and upgrades through existing datacenters. We expect that the effective tax rate for the full year 2017 will range from 32% to 34%. The mix of U.S. and foreign-sourced income and the impact of a new standard governing stock-based compensation accounting could cause variations in the effective tax rate. Beginning in 2017, there is a mandated exchange in stock-based compensation accounting, which impacts among other items, the accounting for windfall tax benefits, the statement of cash flow, the classification of such tax benefits, and the computation of diluted share count. Our tax rate guidance incorporates estimates for the windfall tax benefits related to restricted stock scheduled invested in 2017, but does not include any windfall tax benefit on potential stock option exercises since we can't predict whether such exercises will occur. This standard will create volatility in our quarterly effective tax rate. Also, while we don’t provide specific guidance on our diluted share count, we estimate that the new standard will increase our diluted share count by approximately 400,000 shares beginning in the first quarter of 2017. Rich has made some earlier comments on potential changes in U.S. corporate tax policy. Based on the information available, we estimate that every 1 percentage point reduction in the U.S. federal corporate income tax rate would have increased 2016 EPS by approximately $0.04 per share. Now, let me turn the call back to Rich for some closing comments.

Thank you, Tony. We are pleased with the full year results we were able to achieve in 2016. It is clear that the adoption rates for electronic trading in global credit markets are accelerating. Our success in Open Trading is adding valuable new liquidity solutions to our dealer and investor clients. Our global client footprint continues to grow, supporting both geographic and product expansion. Regulatory changes are likely to continue to support growth in open electronic markets. And let me close with a word of thanks to all of our employees. Your innovative spirit and dedication delivered outstanding results again in 2016. Now, I would be happy to open the line for your questions.

I was curious if you have any preliminary thoughts on what sort of impact any relaxation of the Volcker Rule might have. Obviously, it's very early and we don't know if it's even going to happen. But curious if you have any expectations of what it might mean in terms of market share or liquidity or anything else?

Our belief is that it would be a net positive for market liquidity if there was some relaxation in the implementation of the Volcker Rule where it really has an impact in credit, particularly in less liquid bonds, where if it's difficult to prove the ability to turn those bonds back over in an expeditious manner, it's difficult to comply with the current Volcker Rule. So, we think it would open up more market making and less liquid areas of credit and allow bank owned dealers, if they choose, to use their capital more for proprietary trading, and the net result, we believe, would be a positive for market liquidity.

And then maybe one for you, Tony. With your expense guidance for 2017, it's pretty wide range from the low-end to the high-end. Can you talk about what drivers might cause it to come in at the high or the low end? And, I guess, what are some of the key areas that you are planning on investing in in 2017?

I’d say one thing on the range of the absolute range, arguably, in the past we’ve probably provided two types of guidance range. But when you think about top to bottom if you take the midpoint, we’re talking about a 4% swing from top to bottom. And those big swing factors or those big variables there, it's typical of what you’ve seen in the past. And we expect to grow headcount in 2017 at a similar pace as we’ve seen in the past two years. The timing of when those headcount additions come in and attrition is a little uncertain, so that could be a swing factor. We have the variable bonus accrual that’s tied to operating performance. We generally build the accrual over the course of the year as a percentage of pre-tax pre-bonus income that could swing from top to bottom. And honestly, foreign exchange could impact the expense results substantially. We had something like $40 million to $45 million sterling of expenses, so a change in the sterling to dollar exchange rate would have a significant impact.

And then one last one for me, and then I will jump back in the queue. So, as we look at your Open Trading statistics, obviously, you’re having a fair amount of success with it. But it looks like you're having particular success with high-yield. I think by our math, maybe one-third or so of your high-yield TRACE are now being done through Open Trading. Why do you think it's been particularly successful with high-yield?

What we see so far is the percentage of Open Trading is highest in the least liquid product areas. I think it's where the expansions of the liquidity pool and utilizing the network broadly have the biggest impact for clients. So, it's quite possible that it is connected to the constraints that dealers have not just on their balance sheets but also because of the Volcker Rule. We do see that the Open Trading match rates are greater in high-yield. It's also where we see significant activity from the ETF community, which is a growing base of capital that's coming to work in market making and the credit markets.

Just given the recent change in pricing on Eurobond trading, I guess, I have a separate question relating to the current dealer pay model pricing in high-yield and emerging market products. I know in the past you’ve stated the desire to eventually migrate this to a client pay model. Can you just give us updated thoughts here, and if there is anything in the works over the next 12 to 18 months? Thanks.

We’re always working on any enhancements or changes in the fee model that would provide the proper incentives for dealers and investors who use the platform more. The reality is that we think we've been in a pretty reasonable spot across most products. Eurobond volume growth has been greater than what we have observed in other product areas over the last 18 months or so. The short answer is we don’t have any changes in mind to share with you this quarter. But we have seen great results with the scalability of models that have the concept where liquidity taker pays, and that is what we've embedded into Open Trading. We believe that longer-term, that will be the model of choice around fixed income electronic trading.

And then, you mentioned on the slides, Brexit potentially impacting your passport to the EU, and that you’re evaluating strategic alternatives there. Could you just give us some more color around what options you are considering, and if these options would be material with respect to incremental ongoing expenses?

I believe our current strategy is similar to what other financial institutions based in London are doing. We are collaborating with both our internal team and external advisors to evaluate various factors regarding locations that will remain in the EU after Brexit. This includes assessing the regulatory environment, labor laws, and other considerations to determine where we would be best positioned if we need to create a separate regulatory entity outside the UK. This work is progressing well. In this context, the additional costs for us are not significant. We anticipate that most of our employees will stay in the UK; therefore, an office in the EU would likely be smaller, and we would pursue registration within that regulated entity. However, the extra cost would be fairly minimal.

And then last for me is just another follow-up question about the potential rolling back or easing of the Volcker Rule. Just wondering if you view this as a risk at all to growth rates that you’ve been posting in Open Trading and some of these other liquidity solutions that you’ve developed for the market, which are specifically gaining a lot of traction in less liquid products, such as high-yield TRACE?

I believe that allowing dealers more freedom to make markets at their discretion, while adhering to their constraints, is beneficial. Increased market liquidity that enhances credit market turnover would positively impact us and others in the industry. Therefore, we do not consider this to be a barrier to the growth rates we have been experiencing overall or through Open Trading. However, it is important to note that there is a growing regulatory emphasis on best execution, which is clearly outlined in the MiFID II regulations. Investors are rapidly adopting transaction cost analysis for fixed income as part of the regulatory landscape. This trend is most significant in Europe, but we are also observing a swift increase in demand in the U.S. for both transaction data and performance comparison analysis. I believe this is one of the reasons why we continue to see more investors moving towards electronic trading platforms.

First, just on corporate tax reform and how it could impact MarketAxess. I think there has been a pretty healthy debate this earnings season from CEOs about how much of lower corporate tax rates would fall to the bottom line versus be shared either with employees or competed away. It looks like you are assuming the vast majority of the benefit accrues to shareholders. But wanted to get your thoughts on how lower corporate tax rates could affect that interplay.

Cantor, on the corporate tax rate side, there is obviously still a lot of uncertainty surrounding it even President Trump’s proposal and the House Republican blueprint are not completely aligned. Even though over the course of the campaign, President Trump’s proposal did more closely align with the House Republican side. Even when I try to model out the impact on 2016, we have to make some assumptions around what happens to research-related deductions and research credits. There is uncertainty around what happens on the repatriation side; the two plans treat cumulated earnings and how they treat earnings on a perspective basis differently. So there is still a bit of uncertainty. I’d tell you that looking at some of the thesis that some of the sell-side analysts put out, I think we’re generally in line with the impact on MarketAxess. For us in 2016, roughly 85% of our earnings were domestic, 15% were foreign. We do expect some shift in that mix going forward, favoring foreign side, and rates today are much lower outside of the U.S., so like many companies, we would benefit from that rate reduction.

And then just following up on your comments around the outlook for new debt issuance, I know your share of trading from new debt issuance is considerably lower than other bonds. But is there a way for you to get a little more specific on your market share for new debt issuance, and how we could think about declining DCM activity potentially impacting your volumes?

January is a classic example where we are in a very heavy period of new issuance, and in fact, there are reasonable chances that it could end up being the best month for hybrid new issuance ever. We’re in a risk-on environment. So, in that kind of combination, investor focus does shift to the new issue calendar, and there are plenty of swaps and trades being done to make room for the new issues. The typical pattern we see is short-term weakness in the share around those heavy periods of new issuance, but it typically responds fairly quickly. Our view is that a larger corporate bond market is a very good thing for our future growth. We have clearly benefited over the last five years as the corporate debt markets have become about 80% larger over that time period. In the long term, we think that more debt issuance is a positive for the size of the opportunity.

And then one more, if I could. On Open Trading, I just wanted to make sure I was interpreting the stats correctly. It looks like the depth of the order book is improving significantly, with volume up 86%. The TRACE response is up more than 200%. But I wonder if you could just confirm that and talk about how the depth on that platform has changed over the last year.

Yes, I think that’s fair to say. The depth of that market is growing in every client segment. Investor adoption for Open Trading is growing each quarter. We enhanced our technology solutions to make it easier for both dealers and investors to identify potential trade matches through Open Trading. We’re seeing new capital come into the market with additional dealers that are focused on electronic markets and market making. I mentioned earlier that the ETF community continues to grow; this is a highly valuable tool for creating the gain process, and the relative value trading that goes on between ETF shares and bonds. Another efficiency gain from Open Trading is we are clearly making cross-regional business more efficient than it has been in the past. Each quarter, we see greater participation in all of those areas. We’re also seeing dealers using this system increasingly, not just as liquidity providers but as liquidity takers. So, it’s an asset in balance sheet velocity for dealers, providing another tool and another distribution channel for them to move bonds along more quickly.

So, first, I guess just an industry question. As you think about industry-wide volume growth in high-grade, I think you’ve talked historically about expecting maybe low single-digit growth over the long-term. Given the 5% growth in TRACE volume in ’15, and then I think 17% in ’16. Has your perspective there changed for the next three to five years, I guess, excluding any future regulatory changes? Ultimately, I am trying to figure out if industry volume growth could be sustainable.

There are so many different factors and variables that impact credit secondary volumes. It's hard to be overly scientific about predicting where they might go. What we’ve said in the past about the long-term outlook is that turnover of credit has been steadily declining over the last five years. We think that the combination of the new bank capital requirements and the low volatility environment we’ve been in have contributed to a decline in overall turnover rates. The optimistic view would be, look, we may be entering a different period for the interest rate environment, which could positively impact volatility. There are expectations that economic growth could improve relative to where we’ve been over the last three or four years. Volatility would be a positive for market turnover, and as bank regulations are relaxed, it should be easier for them to go back to work on what they do well in market making. We believe that would be a net positive as well. What we’ve heard from investors is that their active portfolios have not been turning over at normal long-term averages, and it's directly related to low volatility. We are carefully watching because we think volatility would be good, and relaxation of bank regulations around market making would be a positive.

And then, maybe could you just give us an update on your progress with loss rates? I don't know if there are any kind of market-share stats you could share about where you stand in the fourth quarter versus maybe a year or two ago. That would be helpful.

On the block trading side, I'd say on market share, generally speaking. In the fourth quarter, we had gains year-over-year across all size buckets. There were gains in the block trading side bucket as well. When we measure it, we look at TRACE information and measure our market share, which sometimes is right around 8% of volume, and it's up year-over-year. Again, we’re reporting gains across all size buckets. It's probably more evident in our sweet spot right now where we are picking up share in block trades as well. Honestly, when you listen to what Rick is talking about in terms of protocols and Open Trading, a lot of the effort here is around evolving protocols to address larger trade sizes to get more involved in trading block trades.

And then just one last real quick one, the fee rate in other credit, which ticked up quite a bit. I know you’ve called out the fee plan change. But when did that fee plan change go into effect? Was it in effect for the full quarter?

Yes, for Eurobonds, it was in effect for the full quarter. At this time, virtually all of the 40-plus dealers have transitioned onto a new fee plan. Part of these plans includes monthly minimum commitments built into all those plans, and you’ll recall, for U.S. high-grade where we have a similar concept. If a dealer doesn’t meet their monthly minimum commitments, we take that unused monthly minimum and we put it into distribution fee lines. So you're probably still going to see some residual coming out of Europe on the distribution fee line, to the extent we may have some dealers that aren't meeting their monthly minimum commitments.

I’ve been hearing a lot of questions about high-yield and Open Trading. I can see the significant improvements in Open Trading. However, I’m trying to understand the pie charts correctly. It seems like the mix has shifted away from high-yield into other categories. Additionally, it appears there was less volume in high-yield on Open Trading from one quarter to the next. Am I interpreting that correctly?

Unless the pie charts tell the whole story. I’m looking at something that you don’t have in front of you. But from a percentage standpoint, the high-yield percentage of volume represented by Open Trading did increase quarter-to-quarter. I’ll give you a rough number—it went from 31% in the third quarter to 34% in the fourth quarter. So, it did pick up. I have to look at market volumes, and high yield may have been down from the third to the fourth quarter. I don’t have that in front of me right now, but that could be causing some of the variation.

I think it’s true within other categories, Rich. The growth rates in Euros and EM in Q4 were higher overall than they were for high-yield. It was just a lower volatility environment during too much of the quarter in Q4 that negatively impacted the high-yield volume growth rate. I think that’s what you’re seeing in the shift.

If you take 24% of your $831 million in ADV, that would reflect the high-yield Open Trading volume, correct? The breakdown shows 24% on page six.

That is what it should be telling you guys.

The next question is about compensation and headcount. The quarter showed a nice increase in revenue compared to the previous quarter. I'm interested in how you accounted for bonuses, specifically the bonus accrual, since there seemed to be no seasonality in the fourth quarter despite the strong revenue performance.

We are quite clear about how the variable bonus accrual works and the formula behind it. If you look at our proxy statement, you will find a detailed explanation of the formula. Typically, we accrue throughout the year based on this formula. As we approach year-end, we also look at various factors like pure benchmarking and the balance between variable bonuses and equity. Adjustments are made at year-end, and this year, there was a notable adjustment in the fourth quarter. We believe this adjustment brings the compensation structure to the right mix, with a bit more emphasis on equity and slightly less on the cash bonus accrual. Rick and Tony, you've been experiencing rapid growth and making significant investments. When I examine the incremental margins, they remain robust at 65%, which is well above your typical operating margin. My question is, as it was asked earlier, do you consider the incremental margin when managing your investment spending, or does it not factor in since you are contributing more to the bottom line than what you are investing?

Rich, I can honestly tell you that we’re not managing to the margin number, or really that incremental margin in terms of the investments that we're making. We’ve arguably looked over the past three years during the most significant investments period in our corporate life, perhaps outside of starting up the firm. So we've been investing to expand the geographic reach, launching new products, increasing the addressable market, and investing in Open Trading. We’ve still increased the margins. Look over the past three years, it's gone from 45% to 52%. We’re not managing to that in margin outcome, but you can see when we've invested heavily, it has influenced the top line outcome. With the guidance we provided, we've planned another year of investment in 2017, and we think for all the right reasons. You can see that impact coming through in the top line and also in margin expansion.

So, just one housekeeping, the follow up on the discussion, I definitely appreciate the insight on Eurobonds and variable fee capture that should be somewhere in the ballpark of high-grade. On the fixed-rate fees, just want to clarify that all the dealers are now in the new plan. Did the fixed-rate fees stay on the fourth quarter track at roughly about $350,000, or does that fall to zero in the first quarter?

It probably will not fall to zero in the first quarter, but it may go down slightly, talking about $300,000. There were still one or two dealers transitioning. Part of these plans, and not to complicate it, but part of these plans, there are monthly minimum commitments built into all those plans. And you’ll recall, even for U.S. high-grade, we have a similar concept. If a dealer doesn’t meet their monthly minimum commitments, we take that unused monthly minimum and we put it into the distribution fee line. So, you're probably still going to see some residual coming out of Europe on the distribution fee line to the extent we may have some dealers that aren’t meeting their monthly minimum commitments.

And then just a question or two on Eurobond. Last year, we did see that shift in European investor appetite for high-grade for U.S. high-grades from Eurobond, post the ECB bond buying program. How do you see things in 2017 playing out in terms of the mix of interest from European investors between those asset classes?

Between which asset classes?

Between the U.S. high-grade and Eurobond among the European investors, we kind of saw a search for yield and some increased adoption of trading in U.S. high-grade from those investors last year. I was just wondering whether or not you’d anticipate maybe more of a migration back to Eurobonds trading? We’ve read a little bit about the ECB potentially being less active in corporate bond buying this year. I was just wondering if you anticipate that there might be any changes in terms of that mix.

I would expect more of the same. You have stronger economic growth and lower unemployment in the U.S., which is causing the Fed to begin increasing rates here, likely to increase the yield differential between the EU and the U.S., and you have a very strong dollar. So, my expectation would be that we will continue to see healthy inflows from Europe and Asia into U.S. credit products.

Hugh, I would just add that on the market volume standpoint, even with the ECB actions in the corporate bond space that started up back in the May-June timeframe, we haven’t seen any appreciable impact on overall market volumes for Eurobonds. We’ll have to see what happens with this continued ECB program; at least the more recent information indicates that they could continue with the buying, and that the rest is down a little bit in April. But we’re going to continue throughout the year.

And then another one there. Obviously, you guys have indicated that you’re having tremendous success in terms of taking share of electronic trading in Eurobonds. As we think about just the overall level of electronic trading in Eurobonds, is there an expectation that we should see a greater percentage of bonds being traded electronically over the near to medium term? Or would you anticipate that that level of electronic trading should be fairly steady?

What we are hearing from both dealer and investor clients, Hugh, is that the MiFID II obligations around trade reporting are so comprehensive that there will be ongoing appetite to conduct those trades electronically. I think we’ll run into the same differentiation between block trades and flow trades where you have fewer block trades, and clients will have different views about the best way to execute them. But for any flow trade or well-impact trade, our understanding in talking with many investors and dealers is that it's going to be far easier and more cost-effective in Europe to conduct those trades electronically and comply with all the new trade reporting rules that they both have. So, we would expect—and we’ve already seen that to an extent—that the electronic share of the Eurobond market has been increasing. We would expect that to continue into the implementation of MiFID II next January. And then last for me, just as we think about the investments last year you made in munis and leveraged loans, are you guys comfortable just giving us a sense of how you guys are thinking about the impact of that in 2017? Is there, either a revenue or market share target or range that you guys are thinking about and striving for this year? Yes, both are higher. Listen, where we are today in our core market is very different than where we were five years or 10 years ago. What we’ve learned is that any new market takes time. While we’re working with many of the same clients and the dealers, we’re working with a different set of traders. I will tell you that the numbers in munis in particular months-in months-out, quarter-in quarter-out are getting better. We continue to invest very heavily in enhancements for the municipal bond market. The same could be said of leveraged loans; we are onboarding more clients and dealers, it's earlier stages. We're doing trades, and we're optimistic there. It's really hard to predict exactly what the growth rates will be. But as I mentioned in my prepared remarks, we are confident that we have the right solutions for both of those markets.

Thank you for joining us this morning. All the best for 2017 and we look forward to talking to you next quarter.