MarketAxess Holdings Inc (MKTX) — Q4 2023 Earnings Call Transcript

Good morning and welcome to the MarketAxess fourth quarter and full year 2023 earnings conference call. For the call, Chris Concannon, Chief Executive Officer, will provide you with a strategic update on the company. Rich Schiffman, Global Head of Trading Solutions, will update you on how we executed this quarter and then I will review the financial results for the quarter. Before I turn the call over to Chris Concannon, let me remind you that today's call may include forward-looking statements. These statements represent the company's belief regarding future events that, by their nature, are uncertain. The company's actual results and financial condition may differ materially from what is indicated in those forward-looking statements. For a discussion of some of the risks and factors that could affect the company's future results, please see the description of risk factors in our annual report on Form 10-K for the year ended December 31, 2022. 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 Chris Concannon.

Good morning and thank you for joining us to review our fourth quarter and full year results. Our underlying revenue growth trends improved during the fourth quarter as we continue to execute our growth strategy. We delivered 11% revenue growth, including the benefit of our Pragma acquisition. Earnings per share was $1.84, an increase of 16%. U.S. high-grade transaction revenue increased 14%. Emerging markets increased 8% and Euro bond increased by 7%. With these improved results in the quarter, we delivered our 15th straight year of record annual revenue. Turning to my strategic update on Slide 3. First, we are delivering innovation with the launch of our new trading platform, X-Pro, designed to address our U.S. credit market share challenges by retooling the delivery of our trading offering. We are pleased to see our portfolio trading clients increasingly leveraging our unique pre-trade analytics, like Tradability which are only available through X-Pro. 30% of our portfolio trades were executed on X-Pro in the fourth quarter, up from 18% in the third quarter. Next, we are enhancing our suite of automation tools with the addition of Pragma. We delivered new records across our automation suite of products in the quarter. Our automation products crossed a record $300 billion in volume for the full year in the fourth quarter. Adaptive Auto-X, our new client Algo solution moved out of the pilot phase during the quarter with a total of 13 clients, including 6 of the largest. Early results show promising transaction cost savings in U.S. high-grade. And last, in terms of execution, our client franchise has never been stronger with a record 2,100 active firms. We delivered strong growth in our international businesses, portfolio trading and municipals. We also generated record revenue in both our market data and post-trade businesses as our investments to broaden our geographic and product footprint continue to pay off. Slide 4 summarizes how powerful data and content on our platform is helping traders achieve better trading outcomes. We want to capture the full spectrum of order flow in the market by helping traders manage their portfolio composition, protocol selection and counterparty optimization. Our data is at the core of these new initiatives we are delivering through X-Pro. From growing portfolio trading market share to increasing our share of larger-size trades, our proprietary data is what differentiates us from other market solutions. In 2023, we had a record $390 million price responses from liquidity providers across our platform which is growing at a 3-year CAGR of 11%. This unique data set and the magnitude of this price information is what powers our proprietary data and insights that we generate for clients on X-Pro. Slide 5 highlights our action plan for stronger market share growth in corporate bonds in 2024. Using U.S. high grade as a case study, we've done a very good job of electronifying small-sized tickets which has been the key value proposition of MarketAxess since our founding. While the history of electronification would indicate that the largest, most complicated block trades would be the last to adopt electronic solutions. Our market has jumped right to the largest and most complicated trades, the portfolio trade. What is left in the middle is trade size is $5 million or greater which is the target market for the rollout of X-Pro. We've heard from our clients that they need better data and workflow solutions to manage this part of the market. In this environment, hiring more traders is not the answer. To help our clients manage protocol and counterparty selection for larger-sized trades, we have launched Tradability and AI Dealer Select. Tradability helps determine depth of market while AI Dealer Select helps clients determine the right dealers to engage. With Adaptive Auto-X, we are also helping clients manage larger-sized trade by leveraging our different trading protocols, including Open Trading. Helping clients manage small and large sized trades with pre-trade data and analytics, growing our share of portfolio trading and enhancing our dealer-centric trading protocols like dealer RFQ are key objectives for 2024. Slide 6 provides an update on market conditions. In the fourth quarter, ETF market maker ADV our platform was up 68% from the third quarter as market conditions improved but was still down 19% from the prior year. Since the Fed's pivot in early December, we have seen a pickup in duration which has had a positive impact on our U.S. high-grade fee capture. Before I turn the call over to Rich Schiffman, I wanted to provide an update on January activity with one final important trading day remaining in the month. January trends show solid low double-digit growth in U.S. high-grade ADV year-over-year with estimated market ADV up approximately 15%, indicating lower estimated market share. January is historically a lower market share month given seasonally strong new issuance in January. Over $190 billion has been issued to date in January, making it the highest January on record. As a result, trading in newly issued bonds represented approximately 15% of the market, up from an average of 8%. The U.S. high-yield ADV is down approximately 30% from elevated levels in the prior year. The decline is driven by lower ETF market maker activity and increased focus on distressed names that do not lend themselves to electronic platforms and an increased focus on a strong new issue calendar by our long accounts. Estimated market ADV is down approximately 9%, indicating significantly lower estimated market share. Portfolio trading is on track to be a record month with ADV of approximately $800 million, up approximately 160% from the prior year. Now let me turn the call over to Rich to provide you with an update on our market.

Thanks, Chris. We made significant progress this quarter advancing our trading business. Slide 8 highlights the strong expansion of our client network. We had a record 2,108 active client firms trading on our platforms in the fourth quarter which included a record 1,638 client firms active in U.S. credit. Trading volume from hedge fund and private bank clients increased 37% year-over-year and represented 17% of total credit volume in the quarter, up from 14% in the prior year. On Slide 9, we highlight the expansion of our trading business across geographies and products. Fourth quarter growth in international average daily trade volume and trade count was 17% and 19%, respectively. This was driven by strong Euro bond trading volume, up 13% and strong emerging local markets trading volume up 26%. Local currency ADV is growing at a 3-year CAGR of 21% and trade sizes, $5 million and larger represents 60% of our trading volumes. Axess IQ, our front end for private banking clients generated record ADV of $141 million, an increase of 67% compared to the prior year. We are also seeing strong product diversification in municipal bonds with record ADV of $539 million. These strong results were driven by record tax-exempt trading volume, up 14%. We had a record 369 active firms on our municipal bond platform and we are continuing to integrate MuniBrokers with Open Trading to expand sources of liquidity for investors and dealers. Adoption of our automation suite of products continues to grow, as shown on Slide 10. We experienced record automation trade volume and count in the quarter with 3-year CAGRs of 39% and 49%, respectively and a record 185 active automation client firms. Automation trade volume now represents 11% of our total credit volume and a record 25% of our total credit rates. There were a record 10 million Algo responses from dealers, an increase of 40% year-over-year. To share an example of client penetration, our largest automation client executes twice the automation volume of the next largest fund complex. The firm has made a significant investment in automation. We believe this is due in part to an increasing need to manage large inflows and smaller-sized tickets. There were a record 2.2 million trades of $100,000 or greater in U.S. credit on TRACE in the fourth quarter, up 15% from the prior year and nearly doubled fourth quarter '21 levels. Slide 11 provides an update on Open Trading, our market-leading all-to-all liquidity pool. Open Trading ADV was $4 billion and share of total credit volume was 36%, down from 38% in the prior year but up from 34% in the third quarter of '23. A record 202 hedge funds provided liquidity through Open Trading in the quarter a 9% increase from the prior year. Open Trading is consistently the largest single source of secondary liquidity in the U.S. credit markets. We delivered approximately $702 million in price improvement to our clients in 2023 on lower levels of credit spread volatility during the year. Lower volatility in high yield in mid-2023 had a negative impact on ETF market maker activity as shown in the chart on the lower right. As activity decreased, Open Trading share of high yields moved from over 50% at the end of 2022 to approximately 47% in the current quarter. Our launch of Open Trading in select local markets including Poland, Czech Republic, Hungary and South Africa is off to a strong start. We were pleased to see the uptick in EM market volumes in the fourth quarter given the lower levels of growth over the last 2 years. Emerging markets continues to be a very attractive growth opportunity for the company. Now let me turn the call over to Steve Davidson to review our financial performance.

Thank you, Rich. On Slide 13, we provide a summary of our fourth quarter financials. We delivered revenue of $197 million, up 11% from the prior year. These results include $8 million from the Pragma acquisition, of which $6 million is in commission revenues and $2 million is in the technology services revenue line. Foreign currency was a $2 million benefit in the quarter. Record Information services revenue of $12 million was up 15%, including a $400,000 benefit from currency fluctuations. This strong performance was driven by new contracts as we continue to experience strong adoption across our data product suite, especially CP+. Record post-trade services revenue of $11 million was up 24%, including a $600,000 benefit from currency fluctuations. The favorable interest rate environment contributed $6 million of interest income, up from $3 million. The effective tax rate was 16.9% and we reported diluted EPS of $1.84 per share of 16%. Earnings per share benefited from a lower effective tax rate driven by return to provision adjustments and the purchase of transferable tax credits by the company. On Slide 14, we provide more detail on our commission revenue and our fee capture. Total commission revenue increased $13 million or 8% in the quarter. The increase in credit commission revenue was due to stronger estimated market volume and higher fixed distribution fees, partially offset by lower estimated market share and lower average fee per million. The basis points at 15 in the quarter was a key driver of a decrease in ETF market maker activity which negatively impacted our U.S. high yield market share. The reduction in total credit fee capture from the prior year was driven principally by product mix with lower high-yield volume and protocol mix, driven by an increase in portfolio trading. On Slide 15, we provide a summary of our operating expenses. Fourth quarter operating expenses of $120 million included $9 million for Pragma, $2 million in acquisition-related expenses and costs associated with efficiency initiatives and a $2 million negative impact from foreign currency fluctuations. On Slide 16, we provide an update on our balance sheet, cash flow and capital management. Our balance sheet continues to be solid with cash and investments totaling $586 million as of December 31 and we had no outstanding borrowings under the credit facilities. During the past 12 months, we paid out approximately $109 million in quarterly dividends to our shareholders. Our Board of Directors declared a regular quarterly cash dividend of $0.74 per share, an increase from $0.72 per share based on the financial performance of the company. On Slide 17, we provide you with our full year 2024 guidance. Revenue from Pragma is expected to grow in the mid-single digits. Pragma's revenue was $8 million in 4Q '23. We expect total expenses to be in the range of $480 million to $500 million off a base of $438 million in 2023. This would imply a growth rate of 12% to the midpoint of the 2024 range. This includes the impact of Pragma, approximately $10 million in efficiency savings in 2024 from the actions taken in 2023, and $4 million in acquisition-related expenses and costs related to the efficiency initiatives included in the 2023 base. We expect the effective tax rate will be in the range of 24% to 25%. Capital expenditures are expected in the range of $60 million to $65 million, of which roughly 80% relates to capitalized software development costs for the investments we are making in new protocols and trading platform enhancements. Now let me turn the call back to Chris for his closing comments.

Thanks, Steve. In summary, on Slide 18, we continue to execute very well against our growth strategy in the fourth quarter. The market backdrop improved through the fourth quarter, supported by a potential pivot from the Federal Reserve in December. Our focus in 2024 is on growing corporate bond market share by leveraging X-Pro to retool the delivery of our full suite of products and services. X-Pro will be integral to bringing all our data automation tools and protocols together to address trades of all sizes and complexity. Our client network has never been stronger with continued expansion across client segments, regions and products. As we continue to execute and deliver on our key focus areas for 2024, we believe we are well positioned to deliver higher levels of growth in the quarters ahead. Now we would be happy to open the line for your questions.

I was hoping you could help us unpack the January commentary. Market share decline in high grade, no surprise given the issuance levels. High yield implied market share is about 13% which is fairly low level. So just trying to understand the share dynamics, maybe the traction you're seeing on X-Pro versus other protocols and what contributes kind of the shared lines, maybe a little bit more so on the high yield on the high grade.

Sure. Thanks, Chris. First, I want to remind everyone that we have our monthly release coming out on Monday. You'll get all the details then, but I wanted to provide some commentary because we expected questions about the January results. Let's take a step back and look at the macro market. The market conditions that developed in December due to the Fed's pause have been very favorable for us and the broader bond market. We've seen positive behavioral changes in overall market volumes since December. Many of those conditions are still present, contributing to a 24% increase. It's an appealing rate environment, and while people are interested in bitcoin, bonds are safer investments with great yields. We're seeing this reflected in the numbers as reallocations usually happening at the beginning of the year are playing out into fixed income, both at retail and institutional levels. The overall market environment looks quite positive. There is also a strong demand for new issues in January, which reflects this favorable backdrop. We're expecting record new issue volumes exceeding $200 billion in January, indicating that issuers are comfortable in this higher yield environment and eager to issue debt. All these factors suggest a positive outlook for the bond market overall. High-grade market volumes are up 20% year-over-year and 40% from December. This is encouraging. Typically, high new issue months challenge our market share, but today being month-end usually brings strong activity and rebalancing. We think today will be robust, so I won't speculate on results yet. Market share in high-grade has remained stable, with increased trading activity from our long-only clients. However, high-yield presents a different scenario, as its volumes are flat year-over-year, with investors showing less interest in high yield. While there has been a sizable new issue this month, we are seeing declines in the hedge fund and ETF market maker segments. This is a widespread issue, and we are not facing competitive pressures there. Conversations with clients indicate a challenging environment for their business models. High-yield ETF volumes are down 20% year-over-year, reflecting ongoing challenges in that market. We observed similar trends in the second and third quarters. Although there was some recovery in high yield in the fourth quarter, challenges persist. In Emerging Markets, the situation was difficult in 2023, with unattractive investment conditions compared to high-grade markets and treasury yields. Market volumes were strained, but we noted a pickup in Q4 that has continued into January, with nearly a 10% increase. Additionally, our APAC volumes are approaching record levels, indicating positive activity in our international business. I hope this provides a comprehensive answer, Chris, to remind everyone about the market volume release coming on Monday.

Yes. Just staying on market share but zooming out a little bit, obviously and thanks for that chart. I think that's new. So that breaks down the trades volumes and by kind of size of trades and where you focus and obviously a lot of initiatives going on. But when I think about your core business today, can you just remind us what you're seeing on a competitive side there? I mean, obviously again, market share growth comes from gains in these new areas. But just wanted to get an update on how you think you're defending your kind of home turf. And if you're seeing any sort of market participants try other platforms in your kind of home turf like what are the reasons that they are citing why they may be looking at other platforms before they look at yours?

Great question, Alex. First, our core business is the institutional bond market. Our clients are global and seeking liquidity across the entire fixed income market, which is primarily driven by requests for quotes. We have one of the largest electronic request for quote systems. It's worth noting that traders often request prices over the phone and through chat, indicating that the non-electronic part of the market, which includes phone and chat, is significant. When considering our real competition, it is primarily that phone and chat segment, which we believe is quite addressable. Currently, as we experience increased trade activity due to the overall attractiveness of the bond market, our clients are communicating that they are not expanding their trading teams; instead, they must accomplish more with fewer resources. Thus, the demand from our traditional institutional clients is strong as we approach 2024, benefiting from a favorable backdrop for the fixed income market. Regarding competitive pressures, we observe them across the market, especially in the dealer-to-dealer segment, where dealers are quickly trying to unwind large bond positions. This sector is critical and growing because dealers’ balance sheets are expected to decline due to upcoming regulatory changes. Consequently, the demand for dealer execution solutions is anticipated to rise. We are facing competitive pressures across our marketplace, particularly in dealer-to-dealer transactions, which are often highly price-competitive due to the ability of dealers to shift activity promptly. Another area of competitive pressure is portfolio trading. We have seen competitors entering this space with their solutions while we were initially slow to respond. However, we have since acted aggressively in portfolio trading, resulting in record activity in Q4. Regarding portfolio trading adoption, I noted in our opening remarks that I am very encouraged that the most complex block trades in the fixed income market are now being executed electronically. The portfolio market is mainly driven by requests for prices on a basket of bonds, which often involve sizable trades exceeding $100 million. These transactions are now being managed through electronic solutions, including ours. We just launched our X-Pro PT solution, which incorporates extensive data and pre-trade analytics. I’m excited that this complicated segment of the market has embraced electronic trading for block trades, despite initial skepticism about electronic adoption in this area. These are the two primary areas where we are noticing competitive impacts. Rich, would you like to add anything?

Yes, Alex, it's Rich. Yes, I was just going to say building on Chris' comments, the part of the market where we're strongest, where the Open Trading has the biggest impact, the institutional client business. That's 2/3 of the market. We know we've got some work to do in the dealer business, for example, that's about 1/4 of the market. And then PT, as Chris talking about where we're also growing, that's just 7% of the breakdown. And then the last component is retail which we're really not in and that's about 2%. So we feel really good about our core business, the offering that we have there. And then we're investing considerably with X-Pro, with our dealer business to capture that other roughly about 1/3.

I wanted to follow up a bit on that line of questioning. But thinking about it from a fee per million perspective, how does the increasing contribution from these newer protocols impact the overall fee per million when you talked about your RFQ business, institutional being the strong backbone but how do things like portfolio trading have an impact relative with that mix?

Sure, Dan. I'm glad to start. I know Rich has some insights on this as well. Firstly, let’s look at the broader market context. In the current environment, following the Fed's pause, we are seeing an improvement in average weighted years to maturity, which positively affects our fee capture. As we move into 2024, it is more likely that these average years to maturity will increase rather than decrease, which bodes well for our overall fee capture. We certainly see potential for these figures to grow in a favorable direction. The dealer-to-dealer business, which I mentioned, operates with a lower capture rate since dealers are quite sensitive to pricing and often shift their business around. Therefore, I don't anticipate that business will have a consistently low capture rate over time. Portfolio trading, however, tends to have a lower capture rate as well. The crucial factor in securing this business is the utilization of data and analytics. When portfolio trading first emerged, clients would present large line items to decide on whether to proceed with a trade. However, as the market has evolved, we observe that clients are now dealing with significantly smaller line items, which helps optimize pricing. More importantly, they're focused on optimizing pricing throughout the trade process, which demands substantial data and analytics integrated into the solution they are using. This is why we've noticed an increase in portfolio trading on our platform, especially since X-Pro offers enhanced data and analytics that help traders optimize their portfolios in real time. Rich, do you have any additional thoughts on the capture rate?

Yes, Chris, it's Dan, yes, just to add a little bit on it. I mean the transaction fees, I mean, they're broadly set by bid-ask spread in the market. And also on the value of the service that we provide. So it kind of runs the gamut. The Open Trading is most valuable where we deliver the most value to our clients and number was somewhere $700 million-ish north of that in what was a relatively lower benefit delivered. That number has been quite a bit higher in the future. So those trades go for a relatively higher fee rate. And then all the way on the other end of the spectrum is process trades where it's either de minimis or zero and we don't count those even in our volumes. So it's really just clients using our plumbing to process the voice trades. Things like PT, it is closer, it's closer to a process trade than it is to an in-comp trade all to all and taking advantage of Open Trading. So that is going to be at a relatively lower fee rate and of course, you guys are all familiar with the duration impact in some of our fee products where that's going to have a change as interest rates are changing and maturities are changing. One thing about it, we talk about size is also a factor in the transaction fees that we charge and with the move towards automation and Algos being used to break blocks into smaller pieces, that's going to mean smaller-sized trades which leads to relatively higher fee per million capture. So that's a trend that will work in our favor over time. But generally, the rate card is pretty stable and you've got these other variables in terms of product mix, duration mix that reflect themselves in the overall average fee rate that you see published each quarter.

I wanted to circle back to I think it was Chris Allen's question at the beginning. And I know you're about to put out of the January release but maybe thinking about February and how the rest of the year might evolve. Could you maybe talk about the sort of impact of new issuance, clearly, there's a market share impact during that month but how do you see that typically unfold as we go through the year? Perhaps in February is another solid new issuance month. Does that mean at some point, we see a big pickup in secondary market trading and any other macro impacts you think could start to reverse? And what do you think would start to work in the right direction as we go through the year?

Sure, Ben. Great question. Look, the new issue market, when we see a record market like we've seen in January, we see that as a positive sign for market volumes and we've seen that play out in terms of market volumes. It does have an impact on our market share but we're more about growing revenue and growing volumes. And so it has a temporary impact on share but a positive longer-term impact on the overall market and market volumes, particularly secondary market volumes. Remember, people are moving out of product and into new issue. They are reallocating typically into that new issue. And we do see that high activity at month end, like a day like today; we'd see high activity as a result of a sizable new issue market as they reallocate those portfolios. What I think more broadly, outlook for 2024, it's quite an attractive outlook for our marketplace and then were a key component of that overall market. So we feel very positive about 2024. I will tell you, our clients are exceptionally positive about the reallocation that typically happens at this point in the rate cycle, where you see people moving from stocks into bonds and we're starting to see that. You can see it in the retail numbers on our market. Retail numbers are growing and that's really reflective. An early indicator of how people are thinking about this more attractive rate environment, so when we talk to our clients, they are bullish about more allocations, more dollars being allocated into the fixed income market. What's interesting is they are not bullish about their overall revenues coming in as a result of AUM growing dramatically. A lot of that AUM will grow in lower expense ratio products. SMAs and ETFs index-based products. So they are still watching their expenses quite carefully even as AUM is growing in this more attractive rate environment. And that's why the demand that we're hearing from clients, they're managing more AUM on the same fixed budget and that requires them to adopt things like automation and use electronic trading, have more efficient tools like an X-Pro. It's really about doing more with less on the client side. So that is a running theme among our clients in this kind of environment and quite positive as we look out into 2024.

So it sounds like you fully rolled out Adaptive Auto-X in the quarter. Where do you see client penetration of that protocol increasing to in 2024? And as you're coming out of the pilot phase, just curious if anything stood out or you want to highlight that you learned during that phase.

Sure. We recently concluded a pilot program that was intentionally kept small, focusing on a select group of clients. This approach allowed us to concentrate our efforts on development, guidance, and support for our innovative solution in the fixed income market. This was the first instance of launching a client algorithm specifically in credit, marking an exciting milestone for us. Now that we have transitioned out of the pilot phase, we are making this offering available to all clients, and the demand has been significant with a lengthy pipeline. We are thrilled about the potential this holds. Clients are experiencing high execution quality with this algorithm, which is designed as a passive solution for managing orders throughout the day. It enables clients to capitalize on pricing opportunities from other clients or dealers since it responds automatically to market prices. While it may take time for traders to become proficient with its various configurations and algorithms, the rollout of Adaptive Auto-X is generating enthusiasm. It's important to note that Adaptive Auto-X is just one aspect of our broader automation suite, which is vital to our future strategy. The overall acceptance of automation is growing, and Adaptive represents the most complex segment within this suite. The demand for automation remains strong, especially considering the budget constraints faced by our largest clients. There is a notable disparity in the adoption of automation across the market; our top automation users are performing at double the level of the next largest client. From an assets under management perspective, we have yet to fully implement our automation suite among all our clients, revealing significant opportunities. Additionally, I’d like to highlight a remarkable achievement in automation: one of our largest traders using our technology set a record with 240,000 trades handled by a 26-year-old trader from a key client that embraced automation. This individual exemplifies the incredible capabilities of our technology, demonstrating the significant impact of automation, and we are witnessing unprecedented demand for this product category. Also, it's worth mentioning that automation's effectiveness is closely tied to the quality of data provided. Our proprietary CP+ solution and an extensive amount of market data will contribute to the automation suite's performance in 2024, ensuring strong engagement with our products. We've seen remarkable success, and it’s impressive to see an individual trader achieve such a high volume of trades in a single year.

Hi, everyone. Following up on the last question, I am curious about how we should consider the speed at which X-Pro and Adaptive Auto-X can influence your market share, assuming current conditions remain unchanged. Do you expect these changes to take two years to show significant results, or could we see some outcomes this year? Please provide insight on how the rollout can be effectively managed.

Sure, Simon. First, when I look at what we're doing with X-Pro, we have to refresh the MarketAxess technology. We're refacing how the traders in the bond market look at MarketAxess. So it is a technology change that we must make. It also helps our refresh of the entire tech stack underneath MarketAxess. So it's a key element, a key strategic technology change that we're making. The good news, as we make it, we can actually change the workflow for our clients and deliver better solutions and better data to our clients through the rollout of X-Pro. This has been in the works for a number of years. So we're excited that it's now live and being rolled out across our clients. The very positive news on just the basic X-Pro features, we are seeing at the trader level improvements in trade efficiency for the traders on X-Pro. It's been fairly consistent as we roll out X-Pro that the trader volume, that volume of that, that trader handles goes up by about 20% given the workflow and efficiency of X-Pro, the trades that they execute on average go up 30%. So it's a highly useful tool to manage the growing tickets that our traders are seeing on their desktop. We also are embedding unique data features into X-Pro and building what we call a high-touch and low-touch solution. So traditional MarketAxess was very focused with all-to-all on, call it, $3 million in under trades. We actually do much larger trade sizes than that. But the way traders manage their workflow, they were very focused on what they could send to All-to-All and that would be sent to MarketAxess. As you think about X-Pro and its rollout, we're targeting that larger trade size that high-touch trade the $3 million and above. I think of it as the $3 million to $10 million is the sweet spot. Those are a long list of trades sitting on desks that both the dealer and the client would like a more efficient outcome for those trades. And so X-Pro allows a trader to adopt whatever protocol they want. They can load it on X-Pro and do a phone trade, they can load it on X-Pro and go to one dealer. They can go to three dealers or they can go to all to all. All the pre-trade analytics is designed to guide that trader on what protocol they want to use and even what counterparty they want to select from. So it's key ingredients that I think our clients haven't ever seen before and it's a unique offering within X-Pro.

Yes, Simon, I would just add to that. You can think of X-Pro it's the tool that makes a trader's manual activity more productive and that's definitely around the larger trays, more complex or handling large list and things and that's why we have it focused on PTs. The automation, that's going to transform the way people do the large number of flow tickets that they have to bang through and Chris just gave that one example of a trader with hundreds of thousands of trades that they need to work. I can see as the automation matures, gets more widely adopted. If you think about it compared to a portfolio trade which is also a convenience service, right, when a trader buy-side trader has hundreds, if not thousands of line items that they have to get done and they're basically offloading that activity to a dealer to handle the role in one shot. So the automation can actually, I think, eat into that type of activity as people get comfortable with using that and then they can focus their time on the relatively small number of line items in a very large basket that need the traders attention. So it will be interesting over the coming years to see how those two kind of vie for some of that activity.

Just another one around X-Pro. And if I were to kind of tease out maybe the message that you guys are trying to ultimately articulate is you're defending your turf in what's been established in high-grade and you're going after larger size in the market with various new tools. So as you're rolling this out, how big of an uplift, I guess, is that for the client? So does that require any incremental technology spend on their behalf or it's as easy as you roll it out and then it's just a matter of them getting to know the protocol and using it? And then I guess, ultimately, when you look at your high-grade market share, what is the goal, right? You guys have been kind of in the range. So if all of these protocols are successful, what kind of market share do you think you can get in the high-grade space?

Alex, it's Rich. And on the first part of the question about X-Pro, I mean it's definitely our objective to make it as painless as possible for the end users. So there's nothing new they have to do. It's really just coming into our workstation as they always do and selecting the new option for using this interface and the ability to get their orders in is also exactly the same as they've been doing in the past. The big challenge for us and this will take some time. Our objective is to get all of the orders from the buy-side traders and even whether they're going to trade it electronically or not, we believe they will benefit from all of the data and analytics that we have in the X-Pro platform and then that will lead to a greater amount of those trades taking place electronically. And to Chris' point earlier, a lot of that is going to continue to be the in comp and taking advantage of Open Trading but there might be some trades or some orders in there that they may just want to work with a small number of dealers and they'll be able to very effectively do that from X-Pro as well. So it's a tool to try to capture all of this activity in terms of share goals, I mean, certainly, we're after the whole market here. But we also recognize that not every order that comes in from a buy-side firm is necessarily going to be out in comp in the traditional way that we've served the market historically. So we're after all of that activity, it's going to come in a variety of ways. Whether it's PTs, whether it's bilateral trades, whether it's fully in comp, whether it's matching, whether it's RFQ. X-Pro is that cockpit for the trader to manage all that different way, all those different ways that they may want to interact with the market.

I want to highlight that we recently launched X-Pro for portfolio trading, which is the first component of the X-Pro platform. We've received very positive feedback and results related to portfolio trading. It will remain a significant aspect of our market, offering an efficient way for the buy side to gain exposure. As we transition more of the market to electronic trading, these efficiencies are likely to extend into other areas. X-Pro essentially mirrors what traders are doing via chat or phone, making it easier to switch to an electronic solution without altering the trade's outcome, and enhancing efficiency in managing multiple line items. An appealing feature of X-Pro is its provision of pre-trade analytics, allowing traders to choose their preferred protocol. A critical aspect of the X-Pro solution is its high-touch functionality, whether trading in a basket as a portfolio or handling individual line items, as it closely mimics traditional trading methods used on the desk. This replication is a fundamental element of our offering.

Great. Chris, just going back to a question that you answered two questions ago. On the segment challenges in the high-yield market broadly. Maybe just how are you viewing that playing out? Do you see those challenges being overcome and see more of a rebound in that market in the sort of near term? Or do you think it's a little bit more structural? And then to what extent would that be a potential headwind on fee per million, just from the mix favoring high grade?

Sure. I believe we have seen these loans in the high-yield market before, which is clearly an essential part of the market. However, observing that high-yield ETF volumes are down by 20% makes sense to me. We have spoken with clients who elaborated on their models and the reasons they aren't functioning well in the current environment. We also notice strong demand for high-grade products from the institutional market, highlighting the disparity in the products available. This month, we've seen several distressed bonds classified as distressed, which tend to have lower trading activity through electronic platforms. The greater issue lies in the impact on client segments within high yield. I still think this is a temporary situation, and we anticipate that volumes in the high-yield market will increase as conditions improve in 2024. Therefore, I believe the current market environment is what is causing these high-yield challenges for the market, our segment, and our market share.

So I just wanted to go back to Slide 5 and the corporate bond market share opportunity. As we look at these five buckets here, I was just hoping maybe you could walk us through each bucket like what your market share is today? And then given that you've identified it as a major focus area for this year, maybe you could share like in each bucket, like what sort of share gains you would expect in 2024? And then maybe longer term, where do you see your market share growing to in each of these buckets?

Thanks. I wish I could provide specific details on market share growth across a complex set of categories. However, I will outline our approach for tackling that market, especially in 2024. As we begin the year and consider our strategy within that market landscape, the overall market environment appears positive. Particularly in the high-grade market, we anticipate that turnover will keep increasing, reflecting a favorable backdrop. To clarify, I’ll break it down into size categories, starting with portfolio trading, which represents the largest trades in the market. This is a sophisticated trade, and we see that the complexity, such as having baskets with over 1,000 line items, is growing. I expect this market for portfolio trading to expand in 2024 as assets under management increase in large investment funds, which typically utilize portfolio trading to gain immediate exposure. Sometimes it is simply more efficient to execute a portfolio trade given the inflow and outflow of capital. Additionally, we can transition from portfolio trades to line item trades as necessary. Our offering in X-Pro is specifically designed to meet the demands of this market. We are harnessing the capabilities of X-Pro, including the capacity to manage numerous line items and offering traders valuable data analytics to oversee these items, allowing for easy adjustments as necessary. We are aggressively targeting around 7% of the overall market, not just because it holds significant market share, but because the same traders operate in the next segment, which includes large size trades. Typically, traders engaged in portfolio trades are high-touch traders managing substantial block trades. Our aim is to equip these traders with a high-touch X-Pro solution that provides pre-trade analytics for each line item and large block. This includes insights into market depth and tradability, helping traders understand the true market capacity for the size of the block they intend to trade. Another critical element, based on client feedback, is that while traders often know the dealers they wish to engage, they might not be aware of other available dealers for the bond. The AI Dealer Select feature is essential for traders as they navigate larger block size workflows. The sweet spot in the market appears to be trades between $3 million and $10 million, especially those above $5 million. Dealers have indicated that their pricing algorithms are fully automated, allowing them to price bonds across a wide range of CUSIPs and icons. With this enhanced pricing power, they prefer to receive trades electronically, benefiting both dealers and clients through efficiency. Moreover, we are significantly involved in trades under $5 million, where the All-to-All model is crucial. The smaller trade size minimizes concerns about market impact or leakage of market information, allowing clients to maximize the benefits of All-to-All trading. This segment is experiencing rapid growth, with ticket sizes declining while the number of tickets has doubled in the past two years. Managing small ticket trades is a vital component of the X-Pro solution, aided by our suite of automation products. Lastly, the dealer-to-dealer market is one we have served well for some time—initiatives like dealer RFQ are fundamental to this market. I believe this market remains underserved. There’s growing demand among dealers to offload inventory, which is expected to rise further due to evolving bank capital regulations. Therefore, our investments in the dealer segment, including offerings like dealer RFQ and mid-market sessions, are competitively priced to attract dealers. We are also seeing dealers start to adopt our automation suite, which we initially developed for clients, for their dealer-to-dealer operations. We are actively addressing all these market segments, which are mostly interconnected. Rich, do you have any additional insights?

I would like to add that if you examine the distribution here, let's say about two-thirds, we might estimate it as 20% market share for investment grade. The way we reach that figure varies across different sizes and trading methods. We see relatively lower share in larger blocks, but we have very high penetration in our key segment, which includes transactions over $100 million, up to approximately $5 million. This portion of the market, while I don't have the complete electronic total, is likely to constitute a substantial share of electronic trading. Conversely, the larger segment exceeding $5 million in investment grade currently has a lower penetration rate. It will require significant effort to encourage traders to consider electronic transactions in that size category. This is the work that Chris has been discussing in response to other questions about X-Pro and other initiatives. We believe we have all the necessary tools for the two-thirds of the market and we are investing in new capabilities to capture the upper end.

It's Kyle Voigt. Just wanted to ask a two-part question on expenses. Chris, you've been messaging for some time now that expense growth was likely to shift a little bit lower versus where you've been over the past 5 years or so. And we saw that in the 2024 expense guide of 6% organic. When I think about the operating environment, still very competitive. There's still a very large runway ahead to capture market share. So I guess the question is in context of the operating environment, can you walk through how you balance pulling back a bit on the expense growth rate in '24 versus maintaining or even accelerating that expense growth for protocol development or new initiatives? And then also wondering if you could just provide kind of an update to medium-term outlook for expense growth and how we should think about that.

Sure. As we mentioned earlier, we have provided guidance for 2024, targeting expenses between $480 million and $500 million, which includes Pragma expenses. This reflects a shift to a single-digit growth rate, compared to the double-digit rates we've seen historically. Our substantial growth over the years, particularly in our tech team, comes from managing a significant platform, as noted by Rich, who pointed out that we hold 20% of the U.S. credit market, requiring ongoing maintenance. At the same time, we are investing in new platforms and a complete tech stack, which increases our investment in personnel, software, hardware, and development. We have reevaluated how we allocate these expenses and resources within MarketAxess and made some adjustments. Thus, the lower single-digit guidance indicates our careful consideration of future opportunities and where we should focus our investments. Our tech initiative, the X-Pro solution, is designed for a global rollout, not limited to high-grade or high-yield segments, with plans to target Europe and global portfolio trading in the second quarter. This strategy aims to enhance all our products, including emerging markets, where we are also focusing on portfolio trading. We are enthusiastic about the investments we are making and want to clarify that we are not halting investments; we will continue to invest in technology and talent into 2024. The guidance reflects ongoing investments in our overall market talent, and we are confident in the years of investments we've made, including the significant one from acquiring Pragma and integrating their tech team into MarketAxess. As we begin to realize the advantages of Pragma within our tech stack, we anticipate new opportunities for Pragma's technology across our offerings. Pragma will be a crucial component of our automation, especially as we conclude the pilot phase of Adaptive Auto-X and continue its rollout. When considering low-touch trading, Pragma will serve as a key API in X-Pro, demonstrating that our tech investments are closely tied to this acquisition. We are comfortable with the substantial investments we've made while also adjusting to a slight decrease in our expense growth rate. It's important to note that 18% of our expenses are variable, meaning they will fluctuate with our top line performance. As our volumes increase, so will our clearing costs associated with the overall volume processed through our platform. Currently, we are confident in our expense guidance for 2024, establishing a new expense level we feel comfortable maintaining going forward.

Just a question on the automation set of tools that you have. I was just curious where you're seeing the traction across the suite of tools so far as well as from customer set and what's the potential for generative AI to help turbocharge the offering over time?

Great question, Michael. And obviously, I want to talk about automation. Obviously, because the growth rates there are sizable. Just in terms of what we saw in the fourth quarter, our automation grew close to 39% year-over-year. So the demand is high. And as I mentioned on a prior question, seeing a woman of 26 years old, be the number one trader on MarketAxess is reflective of the power of this automation tool. It's powered by unique data. It allows someone who's new to the market, mind you, be able to trade over 240,000 trades in a single year. There is AI indirectly in our automation suite, so our CP+ and the data products that we're rolling out, things like Tradability, AI Dealer Select, those are all driven off of our AI tools as we produce data. Adaptive Auto-X has components of AI in it as it looks at and behaves throughout the day. So I do think there's greater opportunities foreseeing AI development across the automation suite. But I also think we're seeing low penetration of automation in some key clients. And certainly, when they hear about the successes that some of their peers are making in automation. And obviously, when they hear about the success of a 26-year-old of being the number one trader on MarketAxess, they're going to be interested in that automation suite of products. So we think there's huge demand in '24 for the automation suite and pretty optimistic about what clients can do with it. And as you were asking, the AI solution is indirectly embedded in our automation suite but we think there's more to do and a huge opportunity around AI.

Yes, Michael, I would just throw in on the AI piece. I think the most interesting area where it's going to have an impact is helping to find the other side of the trade, who out of the over 2,000 clients might be interested in what somebody is trading right now because today, everybody has to express their interest either by submitting orders or creating watch list and things. It's a pretty manual process. But if you go on to Amazon, it always seems to know what you might be interested in buying at any given time. I could see AI having an impact that way and being able to notify people when there are things that they could be interested in that they could act on and be on the other side and capture that bid-ask spread. So, things we're looking at pretty closely.

Thanks and thank you all for your questions. We look forward to a great 2024. We have lots of innovation, as you heard on the call coming out over the course of the year. We look forward to talking to you in the next quarter. So, thank you.