(EDGAR Online via COMTEX) -- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with "Selected Financial Data" and our consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. In addition to historical information, this discussion and analysis contains forward-looking statements relating to future events and the future performance of MarketAxess that are based on our current expectations, assumptions, estimates and projections about us and our industry. These forward-looking statements involve risks and uncertainties. Our actual results and timing of various events could differ materially from those anticipated in such forward-looking statements as a result of a variety of factors, as more fully described in this section, in "Item 1A. Risk Factors", in "Cautionary Note Regarding Forward Looking Statements" and elsewhere in this Annual Report on Form 10-K. Except as may be required by applicable law, we undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
The following discussion includes a comparison of our Financial Results, Cash Flow Comparisons and Liquidity and Capital Resources for the years ended December 31, 2020 and 2019, respectively. A discussion of changes in our Financial Results and Cash Flow Comparisons from the year ended December 31, 2018 to December 31, 2019 may be found in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of Part II of our Annual Report on Form 10-K for the year ended December 31, 2019.
MarketAxess operates leading electronic trading platforms delivering expanded liquidity opportunities, improved execution quality and significant cost savings across global fixed-income markets. Over 1,800 institutional investor and broker-dealer firms are active users of our patented trading technology, accessing global liquidity on our platforms in U.S. investment-grade bonds, U.S. high-yield bonds, U.S. Treasuries, emerging market debt, Eurobonds and other fixed income securities. Through our Open Trading(TM) protocols, we execute bond trades between and among institutional investor and broker-dealer clients in the leading all-to-all anonymous trading environment for corporate bonds. We also offer a number of trading-related products and services, including: Composite+ TM pricing and other market data products to assist clients with trading decisions; auto-execution and other execution services for clients requiring specialized workflow solutions; connectivity solutions that facilitate straight-through processing; and technology services to optimize trading environments. In addition, we provide a range of pre- and post-trade services, including trade matching, trade publication, regulatory transaction reporting and market and reference data across a range of fixed-income and other products.
Our platforms' innovative technology solutions are designed to increase the number of potential trading counterparties and create a menu of solutions to address different trade sizes and bond liquidity characteristics. Our traditional request-for-quote ("RFQ") model allows our institutional investor clients to simultaneously request competing, executable bids or offers from our broker-dealer clients and execute trades with the broker-dealer of their choice from among those that choose to respond. Our Open Trading protocols complement our RFQ model by increasing the number of potential counterparties and improving liquidity by allowing all participants to interact anonymously in an all-to-all trading environment. Clients can use our auto-execution technology with both our traditional RFQ and Open Trading protocols, thereby using rules-based execution to connect to diverse sources of liquidity while reducing trading inefficiencies and human errors. Leveraging the benefits of our Open Trading marketplace, we launched Live Markets, an order book that will create a single view of two-way, actionable prices for the most active bonds, including newly issued debt, benchmark issues and news-driven securities. We expect that Open Trading participants will improve their trading capacity through the Live Markets order book, by more efficiently trading liquid names in larger size and accessing integrated real-time market data, such as Composite+.
We derive revenue from commissions for trades executed on our platform, information services, post-trade services and other revenues. Our expenses consist of employee compensation and benefits, depreciation and amortization, technology and communication expenses, professional and consulting fees, occupancy, marketing and advertising, clearing costs and other general and administrative expenses.
Our objective is to provide the leading global electronic trading platforms for fixed-income securities, connecting broker-dealers and institutional investors more easily and efficiently, while offering a broad array of trading information and technology services to market participants across the trading cycle. The key elements of our strategy are:
to use our broad network of over 1,800 active institutional investor and broker-dealer participants to drive more clients to our platforms;
to increase the secondary market liquidity on our trading platform by deploying innovative technology solutions, such as our Open Trading protocols, to increase the number of potential trading counterparties on our platforms and to address different trade sizes, bond liquidity characteristics and trading preferences;
to continue to develop innovative next-generation technologies that will allow our clients to further automate and improve the performance of their trading desks through increased liquidity, enhanced trading efficiencies and the ability to identify trends within the bond market;
to expand and strengthen our existing service, data and analytical offerings throughout the trading cycle so that we are more fully integrated into the workflow of our broker-dealer and institutional investor clients; and
to increase and supplement our internal growth by entering into strategic alliances, or acquiring businesses or technologies that will enable us to enter new markets, provide new products or services, or otherwise enhance the value of our platform to our clients. We acquired Regulatory Services GmbH, the pan-European regulatory reporting business of Deutsche B�rse Group in the fourth quarter of 2020.
Critical Factors Affecting Our Industry and Our Company
Economic, Political and Market Factors
The global fixed-income securities industry is risky and volatile and is directly affected by a number of economic, political and market factors that may result in declining trading volume. These factors could have a material adverse effect on our business, financial condition and results of operations. These factors include, among others, credit market conditions, the current interest rate environment, including the volatility of interest rates and investors' forecasts of future interest rates, economic and political conditions in the United States, Europe and elsewhere, and the consolidation or contraction of our broker-dealer and institutional investor clients.
During the first half of 2020, the global economy experienced a period of significant turmoil due to the outbreak of COVID-19 (the "Pandemic"). The Pandemic triggered a steep drop in economic activity that had an immediate and substantial impact on global credit markets. Credit yield spreads in U.S. corporate bonds, as measured by the Credit Suisse Liquid U.S. Corporate Index ("LUCI Index"), increased from 1.1% over U.S Treasuries in December 2019 to 1.5% in March 2020 and credit spread volatility in U.S. corporate bonds, as measured by the LUCI Index, increased from 1.1% in December 2019 to 11.6% in March 2020. Drastic measures taken by central banks and governments helped restore confidence in the credit markets in the second half of 2020, which led to a tightening in credit spreads that helped stimulate record new issuance in U.S. investment-grade and high-yield corporate bonds. During the second half of 2020, the credit markets continued to improve as credit yield spreads and credit spread volatility tightened to pre-Pandemic levels. The volatile market conditions in 2020 led to an active credit trading environment as the average daily trading volume of U.S. high-grade and high-yield corporate bonds for the year ended December 31, 2020, as measured by Trade Reporting and Compliance Engine ("TRACE"), increased by 13.7% and 19.7%, respectively, compared to the year ended December 31, 2019.
As a result of the Pandemic, we have experienced significant changes in our daily operations. In mid-March 2020, we successfully implemented a global work from home mandate for all our employees and we were able to continue to provide our trading platforms and other services to our clients without interruption. In particular, we believe that Open Trading liquidity has been increasingly essential to the functioning of credit markets during the Pandemic, and MarketAxess has played a valuable role keeping our clients connected to the market as traders moved from their centralized trading floors to home offices. During the first several months of the Pandemic, we helped over 10,000 individual users connect to our trading platforms from their homes. Although we have reprioritized certain technology projects due to the changing needs of our clients in the current market environment, we have largely continued with our hiring plans, capital expenditures and the expansion of our trading platforms and services into new jurisdictions.
The global spread of the Pandemic is complex and rapidly-evolving, with authorities around the world implementing numerous measures to try to contain the coronavirus, such as travel bans and restrictions, social distancing, quarantines, stay at home orders, business limitations and, beginning in the fourth quarter of 2020, vaccinations. While we remain confident that we can continue to maintain business continuity, serve our clients and provide efficient execution in a virtual environment as necessary, we have re-opened our offices and have allowed our employees to return to work, on a voluntary basis, where local regulations permit. The re-opening of offices has created additional risks and operational challenges relating to maintaining the health and safety of our employees. We also anticipate that the full re-opening of our offices may require investments in the design, implementation and enforcement of new workplace safety protocols. These efforts may divert management attention, and the protocols may create logistical challenges for our employees which could adversely impact employee productivity and morale.
We believe that we have sufficient liquidity and flexibility to operate during any future disruptions caused by the Pandemic. While we have experienced increased market volumes and market share since the outbreak, we are cautious of the damaging impact the Pandemic may have on the global economy in the longer-term and the adverse impact that a global recession could have on liquidity and market volumes in the global credit markets.
We expect that current cash and investment balances, in combination with cash flows that are generated from operations and the ability to borrow under our Credit Agreement (as defined below), will be sufficient to meet our liquidity needs and planned capital expenditure requirements for at least the next twelve months. We have not altered our capital management programs and we have increased our dividend for the 12th consecutive year. We ended the quarter with a strong balance sheet, no borrowings under our Credit Agreement and with capital significantly in excess of our regulatory requirements.
In response to the current economic conditions, the Federal Reserve Bank of New York (the "FRBNY") established a Secondary Market Corporate Credit Facility (the "Facility") that lent money, on a recourse basis, to a special purpose vehicle ("SPV") that
purchased corporate debt issued by eligible issuers in the secondary market. The SPV purchased eligible individual corporate bonds in the secondary market, as well as eligible corporate bond portfolios in the form of exchange-traded funds ("ETFs"). In September 2020, we were designated by the FRBNY as an Eligible Seller for the Facility, which allowed us to provide end investors and broker-dealers the opportunity to use Open Trading to respond directly and anonymously to the FRBNY's requests to purchase bonds.
The global fixed-income securities industry generally, and the electronic financial services markets in which we engage in particular, are highly competitive, and we expect competition to intensify in the future. Sources of competition for us will continue to include, among others, bond trading conducted directly between broker-dealers and their institutional investor clients over the telephone or electronically and other multi-dealer or all-to-all trading platforms. Competitors, including companies in which some of our broker-dealer clients have invested, have developed or acquired electronic trading platforms or have announced their intention to explore the development of electronic platforms or information networks that may compete with us.
In general, we compete on the basis of a number of key factors, including, among others, the liquidity provided on our platform, the magnitude and frequency of price improvement enabled by our platform, total transaction costs and the quality and speed of execution. We believe that our ability to grow volumes and revenues will largely depend on our performance with respect to these factors.
Our competitive position is also enhanced by the familiarity and integration of our broker-dealer and institutional investor clients with our electronic trading platform and other systems. We have focused on the unique aspects of the credit markets we serve in the development of our platform, working closely with our clients to provide a system that is suited to their needs.
Our business is subject to extensive regulations in the United States and internationally, which may expose us to significant regulatory risk and cause additional legal costs to ensure compliance. The existing legal framework that governs the financial markets is periodically reviewed and amended, resulting in the enactment and enforcement of new laws and regulations that apply to our business. For example, the new administration elected in the 2020 U.S. presidential election may enact regulatory changes that may affect our business. In 2017, the SEC established a Fixed Income Market Structure Advisory Committee in order to provide the SEC with diverse perspectives on the structure and operations of the U.S. fixed-income markets, as well as advice and recommendations on matters related to fixed-income market structure. The impact of any reform efforts on us and our operations remains uncertain.
In addition, the U.K. ceased to be a member of the E.U. on January 31, 2020, triggering a transition period in which the U.K. continued to observe applicable E.U. regulations through December 31, 2020 (commonly referred to as "Brexit"). In preparation for Brexit, we obtained authorizations from the Netherlands Authority for the Financial Markets for our subsidiaries in the Netherlands in 2019. Following Brexit, we now provide regulated services to our clients within the E.U. in reliance on the cross-border services passport held by our Dutch subsidiaries. Brexit has led to legal uncertainty and potentially divergent national laws and regulations as the U.K. determines which E.U. laws to replace or replicate, which may impact our ability to comply with the extensive government regulation to which we are subject. In addition, the cost and complexity of operating across increasingly divergent regulatory regimes is likely to increase following Brexit.
Compliance with regulations may require us to dedicate additional financial and operational resources, which may adversely affect our profitability. However, we believe new regulations may also increase demand for our platforms and we believe we are well positioned to benefit from those regulatory changes that cause market participants to seek electronic platforms that meet the various regulatory requirements and help them comply with their regulatory obligations.
On August 10, 2020, MarketAxess Corporation, our broker-dealer subsidiary, converted to self-clearing for the U.S bond trades to which MarketAxess Corporation is a counterparty via its Open Trading functionality. Previously, these bond transactions were settled through a third-party clearing broker. As a result of this conversion, MarketAxess Corporation is required to segregate funds in a special reserve bank account for the benefit of customers pursuant to Rule 15c3-3 of the Securities Exchange Act of 1934.
We must continue to enhance and improve our electronic trading platform. The electronic financial services industry is characterized by increasingly complex systems and infrastructures and new business models. Our future success will depend on our ability to enhance our existing products and services, develop and/or license new products and technologies that address the increasingly sophisticated and varied needs of our existing and prospective broker-dealer and institutional investor clients and respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis. We plan to continue to focus on technology infrastructure initiatives and continually improve our platforms to further enhance our leading market position. We expect that our transition to agile software development processes will help us continue to be a market leader in developing the technology solutions for our clients' trading needs.
We experience cyber-attacks and attempted security breaches. Cybersecurity incidents could impact revenue and operating income and increase costs. We therefore continue to make investments, which may result in increased costs, to strengthen our cybersecurity measures. See also Item 1A. Risk Factors, "Technology, IT Systems and Cybersecurity Risks - Our actual or perceived failure to comply with privacy, data protection and information security laws, regulations, and obligations could harm our business."
Trends in Our Business
The majority of our revenue is derived from commissions for transactions executed on our platforms between and among our institutional investor and broker-dealer clients and monthly distribution fees. We believe that there are five key variables that impact the notional value of such transactions on our platforms and the amount of commissions and distribution fees earned by us:
the number of participants on our platforms and their willingness to originate transactions through the platforms;
the frequency and competitiveness of the price responses by participants on our platforms;
the number of markets that are available for our clients to trade on our platforms;
the overall level of activity in these markets; and
the level of commissions that we collect for trades executed through the platforms.
We believe that overall corporate bond market trading volume is affected by various factors including the absolute levels of interest rates, the direction of interest rate movements, the level of new issues of corporate bonds and the volatility of corporate bond spreads versus U.S. Treasury securities. Because a significant percentage of our revenue is tied directly to the volume of securities traded on our platforms, it is likely that a general decline in trading volumes, regardless of the cause of such decline, would reduce our revenues and have a significant negative impact on profitability.
Commissions are recognized on a trade date basis and generally calculated as a percentage of the notional dollar volume of bonds traded on our platforms and vary based on the type, size, yield and maturity of the bond traded and individual client incentives. Bonds that are more actively traded or that have shorter maturities are generally charged lower commissions, while bonds that are less actively traded or that have longer maturities generally command higher commissions.
For Open Trading trades that we execute between and among institutional investor and broker-dealer clients on a matched principal basis by serving as counterparty to both the buyer and the seller, we earn our commission through the difference in price between the two trades. For U.S. Treasury matched principal trades, commissions are invoiced and recorded on a monthly basis.
U.S. High-Grade Corporate Bond Commissions. Our U.S. high-grade corporate bond fee plans generally incorporate variable transaction fees and fixed distribution fees billed to our broker-dealer clients on a monthly basis. Certain dealers participate in fee programs that do not contain monthly distribution fees and instead incorporate additional per transaction execution fees and minimum monthly fee commitments. Under these fee plans, we electronically add the transaction fee to the spread quoted by the broker-dealer client. The U.S. high-grade transaction fee is generally designated in basis points in yield and, as a result, is subject to fluctuation depending on the duration of the bond traded. The average U.S. high-grade fees per million may vary in the future due to changes in yield, years-to-maturity and nominal size of bonds traded on our platforms. Distribution fees include any unused monthly fee commitments under our variable fee plans.
Other Credit Commissions. Other credit includes Eurobonds, emerging markets bonds, high-yield bonds, municipal bonds and leveraged loans. Commissions for other credit products generally vary based on the type of the instrument traded using standard fee schedules. Our high-yield fee plan structure is similar to our U.S. high-grade fee plans. Certain dealers participate in a high-yield fee plan that incorporates a variable transaction fee and fixed distribution fee, while other dealers participate in a plan that does not contain monthly distribution fees and instead incorporates additional per transaction execution fees and minimum monthly fee commitments. The average other credit fees per million may vary in the future due to changes in product mix or trading protocols.
Rates Commissions. Rates includes U.S. Treasury, U.S. agency, European government bonds and credit derivatives. Commissions for rates products generally vary based on the type of the instrument traded. U.S. Treasury fee plans are typically volume tiered and can vary based on the trading protocol. The average rates fee per million may vary in the future due to changes in product mix or trading protocols.
We anticipate that average fees per million may change in the future. Consequently, past trends in commissions are not necessarily indicative of future commissions.
We generate revenue from data licensed to our broker-dealer clients, institutional investor clients and data-only subscribers; professional and consulting services; technology software licenses; and maintenance and support services. These revenues are either for subscription-based services transferred over time, and may be net of volume-based discounts, or one-time services. Revenues for services transferred over time are recognized ratably over the contract period while revenues for services transferred at a point in time are recognized in the period the services are provided. Customers are generally billed monthly, quarterly, or annually; revenues billed in advance are deferred and recognized ratably over the contract period.
We generate revenue from regulatory transaction reporting, trade publication and trade matching services. Customers are generally billed monthly in arrears and revenue is recognized in the period that the transactions are processed. Revenues billed in advance are deferred and recognized ratably over the contract period. We also generate one-time implementation fees for onboarding clients which are invoiced and recognized in the period the implementation is complete.
Other revenue includes revenue generated from telecommunications line charges to broker-dealer clients.
In the normal course of business, we incur the following expenses:
Employee Compensation and Benefits. Employee compensation and benefits is our most significant expense and includes employee salaries, stock-based compensation costs, other incentive compensation, employee benefits and payroll taxes.
Depreciation and Amortization. We depreciate our computer hardware and related software, office hardware and furniture and fixtures and amortize our capitalized software development costs on a straight-line basis over three to seven years. We amortize leasehold improvements on a straight-line basis over the lesser of the life of the improvement or the remaining term of the lease. Intangible assets with definite lives, including purchased technologies, customer relationships and other intangible assets, are amortized over their estimated useful lives, which range from one to 15 years, using either a straight-line or accelerated amortization method based on the pattern of economic benefit that we expect to realize from such assets. Intangible assets are assessed for impairment when events or circumstances indicate a possible impairment.
Technology and Communications. Technology and communications expense consists primarily of costs relating to maintenance on software and hardware, our internal network connections, data center hosting costs, data feeds provided by outside vendors or service providers and US treasuries licensing fees. The majority of our broker-dealer clients have dedicated high-speed communication lines to our network in order to provide fast data transfer. We charge our broker-dealer clients a monthly fee for these connections, which is recovered against the relevant expenses we incur.
Professional and Consulting Fees. Professional and consulting fees consist primarily of accounting fees, legal fees and fees paid to information technology and other consultants for services provided for the maintenance of our trading platforms, information and post-trade services products and other services.
Occupancy. Occupancy costs consist primarily of office and equipment rent, utilities and commercial rent tax.
Marketing and Advertising. Marketing and advertising expense consists primarily of print and other advertising expenses we incur to promote our products and services. This expense also includes costs associated with attending or exhibiting at industry-sponsored seminars, conferences and conventions, and travel and entertainment expenses incurred by our sales force to promote our trading platforms, information services and post-trade services.
Clearing Costs. Clearing costs consist of fees that we are charged by third-party clearing brokers and depositories for the clearing and settlement of matched principal trades, regulatory reporting fees and variable transaction fees assessed by the provider of our third-party middle office system.
General and Administrative. General and administrative expense consists primarily of general travel and entertainment, board of directors' expenses, charitable contributions, provision for doubtful accounts and various state franchise and U.K. value-added taxes.
Expenses may grow in the future, notably in employee compensation and benefits, . . .
Feb 19, 2021
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