Cboe Global Markets, Inc. (CBOE) Q2 2017 Earnings Report, Transcript and Summary

Good morning, and welcome to the CBOE 2017 Second Quarter 2017 Financial Results Conference Call. [Operator Instructions]. Please note this event is being recorded. I'd now would like to turn over the conference to Debbie Koopman. Ms. Koopman, please go ahead.

Thank you. Good morning, and thank you for joining us for our second quarter conference call. On the call today, Ed Tilly, our Chairman and CEO, will discuss the quarter and our strategic initiatives for 2017. Then Alan Dean, our Executive Vice President and CFO, will detail our second quarter financial results and provide updated guidance on certain financial metrics for 2017, and Brian Schell, our Deputy CFO, will provide an update on the capital management front. Following their comments, we will open the call to Q&A. Also joining us for Q&A will be our President and COO, Chris Concannon; and our Chief Strategy Officer, John Deters. In addition, I'd like to point out that this presentation will include the use of several slides. We'll be showing the slide and providing commentary on each. A downloadable copy of the slide presentation is available on the Investor Relations portion of our website. During our remarks, we will make some forward-looking statements, which represent our current judgment on what the future may hold and while we believe these judgments are reasonable, these forward-looking statements are not guarantees of future performance and involve certain assumptions, risks and uncertainties. Actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. Please refer to our filings with the SEC for a full discussion of the factors that may affect our forward-looking statements. We will undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise after this conference call. During the course of the call this morning, we will be referencing non-GAAP measures as defined and reconciled in our earnings materials. We will also refer to non-GAAP adjusted combined results, which are also reconciled in our earnings materials. As you know, we completed our acquisition of Bats Global Markets on February 28, 2017. The combined results present information regarding the combined operations, as if the Bats acquisition had closed at the beginning of 2016, in order to provide a supplemental discussion of our results. Now I'd like to turn the call over to Ed Tilly.

Thank you, Debbie. Good morning and thank you for joining us today. Before I begin today, I would like to acknowledge the passing of our friend and colleague, Magnus Böcker. Several of us at CBOE had the pleasure to come to know Magnus while laying the groundwork for an educational partnership with SGX. We are personally saddened and, on behalf of CBOE, I wish to extend our condolences to his family, to our friends at SGX, and others throughout the industry who mourn his loss. Moving on now to our quarterly results; I am pleased to report on a strong quarter 2017 at CBOE Holdings, with adjusted earnings per share of $0.87, a net revenue of $267 million, led by continued growth in our proprietary index products. Our overall options volume during the second quarter was up 15% over the previous year, and our proprietary products continue to outperform the industry. We established an all-time record quarter in VIX trading, which increased 19% over the second quarter last year. Our index options volume increased 9%, reflecting the third highest quarter for VIX options trading and continued growth in SPX options volume. We continue to see strong trading in our proprietary products in July, led by VIX options, which had their busiest month this year. We have grown accustomed to increased VIX trading amidst spikes and volatility. We were obviously seeing that low volatility environments create trading opportunities as well. While VIX-linked ETPs remain key to the VIX ecosystem, we believe the most recent increases in volume can be attributed to a growing group of users trading VIX futures directly, rather than using VIX ETPs. We are also seeing VIX options trade in greater size and users continuing to find utility trading VIX futures and options, regardless of the VIX index level. In other business lines, global FX volume was up 8% in the second quarter, and our market share stood at 12.9% at the end of June, compared to 11.5% a year ago. We saw second quarter market share in both U.S. and European equities decrease against the prior year's second quarter, due to this year's continued low volatility. Our Bats ETF marketplace however, continues to thrive and grow. Our growing market share in ETF listings demonstrates our ability to offer meaningful benefits for issuing firms and deep liquidity to market participants. We are now home to over 221 ETFs, 89 of which were added this year. Of those, 30 are BlackRock iShares funds, which transferred from a competing marketplace earlier this week. Year-to-date, we have won 39% of all new ETF listings, our highest-ever percentage, including some of the largest ETF launches this year. Five of this year's top 10 new ETFs in terms of assets under management are listed on Bats. We also listed -- we also listed our first exchange-traded notes this past quarter. With the addition of new funds from some of the industry's most influential firms, including Franklin Templeton, Janus, UBS and Principal, and new opportunities to leverage our global presence and CBOE brand, we expect our listings business to gain even more momentum. We took an exciting step toward further expanding our growing product line this week by entering into an agreement with Gemini Trust Company that provides CBOE with a multiyear exclusive global license to use Gemini's market data, including Gemini bitcoin auction values, to create bitcoin derivatives products. We are working closely with the CFTC and, subject to regulatory review, we intend to offer trading and cash-settled bitcoin futures on CFE in the fourth quarter of 2017 or early 2018. CBOE will also retain exclusive rights to use Gemini market data for the creation of new indexes, as well as the rights to distribute Gemini market data over CBOE's market data feed. As you know, Gemini previously selected Bats Global Markets to list their proposed bitcoin exchange traded fund. We cannot be more pleased to build on that partnership by leveraging CBOE's experience in product innovation and cutting-edge asset classes to develop and trade bitcoin futures. The collaboration with Gemini is an example of the strong potential for innovation we see in marrying ETP issuer relationships, ideas and capabilities with CBOE's deep product development expertise. We look forward to responding to the growing interest in crypto currencies through potential bitcoin futures traded on the regulated derivatives exchange, with the many expected benefits this brings, including transparency, price discovery, liquidity and centralized clearing. Moving on now to our integration with Bats. As mentioned in our last call, the combination of the two companies provides the opportunity to cross-sell additional products and services to an expanded customer base. We continue to focus on our core index business and target the OTC space with quality listed products, while extending our global reach to promote an expanded product line. I'm pleased to announce we will be opening a satellite Hong Kong APAC office in the third quarter while continuing to leverage our presence in London and Singapore. Our coordinated efforts across multiple locations in the U.S. and abroad enable our equities, derivatives and FX sales teams to interact more frequently and efficiency, with a greater expanded base of buy-side and sell-side clients. Our extended reach enables us to build closer, more collaborative relationships with local brokerage firms and indexers and accelerates our ability to cross-promote our products to a much broader audience. We are preparing for our sixth Annual CBOE Risk Management Conference Europe which, runs from September 11 through 13. This will be our first RMC Europe held near London and the first to feature team members who now represent new lines of CBOE business, including FX products and European equities. RMC typically attracts sophisticated traders who are early adopters of our new products. We very much look forward to sharing our expanded offering with many of our most influential customers. As you know, the migration of our trading technology onto Bats' proven platform underpins the scale and efficiency we expect to gain from the CBOE-Bats combination. We remain laser-focused on working with customers to help ensure a seamless technical and operational integration. Last quarter, we held the second in a series of customer conference calls on the migration of CBOE's exchanges onto the Bats technology platform. On that call, we announced that we expect to complete the C2 options exchange on May 14, 2018, which follows the previously announced migration of CBOE's futures exchange to the Bats platform planned for February 25, 2018. We expect to announce the date for CBOE's migration in the coming quarters as we continue to work on requirements for the hybrid floor and electronic system. We are also implementing a new index technology platform that will serve as the foundation for our growing index business and enables us to better calculate and disseminate data for new and existing indices. Completion of the new index platform is expected in the first half of 2018, and we will announce a full rollout schedule in upcoming technology integration customer calls. Turning to our European equities business and the progress we've made toward addressing the challenges and opportunities inherent in MiFID II. Bats Europe is nearing completion of its technical and operational readiness, having successfully implemented a strategic plan that allows ample time for customers to test our systems and prepare for MiFID II. Last month, we successfully completed our third and most significant software release of the year, which included all of the real-time exchange functionality needed for MiFID II compliance. Our final software release is scheduled for October. Importantly, we also see MiFID II as an opportunity to provide value-added products and services to help customers navigate the changing regulatory environment. These include our Large In Scale, periodic auctions and expanded buy-side trade reporting services. The new volume caps coming under MiFID II will limit trading in dark venues, causing investors to seek new places to trade with minimal market impact. Our Large In Scale and periodic auctions offerings are designed to enable investors to find liquidity and trace large quantities of stock without the associated market impact. We continue to see rapid uptake in trading on our Large In Scale service, a block trading platform launched last December with BIDs, a block trading leader in the U.S. More than 86% buy-side customers are now connected, and we continue to see increased trading on the new platform. The trading experience on the periodic auctions offerings, lit book operating auctions throughout the day, allows market participants to trade in increased size without significant reactive market movements. We believe we will see strong traction in our periodic auctions offering as we near MiFID II commencement. Last quarter, we expanded our Europe trade reporting, BXTR, the largest equity trade reporting facility in Europe to enable buy-side firms to meet their trade reporting obligations under MiFID II by allowing their brokers to submit trade reports using their existing connectivity to Bats Europe. Turning now to our U.S. equities and our Bats market close proposal. We continue to receive questions on this initiative, so I'll take a moment here for an update. Bats market close is a near end-of-day match process for non-Bats listed securities that we created in response to customer demand. It would provide a means to secure primary market closing print prices without disrupting the primary market closing auctions that take place at the end of the U.S. equities trading day. On July 6, the SEC extended the Bats market close review period another 45 days, making August 20 its next action date. At that time, the SEC may either approve or institute a proceeding disapproval, which would give them another 180 days to act. We remain strongly committed to the customer benefits of this initiative, which are highlighted in our response letter to the SEC earlier this week, and we will continue to advocate for its approval. In closing, I would like to thank the CBOE team for a great second quarter, our first full quarter as a combined company with Bats. It is a credit to the talent and professionalism of the entire team that we continue to systematically hit our internal integration milestones while delivering strong results in our core business lines and positioning the company for future success through the consistent execution of our strategic growth initiatives. I am excited about the opportunity that lies ahead for this team to leverage our expanded product line and extended global reach to continue to grow CBOE and reward our shareholders for years to come. With that, I thank you for your time. I will now turn it over to Alan.

Thank you, Ed, and good morning. Before I begin, let me point out that our GAAP and our reported second quarter 2017 results include Bats for the entire quarter this year but not for the comparable 2016 period. Therefore, the year-over-year variances on the GAAP basis were largely due to the addition of Bats on March 1. To provide an additional review of our business, my remarks will focus on our non-GAAP adjusted combined results, which present financial results to reflect the Bats transaction as if it had occurred on January 1, 2016. On that basis, for the combined company, we saw strong results for the second quarter, primarily driven by the continued strength of our proprietary index products and growth in non-transaction revenue against the backdrop of subdued market volatility and essentially flat U.S. equities and options trading activity quarter-over-quarter. Summarizing our adjusted combined results, net revenue was $266.9 million, up 5% above last year's second quarter. Operating expenses were $101.3 million, down 5%, and the operating margin increased 410 basis points versus last year's second quarter to 62%. Diluted earnings per share of $0.87 was up 16% over the prior year period. Looking at our results further, starting with net revenue. Our revenue growth was primarily fueled by increases in transaction fees, market data fees and exchange services and other fees. Turning to the revenue contribution by business segment, you can see that we achieved higher revenue across each business segment, with futures contributing the largest increase. We also benefited from the diversity of our revenue streams, with growth in non-transaction revenue and U.S. equities offsetting the shortfall in net transaction fees in that business. I'll get into this in more detail when I review each business segment. In our options segment, adjusted combined net revenue of $126.7 million was up $2.1 million or 2% compared with the second quarter of 2016. The increase was primarily driven by higher revenue from net transaction fees, exchange services and other fees and market data fees, offset somewhat by an increase in royalty fees and a decrease in access fees. Net transaction fees for options were up $3.7 million in the second quarter, with higher revenue from index options, offset somewhat by a decline in multiply-listed options. Transaction fees from our higher RPC index options were $80.7 million, up $4.8 million or 6%. This increase reflects a 9% increase in average daily volume over last year's second quarter, led by average daily volume increases of 9% in SPX options and 15% in VIX options, offset somewhat by a 1% decrease in index RPC, primarily due to a mix shift. The increase in options market data fees was primarily due to gains in our share of U.S. options transactions this quarter as compared to last year's second quarter. Total market share for CBOE Holdings was 42.2% for the second quarter of 2017, up from 38.7% in the second quarter of 2016, reflecting market share gains across each of our options exchanges on a both year-over-year and quarter-over-quarter comparison. Moving to futures. Our fastest-growing and highest RPC business segment posted record trading volume and average daily volume in the second quarter. CFE traded an average of 307,000 contracts per day for the quarter, fueling net revenue of $36.2 million, a 20% increase compared with the same quarter one year ago. This increase resulted from higher net transaction fees, driven by 19% year-over-year increase in futures average daily volume and a 5% increase in RPC. Futures RPC for the quarter was $1.76, compared with a $1.68 in last year's second quarter, primarily reflecting the impact of fee changes implemented in January of this year. Looking at CBOE's organic growth from options and futures, excluding the Bats revenue contribution, you can see that we had strong organic growth of 5%, driven the strength of our proprietary products, particularly VIX futures and index options. On a combined basis, proprietary products accounted for 65.4% of net transaction fees in the second quarter of 2017, compared to 62.2% in the second quarter of 2016. Turning to U.S. equities. Net revenue was up 3%, primarily driven by increases in non-transaction revenue, offset somewhat by lower net transaction fees. Our results reflect a 5% decline in market volumes and a 1.2 percentage point decrease in market share, offset somewhat by a 5% increase in net capture. We witnessed a continuation of low volatility during the second quarter, wherein generally, overall equities volumes declined as a higher percentage of shares are traded off-exchange. However, strong non-transaction revenue more than offset the shortfall in net transaction fees, with solid growth in exchange services and other fees and market data fees. Conversely, market volumes for European equities were up 4% in the second quarter. In U.S. dollars European equities reported net revenue of $18.5 million, an increase of 3% versus last year's second quarter despite the weaker pound. In local currency, net revenue actually grew 16% to GBP 14.5 million in the second quarter of 2017 from GBP 12.5 million in the second quarter of 2016, reflecting growth in both net transaction fees and non-transaction revenue. The increase in net transaction fees resulted from the increase in overall market average daily notional value and a 7% increase in net revenue capture. For the second quarter of 2017, Bats retained its position as the largest European stock exchange, with 21.3% market share. Net revenues for Global FX rose 21% to $10.9 million in the second quarter of 2017. This increase was due to access fees implemented in the third quarter of 2016. In addition, market share increased from 11.5% in last year's second quarter to 12.9%, tying an all-time high also reached in the first quarter of this year. During the second quarter of 2017, nearly $28 billion of average daily notional value traded on the Hotspot FX platform, up 8% from nearly $26 billion in last year's second quarter. Turning to expenses, this next slide details total adjusted combined operating expenses of $101.3 million for the quarter, down $5.7 million or 5% compared with last year's second quarter. Looking at the expenses in detail, the favorable variances are mainly in professional fees and outside services and depreciation and amortization. The decrease in professional fees and outside services reflects the realization of synergies, which resulted in lower expenses for legal services, consulting fees, audit fees and other corporate overhead. The decrease in depreciation and amortization primarily resulted from the acceleration of certain systems depreciation and amortization in 2016. For the second quarter, we realized $7.1 million in pretax -- $7.1 million pretax in expense synergies, primarily seen in compensation of benefits and professional fees and outside services. We continue to make solid progress executing on our integration plans. And as we noted on our last call, the realization of synergies is ahead of plan, and we expect to end 2017 with $20 million in GAAP run rate synergies and to achieve the $50 million run rate in year 3. We look forward to updating you as we make further progress in the integration process. Turning to guidance. Looking at our expense guidance for the full year 2017, we now expect to be at the low end of our guidance range of $415 million to $423 million. Adjusted combined operating expenses in the third and fourth quarters are expected to increase somewhat compared to the second quarter, reflecting merit increases and higher cost for professional fees and outside services, driven in part by expected fees for the consolidated audit trail, CAT, to be incurred in the third and fourth quarters. Moving to income taxes, our effective tax rate on adjusted earnings for the second quarter was 36.2%, within our guidance range of 35% to 37% we provided on our last call. Looking ahead, as a result of the corporate income tax law changes enacted in Illinois in early July, we now expect our effective tax rate on adjusted combined earnings for the full year to be in a range of 35.5% to 37.5%, resulting in an effective tax rate in the third and fourth quarters closer to the high end of our range. This guidance excludes a onetime charge we expect to take in the third quarter to remeasure our deferred tax positions as well as other non-GAAP adjustments. The effective tax rate on GAAP earnings is expected to be in the range of 37% to 39% for the year. In addition, we are reaffirming our guidance for depreciation and amortization and capital expenditures for the year, which projects increased CapEx spending in the back half of the year. Now I'd like to turn it over to Brian to provide an update on our capital management.

Thanks, Alan. We continue to take a balanced approach to our capital management that we believe results in long-term shareholder value. As such, our capital allocation priorities have not changed. We plan to invest in the growth of our business, return capital through dividends and utilize excess cash to pay down our five year term loan as quickly as possible. Consistent with that philosophy, last week our board declared a dividend for the third quarter and raised the third quarter dividend by 8% to $0.27 per share from $0.25 per share. Our quarterly results once again generated strong cash flows, which enabled us to reduce our debt by an additional $75 million and still end the quarter with adjusted cash and investments of $149 million. During the quarter, we also completed an offering of $300 million of two year 1.95% senior notes. All of the net proceeds were used to pay down a portion of the five year term loan. This transaction resulted in a compression of our interest rate spread and, by converting a portion of our debt from floating rate to fixed rate, reduced our interest rate exposure to possible future interest rate hikes. Our debt-to-EBITDA ratio based on trailing 12 months adjusted combined EBITDA at quarter end was 2.1x, which is down from 2.4x at the end of the first quarter. And while we don't have a specific leverage ratio target we are currently managing to, we will look to reduce our debt to enhance our balance sheet flexibility. While we did not make any share repurchases in the second quarter, we may allocate capital to make opportunistic share repurchases in the future, depending on the circumstances. To summarize, during the second quarter, we built on the strong momentum we experienced in the first quarter and continued to demonstrate the strength of our proprietary index products, generating strong organic growth; diversifying and stabilizing our revenue streams with increased mix of non-transaction revenues; disciplined expense management; leveraging the scale of our business model, producing higher profitability margins; an integration plan on track with a strong cost synergy realization; and finally, ongoing focus on capital allocation by reducing debt and increasing our quarterly dividend. Overall, we are pleased with the progress we are making and are excited about the strength of our core business. We are committed to maintaining our focus on expense discipline and driving enhanced returns for our shareholders. With that, we thank you for your time this morning. We'll turn it back to Debbie for instructions on the Q&A portion of the call.

Thank you, Brian. At this point, we'd be happy to take questions. We ask that you please limit your questions to one per person to allow time to get to everyone. Please feel free to get back in the queue, and if time permits, we will take a second question. Operator?

[Operator Instructions]. And the first question comes from Rich Repetto with Sandler O'Neill.

Yeah, good morning. First, I'd thank you for the mention of Magnus, he was a true exchange guy. So anyway, my question would be to get to Alan on expenses. So a couple of things on the expenses. If you look at the low end, if you see what you did in the first half, it implies we can see back into what it implies to the second half. The 2Q run rate is already well below that. And I know you talked about some expenses incrementally coming on. But the question would be, with the synergies, why wouldn't the synergies offset these incremental expenses? And am I interpreting the synergies, like the $7.1 million in 2Q, if -- theoretically, if nothing changed, wouldn't you realize another $7.1 million in 3Q and $7.1 million in 4Q, or is that not the way you calculate it?

Yes Rich. That is the way we would calculate it, and if nothing changed, there would be another $7 million in Q3 and Q4. We did modify our expense guidance for 2017, guiding to the lower end of the range. And that does imply increased expenses for the third and fourth quarter, and that's the way we currently see it. I hope that we come in below that. But right now, what we think is achievable is that the lower end of that range, Rich. You can't count your chickens until they're hatched, and so we have work to do, and I think another part of your question was you implied that there might be further synergies happening later in the year, and yes, that's true, but the bulk of the synergies happened early on. Ed Tilly and Chris Concannon worked hard to give us a strong start out-of-the-box on the realization of synergies, and so when February 28 came around, we closed the transaction. Lot of things were ready to be implemented, and we did it. And the low hanging fruit, things like audit fees and board fees and insurance, those were realized relatively quickly as well. So to summarize, Rich, we do see the possibility that expenses will rise in the third and fourth quarter, and that's why we maintain that guidance range of $415 million to $423 million, but we're guiding towards the bottom end of that range.

Okay. You stuck to your conservative knitting, Alan. Thanks.

Thank you. And the next question comes from Michael Carrier with Bank of America Merrill Lynch.

Thanks guys. Maybe just a question on -- it seems like you guys have a lot going on across each of the different businesses, some of the new initiatives with bitcoin. Just wanted to try to gauge, like, over the next year or two, where are you seeing the best growth opportunities for the combined entity? I think, we all focus on the synergies and progress there, but more on the revenue side, where are you seeing the potential?

Michael, great question. It's one that we focus on, probably the first question our board asks us at every quarterly meeting. They too see the opportunities to execute on the revenue synergies that we laid out, gosh, almost a year ago. But really the opportunity we continue to focus on here, is growing the index complex, really leading with this incredible uptake in volatility trading, even in a low environment. So VIX futures and options, and then the growing appeal and the flexibility that our retail customers are seeing in a Monday, Wednesday, Friday SPX complex. So the opportunities are to take those core index products and use the broadened and expanded business development lines, that is really leveraging the U.S. team here and really looking to Mark Hemsley, who runs the European operation, getting his team up to speed on education. I think I mentioned last quarter, that we were sending our own options institute instructors over to Mark's team in order to really get them up to speed, inform -- a much, much more informed lead generation, so that we can grow this product not just domestically, but globally. So that remains the focus. This will continue to be an index story, I think, proved out in both high and historically -- incredibly historically low volatility. So that's the core. But you did bring up a good mention of our interesting release yesterday. I want to turn it over to Chris and maybe John Deters. Just a little bit of overview, while we're sticking to the core, we're still looking to the future to build new opportunities that we'll be able to tell you stories in the coming quarters. So John and Chris, if you could maybe kind of give an overview of the relationship with Gemini, and then, Chris, maybe how we see the opportunity to roll out products after the initial relationship begins.

Thanks Ed. Thanks, Michael. So this is John Deters. Just some quick perspective on the relationship with Gemini. It really represents coming together of two partners who are well positioned to serve the needs of the cryptocurrency market. And I think Ed just touched on it in the prepared remarks, but the partnership really came to life as a result of the CBOE-Bats combination. CBOE, on our end, we were exploring opportunities in the cryptocurrency space but looking for the right entry point. And the Gemini team really had built a good, solid infrastructure that we could leverage for derivatives products. So we're excited about the opportunity. I'd say that, while the cryptocurrency market is nascent, we really, together with our partner, have an opportunity to play a central role in the market. And Chris, if you want to say a word, too, about the cadence of new products and the opportunities set there, broadly?

Sure. Thanks, John. Real quick, we are excited about the relationship with Gemini. This is a relationship that goes back to a listing relationship with the Gemini ETF product that is currently before the SEC. And obviously, we're seeing more bitcoin and cryptocurrency products that want to come to the market. The largest issue with bitcoin and cryptocurrency is storage and effectiveness of storage and really, when you think about it, this futures product, which is still pending regulatory approval, has an opportunity to touch a broader set of investors and clients because it does solve the storage issue. Ultimately, it's a regulated futures market that is underpinned by a commodity that's been recognized by regulators around the planet. So we're excited about the relationship. We're excited about the opportunity to move further into the ETP space of cryptocurrency. We think this future does create opportunities in that space as well. And one thing I'll note, just following up on Ed's comments about revenue opportunity, and you've seen it in the numbers, our non-transaction revenue growth looks to continue. It's an area that we're very focused on in all of our asset classes, whether it's equities in Europe or FX across the globe. So we're excited about the opportunities around non-transaction revenue, given the footprint that this combined company has today.

All right. Thanks a lot.

Thank you. And the next question comes from Alex Kramm with UBS.

Yeah, hey good morning. Ed, I want to come back to the comments you make about the index business being still the area of most focus. Clearly, when you look at the VIX volumes in particular in the second quarter and so far this quarter, it's one of the few areas in exchange trading that you should be excited about given the volume trends. So I hear you in terms of people are finding ways to trade in low and high volatility environment. But I think there's also this view out there that some people have that everybody's betting on volatility to be low forever. And at some point, it's going to come to haunt us, and it's going to look ugly in the future. So when I think back to the beginning of 2015, the curve was inverted. Volumes were down. I mean, what's the risk that we go back to a pretty soft environment here and this is just a short-term sake as volatility is still low?

I think if we look at all of the opportunities and how people are employing this, I think you're right. I think in the last six to nine months, we've seen our users change the way that they view and are able to harvest premium, and our products are almost directly benefiting that change in opinion. And again, if I remind you what volatility our VIX contract is actually measuring, it's the market's perception of risk. And the spot VIX is a 30-day measure of that perception of risk. So the contract itself is just a direct reflection of where people view their risk over the next 30 days. And, of course, the term structure is look at their perception risk over time. And to your point, that has been flat in the past. That has been in contango and, on occasion, goes in to backwardation. Now the opportunities as soft [land], I'm not quite sure where you're going with that. Our existing customers are, in fact, finding the utility in a low volatility environment, employing different strategies. The fact that everyone piling into a short model strategy was probably more the norm in the first quarter. We see people now getting out of spreads that allow them to leverage those positions and taking outright positions, whether it's all-in short, as the trend has been. But we see now the interest in long ETP exposure in a more binary effect like -- I've given up on this short model, can't get lower. I'm flipping my -- use the analogy of my old floor days, I'm flipping my trading card over, and I'm taking an outright-long position on volatility. There are too many things uncertain in the world. You can pick up the paper, debt ceiling looming, North Korean missile tests in the future. And what that impact and my perception of risk over time is reflected, I think, in the activity we see going from all-in short, to now taking outright long positions. So not atypical to what we've seen in the past. There are changing perceptions of risk, and that's been reflected in our marketplace.

And Alex, it's Chris. I'll just add, it's not all about volatility. We're seeing a great growth in our SPX complex, as Ed mentioned. Part of that is driven by what we're seeing as broad adoption of option-based strategies in managed funds, in robo-advisors, in ETPs and among insurance and pension funds. So that broad adoption of strong option based strategies that are not related to volatility but are related to other basic strategies. As you can see, the SPX volumes are growing year-over-year and grew quarter-over-quarter. So I think we're in early innings in the broad adoption of option-based strategies.

Let me just punch the point, Alex, and what we've observed, and it was a big one for us, we saw a million contract VIX options trade, which is really taking a position, using the leverage of an options contract, taking in premium, I should add, that really takes a position mark that I don't think we're going to stay in this low volatility environment. And on a way back to a normalized volatility, all the way up to a 35 level, this is an incredible payout for someone who's completely taken a different position on vol and expected risk in the future. So we're seeing much bigger positions from existing and much more activity from new customers. So I'll leave you with those thoughts.

Great color. Thank you very much.

Thanks Alex.

Thank you. And the next question comes from Ken Worthington with JPMorgan.

Hi, good morning. Maybe a question for Chris. On CBOE's closing option proposal, can you talk about the support you're getting from different groups of investors and traders? And maybe give us some anecdotes that you find interesting, both from the supporting side and from -- maybe from some detractors. And given this is a pretty radical proposal, is the support you're getting sort of enough to improve the odds if this actually makes it through the SEC? Thanks.

Hold on. Debbie, can you get ready for the mute button? If Chris starts giving anecdotes, we've got to be careful.

Ken, I appreciate that question. Look, we have great support from the industry, SIFMA wrote a great letter. We're seeing additional support. I know some of the distractors were able to get form letters in from some issuers. But really, it comes down to what is the -- what is our legal right to have an offering that is largely already offered by the other exchanges. So we found it ironic that both New York Stock Exchange and NASDAQ were so unsupportive of our proposal, when they both offer competitive closing proctors on each other's closing listed stocks. So our biggest point is one of fairness. If they can compete, why can't we compete with them? And that's an important point for the SEC to consider. I'm not going to speculate on what the outcome is, because it is before the SEC and pending regulatory approval, but we feel pretty optimistic about the opportunity that we have with the SEC and our arguments that we just filed just the other day. So I feel good, don't have any anecdotal things I can share with you right now but happy to talk in the future.

Great. Thank you very much.

Thank you. And the next question comes from Ben Herbert with Citigroup.

Hi, good morning. Thanks for taking the question. I would like to get your perspective on MiFID II and progress there, but also specific to the systematic internalizer provision and what you think that might mean for exchange volumes.

Great question. First, we were able to put in place a fully MiFID II-compliant work on our platform in Europe, with a huge lift by the team in Europe, successfully implemented just a few weeks ago. There will probably be one more cleanup release before the end of the year, but that most recent release allows our clients to begin to be MiFID II-compliant way before the deadline in January of 2018. So it was an important release for us, and it was an important lift. And -- so we feel like we are way in advance of MiFID II, have our systems ready and up and running. With regard to the impact of MiFID II, it's still hard to predict. MiFID II is certainly not favorable for internalizers and dark pools. It's -- certainly the principle of MiFID II is to support the lit market and push more volume into the lit market. I think there's -- there are -- there is an opportunity for us to play a role with systematic internalizers that are permitted under MiFID II. We continue to explore different ways and means for us to support systematic internalizers. Today, we support them regularly. We allow systematic internalizers to quote into the public quote through our system. We also provide a trade reporting and clearing mechanism for systematic internalizers. So we think with the robust offering that we have today and the network of clients that we have connected to our platform in Europe that we have an opportunity under MiFID II, not only as a traditional exchange market but also as a supporting role to all market participants, post the effective day in January.

Great. Thanks for taking the question.

Thank you. And the next question comes from Kyle Voigt with KBW.

Hi. Good morning. I just want to get an update on leverage and capital deployment. You continue to delever nicely just above 2X on a gross debt-to-EBITDA basis, and you've made really solid progress on the synergies already after such a short period of time. Just given the fact that a couple of exchange assets are for sale right now, I'm just wondering, as we head in to the end of the year here, what are your thoughts on M&A at this point? And where would you potentially be comfortable flexing the leverage to if the right deal came to the table?

Brian, why don't you give a little background on the philosophy? And I can get into maybe the broader view on M&A and just how we've accomplished this over the last couple quarters.

Sure. Kyle, the -- as all capital management and capital allocation decisions, we review this pretty regularly with our board. Looking at our current situation, our cash flows, our expectations and our historical capital allocation choices. And again, with the ultimate goal of -- as most leadership teams should be, of delivering -- how do we deliver that best long-term shareholder value? And as we've previously stated, as we looked at the leverage and, specifically, our goal and our focus has been to delever, producing obviously lower interest cost. And more importantly is that balance sheet flexibility that put us -- this combination to come together and be as accretive as it has been to-date. Had there been a highly leveraged CBOE pre-acquisition, it may not have looked the same way. The execution may have gone in the same way, so that discipline and that focus enabled this to come together. So we are looking towards getting back to that without saying, we need to pay x leverage ratio to get back to. So again, it's the flexibility and the capacity that will get us there, and if there's an outcome of things positive that come along the way, whether it's lower cost ratings upgrade, that's not our goal. Again, the goal is to get to the best position.

Yes. This is Alan, Kyle. I'll add that the philosophy of our board, the objective of our board hasn't changed, don't hang on to shareholder cash. And we're going to find ways to get those monies back to shareholders, and we've demonstrated that in the past, and we will in the future as well.

So with that as the background, the way we view M&A and you've referenced some properties that perhaps could be out there. Wouldn't expect us or this board to have any targets that are very, very large scale acquisitions. But we're typical to the activity that we were employing pre-Bats. We're looking to grow this core business, period. And if that means we can build tools that make that easier for our customers to either find and interact with our proprietary complex, if there are tools that Bryan Harkins needs on the equity side or Mark Hemsley sees an opportunity in Europe, we will chase them down. We'll look either to build or buy. And if it makes more sense for us to go out and make smaller bolt-on acquisitions that further this strategy, we'll do it. But right now, we are deep in integration and migration of this platform to deliver what we set out to deliver to our shareholders last September. So again, think smaller bolt-on. If we think it's quicker to market for us and more effective, we'll build otherwise, but nothing planned large scale at the moment.

Thank you.

Thank you. And the next question comes from Chris Harris with Wells Fargo.

Great, thanks. On your success in ETF listings, I believe one of the benefits of that is the potential to drive a larger share of trading in those ETFs. And so just wondering if you guys are actually seeing that. And then as you continue to grow the ETF listings business, any opportunity for developing some corporate listings?

Sure, it's Chris Concannon. I'll take that. First, thanks for recognizing the exceptional growth we've had in ETF listings. Obviously, you saw the announcement of iShares moving 30 of their existing products to Bats, which is really just -- they are the leading ETF issuer in the States. And this is further validation of the product offering that we have for ETF listings. And it really is reflective of the power of this combination with CBOE, because the full offering that we were able to provide iShares, from educational products and distribution of content, that's something that only came about through the combination with CBOE. So we're excited about that decision and how it validates our offering. We're also excited about, we have now 221 ETFs listed on our market. We are largely focused on those continued listing of ETFs, that will remain our focus for the foreseeable future. To answer your question, on the trading side, with each listing and as they grow in AUM, and we did have some record AUM listings, new listings just this year, we are seeing increased trading volume of those ETFs that are primarily listed on Bats. So not only do you get increased market share from 9:30 to 4 when you are the primary market, but you also get the volume in the closing cross in the primary market. So we're seeing both evidence of growing share and larger closing crosses, as these products that we list continue to grow AUM.

Great. Thank you.

Thank you. And the next question comes from Alex Blostein with Goldman Sachs.

Great. Hey, good morning everybody. So question just around longer-term outlook for investing and expense for you guys. Clearly, there's a number of growth opportunities you're pursuing on kind of legacy CBOE or legacy Bats, and obviously on a combined basis. How, I guess, should we think about the investing back in the business in this environment? And so sort of think about the kind of the gross expenses over the next couple of years, understanding there are synergies that are going to come out that?

So, this is Alan, Alex. We are fortunate to be in an industry and a business that doesn't require huge CapEx commitments. It's largely IT, and we -- and the cost of IT equipment over the years has been coming down. So we will reinvest in our business as we need to, to ensure our future growth in the segments. And I -- we will do that. And as far as expenses goes, our goal line expenses is to see increases that mirror or parallel inflationary rates. So 3% to 5% is kind of where we want to be. Of course, that will be net of any future synergies that we still expect that we'll realize some expense reductions in the future. But that's our goal. And I will add that absolutely the biggest investment that CBOE ever made was just in February, the acquisition of Bats, and that turned out pretty good. So really staying the course, conservative on expenses, conservative on CapEx. The CapEx needs are minimal and to ensure future growth. So not much new there, Alex.

Thank you. And the next question comes from Brian Bedell with Deutsche Bank.

Hi, good morning. Chris, can you dig a little bit deeper on the MiFID II opportunity for market data as you see that, and sort of maybe just more broadly, to what extent do you think you can push market data for the combined firm as a percentage of overall revenue, it can be higher longer-term? And then just an update on the timing for the complex order rollout in the second half on options, U.S. options?

Sure, first on MiFID II. We do think there's an opportunity for continued growth in market data revenue in Europe. Some of that is driven by MiFID II. But largely, what we have in place today can help us grow market data revenue as well as non-transaction revenue. All the revenue that comes in associated with people connecting to our exchanges and connecting and reading our data. So we're excited about the opportunity. We do run, as Ed mentioned, the largest trade reporting service in all of Europe. That's very valuable information. And with MiFID II and SI quoting requirements, we expect to provide -- continue to provide a facility for systematic internalizers to quote through our platform out to the public. So we think there are opportunities for further market data revenue growth in Europe. Broadly speaking, non-transaction revenue is a great opportunity for this combined entity. We have so many platforms in so many markets across the planet. We're excited that each one of those has its own unique non-transaction revenue growth opportunity. And we will use a very carefully -- a very targeted growth areas. If we're a growing market like FX, we'll be very careful about non-transaction revenue. If we have a very large footprint in -- whether it's in equities or options, we're excited about the opportunity, both from data as well as access. So hopefully, that answers your question.

And then the -- Chris, the October EDGX Complex Order Book.

Sorry. Yes, so October 23, we announced this summer that we were rolling out the EDGX Complex Order Book. And as we call it, that's a down payment for the rollout of both our C2 options platform as well as C1. Because both of those markets are going to have a Complex Order Book. It will not be perfectly identical, but the code and the base of the complex order interaction will be very similar across those three markets. So it's a big step. While it doesn't read integration, because it's a new product, it's a big step in the integration process, one that we've -- we're seeing progress quite nicely given that we've announced the re-platforming of CFE in February and then followed by the re-platforming of C2 later in the year.

Any early view on pricing there, or to be determined?

It's really too early to tell. It is EDGX, so it's one of our smaller markets. So we want to gauge the demand. We want folks to use it, so we'll encourage that behavior, but we have other Complex Order Books that we want to be mindful of, as we enter the market with our new Complex Order Book.

Great. Thank you.

Thank you. And the next question comes from Patrick O'Shaughnessy with Raymond James.

Hey. So a question on your bitcoin futures platform that you're hoping to launch later this year. How do you go about attracting market makers to that product when, presumably, there aren't a ton of correlated assets?

Sure, it's Chris. I'll take that. Obviously, we've spent a lot of time talking to our market maker community. And this is a market maker community that crosses across not only equities and options, but foreign exchange. And bitcoin, in their view, is just another instrument in the foreign exchange market. Our market makers are, in fact, active in bitcoin, on the various bitcoin exchanges. So we've talked extensively with our participants on the opportunity in bitcoin and across cryptocurrency, not just bitcoin. So we -- I don't think we need to spend too much time attracting market makers. They're already connected to our platform, and they're already actively trading in the cryptocurrency market.

Patrick, I'll add one more point. It's an opportunity for us to just say briefly, a very important aspect of our design is that the Gemini bitcoin auction, which our products would settle to, is an actual traded price of transaction in bitcoin. So market makers have that assurance that there's convergence to a price of tradable bitcoin.

And I'll just point out that this is pending regulatory approval. So the date of launches is not determined yet. We are waiting on our regulators to be comfortable with our offering. But we were excited to announce the partnership with Gemini.

All right. Very helpful. Thank you.

Thank you. And the next question is a follow-up from Alex Kramm with UBS.

Yeah, hey thank you. Just a very quick one for Alan or Brian. You talked a lot about the moving pieces on debt. So can you just give us the expectation for interest expense for the remainder of the year, 3Q, 4Q and into next year, as you're, obviously, doing a lot of things here?

Yes, so I wouldn't -- I mean, as you model that out, I would just continue to look for -- as we've talked about kind of what are we -- and this goes back to the original kind of capital allocation question and our focus on delevering. So we would continue to, as far as reviewing these decisions with our board, continuing to model that out. We've talked about our prioritization with making sure the business has adequate capital as far as the -- everything we need to fund the business. But we will continue -- expectations are that we continue to focus on delevering. And we see that pace, whether that picks up or changes, again, depends on the opportunities in front of us. And so all along that mix. So we would continue to expect to see a declining interest rate. As far as the aggregate amount roll forward as we continue to delever.

And Alex, we should benefit from this $300 million note deal that we did at the end of June. There's a nice interest rate pickup there, nice savings that will flow to our shareholders. So that, combined with the deleveraging effort, you need to look at our 2Q interest expense and then factor in those couple of things, and then you'll get to the rest of the year.

No, fair enough. I guess I'll do the math myself. It's just you guide on so many different things, and this one you don't guide on, so I figured I'd ask.

Why did Alex get two questions, Debbie?

I will leave it at that. Thank you.

Two more follow-ups.

And we have a follow-up also from Alex Blostein with Goldman Sachs.

Sorry guys. Another Alex follow-up. So just a quick question around pricing. So with the VIX futures, obviously, you had an increase there in the first quarter, RPC holding up still quite nicely, even though volumes are up here. How should we think about pricing power at CFE over time? And I guess, more importantly, how does the evolving mix of clients that you guys alluded to earlier in the call add to the kind of RPC sustainability and potential improvement over time here?

Well, let me be specific [ph] that we heard you right, Alex. It was pricing on CFE?

Correct.

Yes. So I'm going to touch on SPX and CFE VIX futures and VIX options. We do have the greatest amount of pricing power in VIX futures. The notional size of that kind of [indiscernible] is large. It's -- there aren't economic equivalents that really match up well to that product, and so the combination notional value and the proprietary nature of the product gives us maximum flexibility on pricing. Now with that being said, we try to be really deliberate and thoughtful in what we do on pricing for that product. We don't want to turn off any new or turn off any existing customers. We'd rather have a new customer come and start trading VIX futures and then stay there and trade and trade and trade. I'd like to see revenue grow that way rather than have an existing customer leave or a new customer not come at us because of price, so we're really careful about what we do there. On SPX, there's more economic equivalence out there than on VIX futures. You have spiders, you have the futures at the Merc. You have options on the futures at the Merc. You have over-the-counter. So it's a little bit more complex. But the same strategy holds. So even though we have less pricing power there. Still, our emphasis is on driving revenue through increased customers. VIX options, that contract is one-tenth the size of VIX futures. And so of all of our proprietary products, that's the one we see the most pushback from customers from. And that's probably the product that we have the least amount of pricing power. And in fact, we've given customer accommodations that actually slightly lower our RPC in that product over time. And I would expect that the RPC in that product would -- the chances of that going up are the least of all of our proprietary products.

And then the second part of that question really in mix. So if you saw the increase in the first quarter this year in RPC and VIX futures over the previous that was the price adjustments we made in January. And then the difference between Q1 and Q2 in RPC, really is due to the active day trader discount. So you're right, as we see the day trader pick up their volume, we'll see a slight decrease in RPC, but we'll see that bounce quarter-to-quarter just depending on the mix. So right to your point, you're right. You did see that and quarter-over-quarter, it just is the blend between pure customer or day trader -- people taking advantage of the day trader discount.

Great. All right. Thanks guys.

Thank you. And as there are no more questions, I would like to return the call to management for any closing comments.

Thank you. Thank you for your interest in CBOE. I will be available. If anybody has any follow-up questions, feel free to contact me. Thank you.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.