Intercontinental Exchange Q3 2009 Earnings Call Transcript

Intercontinental Exchange, Inc. (NYSE:ICE)

Q3 2009 Earnings Call

November 3, 2009 8:30 AM ET

Executives

Kelly Loeffler - VP, IR and Corporate Communications

Jeffrey C. Sprecher - Chairman of the Board, Chief Executive Officer

Scott A. Hill - Chief Financial Officer, Senior Vice President

Analysts

Ken Worthington - JP Morgan

Richard Repetto - Sandler O'Neill

Roger Freeman - Barclays Capital

Daniel Harris - Goldman Sachs

Howard Chen - Credit Suisse

Chris Allen - Pali Capital

Mike Carrier - Deutsche Bank

Jonathan Casteleyn - Susquehanna

Presentation

Operator

Welcome to the Intercontinental Exchange third quarter 2009 earnings call. This call is being recorded. I would now like to turn the presentation over to your host for today's call, Miss Kelly Loeffler, Vice President of Investor Relations and Corporate Communications. Please proceed.

Kelly Loeffler

Good morning. To obtain a copy of the company’s third quarter earnings release and presentation please visit the investors’ section of our website at theice.com. These items will be archived and our call will be available for replay. Before we begin, please be aware that our comments may contain forward looking statements that represent our current judgment and are subject to various risk, assumptions, and uncertainties, as outlined in the company’s filings with the SEC; including our Form 10-K and Form 10-Q which we expect to file today. For a description of the risks that could cause our results to differ materially from those that are described in the forward looking statements, please refer to these filings.

Actual results may differ materially from those that are expressed or anticipated in any forward looking statement. We may discuss adjusted net income, adjusted earnings per share, and adjusted EBITDA on the call this morning. These are non-GAAP financial measures that exclude certain non-operating charges that we believe are not reflective of our normal operating performance. A reconciliation of these non-GAAP measures to the equivalent GAAP results and an explanation of why we deem these non-GAAP measures meaningful appear in our earnings press release and earnings presentation.

With us today are Jeff Sprecher, Chairman and CEO, Scott Hill, Chief Financial Officer, and Chuck Vice, President and Chief Operating Officer. At the conclusion of the prepared remarks we'll take your questions until 9:30 AM Eastern Time. I'll now turn the call over to Scott.

Scott A. Hill

Thanks, Kelly, and thank you all for joining us today. We are pleased to report strong third quarter results. We once again achieved record revenues in the third quarter reflecting broad demand for our market clearing houses and services, despite ongoing market challenges. These results show continued healthy trends in our core commodities business across futures and OTC markets and were achieved while continuing to invest in several key growth initiatives including the launch of our European CDS clearing business.

Throughout 2009 ICE has taken a leadership role in delivering on important reform initiatives that are reducing systemic risk and enhancing market. We've made a substantial commitment in terms of capital, time, and human resources, and we are confident that these investments will enable us to continue to outperform over the long term.

Beginning on slide four you'll find the summary of our third quarter results. During the quarter ICE achieved record consolidated revenues of $256 million, an increase of 27% over last year's third quarter. Consolidated operating income was up 17% over 3Q08 to $140 million and up 4% over this year's second quarter.

Operating margin once again improved sequentially to 55% in the third quarter. Importantly, operating margin for our non-CDS business was 65% during the quarter. Though our credit offerings remain an early stage investment, we are the global leader and have established a solid base for future growth without impacting profitability in the quarter or the year. We've continued our successful strategy of leveraging the profitability of our core business to invest in future growth while generating solid current period returns for our shareholders.

Before leaving that slide, I want to focus you on our adjusted EBITDA metric on the lower left-hand side of the chart. 3Q adjusted EBITDA was up 33% year to year to a record $154 million. For the first three quarters of 2009 this measure of financial performance is up 10% despite the global recession. We believe a good business produces strong results throughout market cycles and not just in periods of economic health or expansion.

We also believe that a good business does not need to rely upon one-time cost cutting to deliver strong financial results. Instead it must be able to deliver solid returns even as it funds investment and future growth by executing on integration and cost efficiency initiatives.

Let me provide a few examples. Since we acquired NYBOT in January 2007 we have more than doubled both operating margins and quarterly revenue. Since acquiring Creditex one year ago we've improved operating margins in a commission based business by nearly 20 points despite this off CDS market. And as noted previously, we've integrated acquired assets and leveraged existing resources to start an OTC derivative clearing house that is already self funding in the first six months of operation. Each of these examples reflects our strategy to build a global exchange business that is well positioned to outperform in any environment.

Moving next so slide five I’ll discuss our consolidated financial and volume results for the first three quarters of the year. As you can see, we are on track for a record year in many key financial metrics. Our customer products and geographic diversification are key competitive differentiators. OTC revenues represented 49% of our consolidated revenues during the third quarter, futures represented 40%, and market data contributed 10%. Further, over one-third of our revenues come from outside of the US, driven by the global relevance of our markets.

Turning to slide six I'll detail our consolidated revenues and expenses. Third quarter transaction revenues increased 34% to $229 million. This includes nearly $104 million from futures, $82 million from OTC energy, and $43 million from OTC credit. Market data revenues were stable year to year and quarter to quarter at $25 million.

On the expense side, consolidated operating expenses were $116 million compared to $82 million in 3Q08. The expense growth was driven by a $27 million year to year increase related to the addition of our OTC credit business and a $6 million increase in amortization relating to our Russell license.

Moving now to slide seven you'll find detail on our energy futures business. At ICE Futures Europe we achieved record transaction revenues of $66 million up 44% year to year with average daily volume, or ADV, of 676,000 contracts. The rate per contract, or RPC, for energy futures was $1.53, up from $1.22 in 3Q08. While RPC decreased slightly on a sequential basis, our average daily volume and our Brent and gas-oil futures revenues all reached record levels during the quarter. Open interest exchange wide has grown 33% this year reflecting the strong presence of commercial customers in our market and offering the solid base from which to grow in 2010.

As reported this morning, October numbers in our energy futures markets remain strong with ADV up nearly 12% over last October including European Brent ADV growth of 11%. The three month average RPC in October was $1.52.

Turning now to slide eight you'll see the third quarter performance of our agricultural and financial futures business. ADV was 386,000 contracts per day, up 33% year to year. Strength in our largest agricultural contract, sugar, along with the addition of the Russell contract underpins this growth. Despite continuing sluggish volumes and cash equities and index products, we saw record volumes and open interest in the Russell 1000 contract and continued to increase our Russell 2000 market share relative to the S&P 500 futures.

Agricultural RPC in the third quarter was $2.08 compared to $2.22 in 3Q08. As with our oil markets, while RPC for our age contracts was down, volumes were up materially, specially in our benchmark sugar contract, which drove solid revenue performance. This is an important point in that we managed to maximize profitability rather than a single discrete metric. RPC for equity indexes and foreign exchange for the quarter averaged $0.89.

This morning we reported that October ADV for Ice Futures US declined 15%. The first full month of Russell trading occurred in October of 2008 and our volumes reflect the aforementioned difficulties in the index market. However, while industry volume is not where we want it to be, nor where we expect it to be over the long term, we were pleased with our relative performance in share gain. The three-month average RPC in October was $2.05 for ags and $0.86 for financial contracts. We continue to see improving open interest trends across the agricultural commodity complex, and as we look to 2010, agricultural and financial products are poised to benefit from improving credit market, increased share, and a return to more traditional equity market activity.

Our OTC segment performance is detailed on slide nine. Total OTC transaction revenues rose 39% year to year. Third quarter average daily commission, or ADC, in our OTC energy markets were $1.25 million up 12% from 3Q08 and up 11% sequentially from our second highest quarterly ADC on record. Our natural gas prices have rebounded from the historic lows we witnessed in the second quarter. Storage levels remain high due to a weak US economy, mild temperatures, and an uneventful hurricane season. However, the combination of the winter (inaudible) storage season and mixed expectations for an economic recovery has resulted in increased price volatility in recent months.

The healthy OTC energy performance reflects our second consecutive quarter of revenue records in both OTC oil and power. It was also driven by the 150 new products that we've introduced for clearing since last November. These new products contributed $2.8 million in net revenue or roughly $0.02 of earnings per share in the third quarter and reflecting the markets’ move in advance of regulatory and political calls for clearing solutions, 96% of our 3Q contract volume was cleared.

Our OTC energy business continued to perform well in October with average daily commissions for the month of approximately $1.4 million, up from our third quarter average and up significantly from the prior year period.

Turning to our credit business, revenues totaled $43 million during the third quarter. This includes $30 million from Creditex which was down roughly 27% over the third quarter of 2008 on a pro forma business. In addition to the seasonally slow volumes typical of the third quarter, the credit markets remain subdued as the industry recovers and focuses its efforts on standardization and clearing.

However, while the traditional brokerage environment remains difficult, our electronic offerings continue to provide growth at attractive incremental margins. These electronic services include post-trade processing, execution, and risk management, and accounted for 43% of our third quarter Creditex revenue.

CDS clearing generated $13 million of revenue during the third quarter and as updated previously, we now expect full year revenues to be at or above $30 million. I'd like to emphasize that we expect this initiative to be profit accretive in 2009 despite heavy investment typical of any startup business. We've worked closely with industry participants and regulators to establish a global clearing solution backed by a sound risk management regime and a dedicated guaranteed fund.

During the third quarter we began backloading in Europe and continue to process those trades while adding the on-the-run index trade. In the US backloading is largely complete and like Europe we've added new clearing members. We continue to expect to launch our single-name and buy-side clearing operations this quarter.

Our forward visibility in the CDS clearing revenues remains limited. However, we've established ourselves as the global leader in the space and we are confident that this initiative will yield further revenue growth in 2010 even as costs decline as investment levels subside beginning in the fourth quarter. We will continue to provide updated guidance as our progress continues.

We are pleased with what we accomplished in the quarter and year to date. Our operational and financial performance continues to distinguish ICE from our peers. We've grown our top line, improved margins for three consecutive quarters, added cash to the balance sheet, reduced leverage, integrated and improved margins in our voice brokerage business, and built a global OTC derivative clearing business from the ground up.

We have a demonstrated track record of being consistently ahead of the curve which has allowed us to outperform in any business context and we believe we have positioned ourselves to continue to outperform in 2010.

I'll ask that you please refer to this morning's earnings press release for further details on our quarterly performance as well as updated guidance. We expect to file our 10-Q later today, and of course I'll be happy to address any questions during the Q&A. Jeff, over to you.

Jeffrey C. Sprecher

Thank you, Scott, and good morning, everyone. You've just heard about the strong performance of our business so I'd like to take a few minutes to provide some context for that performance as well as outline some of our larger opportunities.

There have now been several quarters that have followed since the global downturn in economic activity began. During that time many of our market participants have come under financial pressure and significant regulatory changes have been occurring in our business, yet ICE has continued to grow throughout this period.

Despite an extended global recession and the regulatory requirements added to our business over the past year, ICE's net income in the most recent quarter was 34% higher than when the crisis began in the fourth quarter of 2007 and open interest in many major contracts in our clearing houses are at all time highs.

ICE remains one of the strongest performing exchange businesses globally. It's against this backdrop that I’d like to cover four key topics this morning. These include the legislative and regulatory activity, ICE's profitable product innovation, and our move towards over the counter clearing, and the strength in our core commodity businesses. These are also detailed on slides 10 and 11 of the presentation.

So turning first to the legislative and regulatory landscape, there's been a decided policy shift towards increased transparency and contract standardization around the world. These important transitions have actually been taking place since ICE first established its electronic energy markets in year 2000, but obviously recent events have resulted in new and renewed focus by policy makers.

Transparency promotes increased liquidity and inspires confidence in markets and contract standardization allows markets to be exchange traded and cleared. While many over the counter markets remain largely voice brokered, ICE led the development of a liquid electronic market in over the counter energy. Today, even transactions that are executed via voice brokers typically end up on exchange as swaps dealers lay off the risk they manage on behalf of their customers.

As evidence of this is focused in the United States, two separate bills were advanced through the House Financial Services and Agricultural Committees in October. Each bill has a central tenant of insuring that qualifying transactions are executed and cleared on exchange using standardized contract. Regulation encompasses many aspects of an exchange's obligations to the markets, but position limits have been the most recent area of focus by many of our stakeholders.

ICE has advocated for CFTC established limits that take into consideration the overall size of the market should the commission deem it appropriate to use their authority in this way. In the meantime, ICE has already instituted position limit regimes in our two largest US link contracts; our WTI crude futures and our over the counter Henry Hub natural gas swap.

We expect the position limits may apply to additional over the counter contracts as the CFTC works through its obligations under the 2008 Farm Bill. However, for our key revenue producing products, such measures are already in effect. We believe that prudently set limits will lead to an increased confidence in properly functioning markets and will drive transaction growth as more hedging follows with that increased adoption of risk management practices.

Our customers have been anticipating position management changes and we believe most are already acting to stay ahead of this regulatory trend. In fact, you can see this shift in our third quarter operating results as more over the counter bilateral positions are migrating into ICE's clearing houses.

I'd like to point out the tremendous resiliency of the market in managing through this period of significant regulatory uncertainty. In addition to bringing transparency to the energy markets, we've seen great strides being made in transparency in the credit derivatives markets.

Credit derivatives markets are among the youngest major derivatives markets and were essentially spreadsheet based just less than two years ago, as these markets' credit products were not typically standardized and daily price transparency and clearing were not widely available. These issues were similar to those that we experienced in the over the counter energy markets when we began developing energy clearing for energy swaps. Today however, due to efforts by industry, regulators, and companies like ICE, we've established electronic CDS solutions that support back office connectivity, realtime confirmations, and enhanced price transparency.

Each of these has helped the credit market become more accessible and more accountable, and we're continuing to develop services to meet the expanding requirements of a restructuring market with strong potential.

I'd next like to highlight ICE's demonstrated ability to innovate to drive top and bottom line growth. We've put a premium on innovating to provide best in class service to our customers and producing profitable growth for our shareholders, rather than simply seeking to become a large exchange.

As entrepreneurs, we've taken calculated risks and we've made substantial investments in domain knowledge and assets to reach new markets rather than waiting for those markets to come to us. As a result, we're delivering on our promises to more deeply penetrate the over-the-counter markets to grow through the business cycles.

While it’s human nature to be averse to change, we look for opportunities that exist within change, including changes in regulation and demand for new products to serve emerging markets such as emissions and credit derivatives.

This leads me to the third area I'd like to talk about today which is our progress in clearing the over-the-counter markets. We've made a significant investment of resources, capital, and time, to demonstrate our commitment to clearing the OTC markets. Over the past year we've built a new European futures clearing house and we've acquired a second US clearing house, at the moment in time when markets are demanding more clearing alternatives.

With these assets we've launched a new OTC credit clearing business in March which is already cash accretive, something virtually unheard of in the first six months of a major startup business. As a result, ICE is introducing a new standard for risk management globally. In fact, last week our clearing operations in the US and Europe were recognized by Futures and Options Week for their innovation in solving market challenges.

And the numbers are backing up our success. Since March, ICE has cleared CDS swaps totalling $3.5 trillion in notional value as noted on slide 11. As of October 31, the cash in ICE Trust US Guaranteed Fund was $2 billion which we believe is the largest cash guarantee fund of any global clearing organization and it all supports just one single product: credit.

In addition to providing the only large dedicated default fund for CDS, we believe that we have the most stringent risk standards of any competing model and we're working with regulators to ensure that competing risk models are more consistent and adequate across all solutions.

During the quarter we expect to roll out additional phases within our derivatives clearing effort. We're operationally ready to begin buy side and single name clearing, however, the regulatory reviews have taken substantially longer than we expected. We have a robust and tested single name clearing framework and we continue to expect a roll out in November. As we announced last month, we're also expecting the launch of our segregated funds solutions shortly. Testing is under way with participants and we've made excellent progress in a very short amount of time. This important solution will allow the buy side to participate in clearing and we're eager to bring the systemically important service to market to meet the demands for clearing.

I'd like to close out my remarks by addressing our core global commodities business. When we meet with many of our shareholders we often spend more time on questions about clearing and global regulation, so I'd like to take advantage of the captive audience that I have here today to discuss the subject that often gets very little mention and that is how well our core business continues to perform.

Commodities market play a central role in the global economy and our markets are vital to a growing number of customers. In the soft ag commodities market, a significant number of commercial participates were credit constrained, but volumes are now recovering with sugar volume up 11% in October. On the energy side, historically high oil inventory are being offset by resurgence in Asian demand, reduction in refining capacity, and improving global economic indicators.

Given these conflicting signals and the volatility that they produce, our energy futures market continues to perform at or near record levels. ICE's European crude and refined oil futures have grown significantly over the past several years and this is largely due to the importance of Brent and gas oil contracts in Europe and in Asia. In fact, I'll note that our European energy products have already provided us with an important footprint in Asia that is unmatched by most other derivatives markets.

We continue to expand our over the counter energy market cleared products offerings and today ICE operates the largest cleared marketplace for over the counter energy swaps both in terms of volume and revenue.

Our new products, in addition to our existing over the counter products suite, continue to attract the attention of risk managers around the globe. In total we offer more than 230 cleared over the counter energy contracts, a figure doubled from this time last year, which is a result of our successful move into clearing.

Scott also mentioned the contribution from these new OTC energy contracts and you can see the growing volume on slide 11. This is notable because generating meaningful revenues tends to be very challenging for products in our sector.

I'll summarize my discussion of ICE's core business by reiterating our opening remarks this morning. ICE achieved record revenues coupled with the highest third quarter profit results in our history on the backing of strong commodity performance, and our continued outlook for growth remains strong. On slide 11 you can see the healthy open interest increases that we've experienced since last October. 38% open interest growth in our over the counter market, 20% open interest growth for Brent crude oil, 44% for gas oil, and open interest in our key soft ag markets up 21%. You can also see that our emerging utilities and emission markets are truly a source of opportunity with open interest up 130% year over year.

Because open interest trends tend to support trading volumes in the future, we have a high confidence level in the health of our market.

In closing, drivers that are having a positive impact on our business are numerous. There are things like the ongoing shift towards clearing and execution in more transparent markets innovation in financial services, the global reach of our model, and the increasing reliance on commodities and derivatives markets for risk management.

These are the transformative changes that are shaping ICE's results. The model that we pioneer in the over-the-counter markets over the past decade and our global footprint in the commodities markets positions us to meet the demand for global risk management around the world.

I'd like to congratulate the ICE team on today’s milestone. It's the one year anniversary of the launch of ICE Clear Europe. This successful clearing house has driven new revenue opportunities including serving as a platform for the launch of ICE's European clearing services. And on behalf of everyone at ICE, I want to thank our customers for their business during a quarter of greater uncertainty.

Operator, I'll now turn it back to you for our question-and-answer session.

Question-and-Answer Session

Operator

Thank you. (Operator's Instructions) We'll take our first question from Ken Worthington of JP Morgan.

Ken Worthington - JP Morgan

Hi, good morning. I'd love to dive a little bit deeper into the financials around the CDS business. You spent a lot of money building up the CDS business and now that it's off the ground I've love to know if you could update us on the targeted return you expect on the investment? And even if you give us something more generic like an IRR that you expect in deals, I'd take that. But I'd love to figure out what needs to happen for you to get there. Because I think what we don't understand is what's gravy and what is part of your expectations. So for example, is buy-side clearing gravy or is that part of what you need to make CDS really work for you from an investment standpoint? Thanks.

Jeffrey C. Sprecher

Thanks for the question, Ken. We look at the overall credit investments we've made the same way we look at any deal. We take a very disciplined approach. We look for returns that are in excess of our weighted average cost of capital which is around 11%-12% so we typically target deals that will yield at least the 12% return so you can think of that as kind of the hurdle rate. And again, we're looking at the investments we've made collectively across the Creditex acquisition and the ICE Trust and ICE Clear Europe build outs as the investment upon which we'll deliver that return.

I think you'd be hard pressed with any investment six months in to say that it's actually where you expected it to be, but I would tell you that we have established a global leadership position and the CDS clearing business. We've cleared over $3 trillion. We're up to 13 clearing members in the US, 12 clearing members in Europe. We've got the index clearing going in both places. We're in tests right now with the buy side solution in the single name and we're operationally ready on both of those.

So, I feel very good about the position we've established. The things that we need in order to make the return on the investment come to fruition are continued performance in index, continuing to add new clearing members, continuing to bring the buy side in through our customer segregation platform, we get single names launched, and then frankly as we made the investment I don’t think any of us envisioned the CDS market quite imploding the way it did the month that we did the Creditex deal. It's not something we haven't seen before, it's the same thing that happened in the energy business, and so our expectation is what will really drive the return on this investment which is the CDS market recovery and people going back to viewing that product as a key place where they can hedge their credit risk and frankly treat the CDS almost as if they do equity today.

So I think we've got all of the elements in place that we expected to have in place. I think we've very well positioned in terms of the leadership position we've established and I think we're well on our way to generating an above hurdle rate return on the investment.

Ken Worthington - JP Morgan

Okay. Thank you very much.

Operator

We'll take our next question from Richard Repetto of Sandler O'Neill.

Richard Repetto - Sandler O'Neill

Good morning. I guess my question is more broad in general. If you look, your results look good on a beat, but across the trading countries whether it is equities, whether it is interdealer brokers, agency, even Creditex — the trading companies have underperformed, to my knowledge every single one of them.

So, I guess the question is, is there some explanation in this economic turmoil to explain this, and then more specifically with you that just the only credit company you have is Creditex, and I see in the electronic portion that it went down a bit, is there a shift going on between exchanges and their customers.

Jeffrey C. Sprecher

Rich, let me just walk you back in time to the point of our IPO and when we first started talking to the public about our business. I think you'll recall that we have always made a conscious effort to try to figure out where there are emerging asset classes where we can provide services and position ourself in those, basically set our sales in that wind to ride the growth. And I think our exchange business has outperformed other exchanges because of decisions we made a long time ago that commodities were being globalized and that electronic trading was taking stream around the world and trading was moving to 24-hour real time risk management.

And so if you think about ICE in particular, we've really targeted and very selectively targeted markets that are growing because of the growth of right now, largely Asia and the BRIC countries. Our exposure to energy which is obviously global, but also soft ags which are really non-US products; things like sugar and cocoa and coffee are non-US products — these are all consumptive products by emerging nations.

We've moved into the credit business because it's, in our minds, the one asset class that is never electronified. The management of credit is the global banking industry. Obviously the global banking industry has been turned down, but we expect it to recover, like most, and that industry has never risk managed using anything other than telephones. And so we've seen how global the interconnected banks are now and we think that it's going to move off the telephone onto the screen and it's going to be clear. And so that's the positioning that we've made in that OTC market.

I think in terms of you looking at the entity of the brokers and other kinds of platforms, there's no question that in interest rates and in equities and in interdealer services, the velocity has slowed down and banks themselves, who have trading companies, have made a lot of money in this because they're doing a smaller number of trades with larger spreads and so those markets where you can capture the spread are doing well. That happens to be the bond market and some of the interest rate markets if you happen to be a dealer.

But as you know, the platform business that we're in really is based on velocity and the number of trades because that's how we charge our commission. We've avoided that because we haven’t really been levered to the industries that have turned down, other than credit, but we've made a conscious decision that that is the one business that is still analog in a digital world and I think you’ll see long term that taking a small piece of our effort and equity to get into the credit business will pay long-term results.

Richard Repetto - Sandler O'Neill

Okay. That's very helpful. And then my one followup would be more concrete which is they've talked; you know these headlines about the Saudis moving away from the WTI benchmark. Can I just get your thoughts, as I know you'll be a very neutral and unbiased bystander — you're actually not with your WTI bar, but what are your thoughts on their move, I guess, and the impact to ICE and to CME?

Jeffrey C. Sprecher

Sure. The Saudis have never used the exchange trade WTI futures as a benchmark. They actually lack the confidence in the WTI market that we trade. So they have not been relevant per say. I am sure major oil companies that the Saudis do business with may have used the WTI market as a hedge, but the Saudis themselves have not.

We talked a lot about, even on past earnings calls, how the WTI market is really structure ally flawed because there is no such oil anymore as West Texas Intermediate Crude that's particularly relevant, and Cushing, Oklahoma is not really the center of the oil industry any longer. And so really what the Saudis are doing is because Cushing is hooked via pipelines to the Gulf of Mexico, and really oil going into Cushing comes from Canada and from the Gulf via pipeline, they're simply moving geographically closer to the gulf to get rid of pipeline and storage constraints that exist at Cushing, and that's probably a positive move for the exchanges because they will start hedging with a contract that is traded in the world right now and that is the differential contract between — and it's a location differential between the gulf and Cushing, Oklahoma.

I think we've seen that even though ICE talks about WTI as being a flawed marker, it's still a highly traded contract because people do hedge and speculate around those storage problems at Cushing because the pipelines do go through there. But I think it's accretive, ultimately, to the business. I should mention we have the rights to that license at Argus that they're going to benchmarking too. We licensed that just recently in anticipation of this move. We have a relationship with the Saudis. We know and understand their concerns and we've built that product into our systems. We haven't announced its launch yet or exactly what we're going to do, but we will be a player in the market as well.

And so net-net I think frankly you could think of it as just a new contract that's going to provide a new differential to the market and that's probably a net positive for exchanges.

Richard Repetto - Sandler O'Neill

Okay, thank you. I'm assuming that Argus is not exclusive, but I have no more questions so I won't ask that (laughs).

Jeffrey C. Sprecher

Yeah, it is. They have a non exclusive license with us and with some of our competitors.

Richard Repetto - Sandler O'Neill

Got it. Thanks, guys.

Operator

We'll take our next question from Roger Freeman of Barclays Capital.

Roger Freeman - Barclays Capital

Hey, good morning. I wondered if you could, just on CDS, maybe Jeff, could you talk a little bit about what some of the challenges have been on the single name side with clients? Has it all been regulatory? Or, I think over the summer you were suggesting that there were some operational issues and it was just the different ways the dealer’s margin requires less margin than the clearing house does. Then sort of tied to that, as you look at what CME is now announcing from a customer perspective, it seems like they’re getting some traction because they take wider collateral than you do, i.e. more in treasuries than cash and maybe have more efficient margining? So maybe you could address both of those?

Jeffrey C. Sprecher

Sure. Well, there are a number of things that have gone on. First of all, this is a startup market and so it's changing behavior. What we are doing is building a clearing house that fits into the current work flow. In other words, any mechanism that you use to do a trade today will make its way into the clearing house. And we have integrated with the DTTC warehouse which is where all these trades ultimately go for accounting purposes and confirmation purposes, and we have integrated ISDA Master Agreement Process which is the agreements that govern credits of flawed swaps today.

So we have built a truly over the counter platform. What we have not done is to try to make these things look and smell and act like futures. In futures you don't necessarily connect to the DTTC warehouse. You don't use the ISDA Master Agreement; you use your clearing agreement. In futures in the United States, all members of a futures clearing house must be a US FCM. There are capital requirements there and we have worked on a global framework having a lot of non-US members in our clearing house. So there are two different models out there.

These will ultimately converge, I suspect. If you look at what's going on in the bills that are making their way through the House, and from our conversation about what the Senate is intending to do, it's very, very likely that ultimately credit will be overseen by the SEC and the CFTC in some regard with the Fed being involved in some systemic role. In other words, all the regulators are going to somehow be brought together for some common oversight, which we support. And so I think over time the various models will, by regulation, merge together, but we're starting from two different endpoints.

There's no question there are some buy side people who would like to trade this like futures and that would like to have a one-stop shop to do everything as futures. There are also a lot of people who want to keep this in the over-the-counter market, particularly because of the risk management and the way that prime brokerage works today. And all those eventually, I t think, will come together somehow, but as we're mentioning, at two different starting points.

The buy side that you are probably referring to that are most vocal, many of them like the futures model. I think ultimately what they're going to realize is that they’re going to get something like that through regulation probably in 2010 so I'm not sure that making a decision today really matters because it's all going to converge by the time this really gets rocking and rolling.

Scott A. Hill

And Roger, just to put a fine point on it, despite all the challenges that Jeff mentioned that we’ve overcome, from a single name standpoint we are operationally ready on every single one of those elements. So right now it is a discussion with the regulators just to get launched, similar on the buy side initiative we're in test right now and expect to be operationally ready in a matter of a couple of weeks. So we have developed a solution that works the way the industry trades today, the way they traded yesterday, and we're operationally ready on all aspects and areas.

Jeffrey C. Sprecher

And Roger, just to finalize you had asked about the regulatory interface. This is a very unique product, a single name CDS. It has a binary risk element to it where it can either expire worthless or completely in the money and it can go from zero to 100% overnight so it is very complicated to figure out how to margin that without requiring full margin. Regulators are obviously aware of the AIG problem where there was a lack of margin and want to make sure as we introduce the buy side that people are properly margined and that we truly are breaking systemic risk.

Similarly when we introduce the buy side and there's a sense that it will provide liquidity in the market because the markets are now somewhat stunted because we're in this interim period where the buy side knows it's going to move into clearing, but doesn't have everything in place yet — the regulators know once that’s in place the velocity of trading can increase and people like the SEC and others want to make sure that they have transparency into the way the buy side is acting so that we prevent any kind of trade that may ultimately result in a run on the bank by blowing up CDS spreads and pulling prime brokerage lines and the kind of things that happened around Lehman and Bear.

So you can imagine from our vantage point we're having to deal with various regulators about both trading and risk and they all want to get that right before we unleash the gate and it's just taking awhile because it involves a lot of regulatory jurisdiction. I think in our office today there are probably 14 regulators who are there full time from various agencies. We've been working with the OCC, the FDIC, the New York Banking Commission, the Fed, the SEC, and the CFTC, and the FSA, all of whom are working together on this so it's quite a global regulatory work that's going on right now.

Roger Freeman - Barclays Capital

Okay. That's very helpful and very thorough, thanks. I just have a very quick followup, what percent of dealer to dealer CDS new volume is being cleared today?

Jeffrey C. Sprecher

Well, the dealers had promised, I think the end of November, that 95% of all eligible trades, in other words the trades that we offer for clearing will be cleared and I was with a group of dealers on Friday and they are close to making good on that commitment so it is a very high percentage right now that's going in.

Roger Freeman - Barclays Capital

Got it. Okay, thanks.

Operator

We'll take our next question from Daniel Harris of Goldman Sachs.

Daniel Harris - Goldman Sachs

Hi. Good morning, everybody. I'd actually like to followup on that comment there, Jeff. So as you think about new trades coming into the CDS clearing house, if I look at the open interest in the US it really ramped up through the end of August to about $190 billion and it's been flat there. So I mean would you anticipate that as if we just focused on the index for as second, does that grow from here or is that about the right level, i.e. that's the majority of clearable transactions that are occurring today and historically?

And then as I think about single names, how does that fit into both the open interest and then to the guaranteed fund given what you're talking about with the differences in requirements for margin? It looks like it’s a little bit less than 1% given some of your data points earlier. Does that really grow much going forward?

Jeffrey C. Sprecher

Good questions. First of all, it's hard to get pure visibility into what's going on in the credit markets because it's under a lot of stress right now. It's not only the fact that credit is constrained, CDS will be very tied to new lending which obviously you need the banks unlocked and lending, which I expect will happen, but you do get the sense we're in a transition right now. And you have the buy side that right now doesn't know whether they're going to go clear it or not and how much each new trade is going to cost them so there is some trepidation on entering into new trades knowing that when they put them in the clearing house it may change their margin.

So it's kind of stunted right now, but I'll give you anecdotally, the banks are hiring in the credit-derivative space. In fact, we hear there is tremendous competition to bring in qualified people into this space. There is a real anticipation from a staffing standpoint and a systems standpoint that we've been working on that this market is going to recover and recover strongly. That's our best guess of sort of how the future looks.

When we bring in single names we actually frankly clear the index business by deconstructing them. So if an index is an index of 125 companies, we actually have deconstructed them and clear them like 125 single names. So as we add single names to that index business there will be some people who will be getting offsets because they have hedged positions, there are some people who haven't yet put their entire index into our clearing house because they're keeping the hedge as a bilateral over the counter contract. And so we don’t exactly know how the default fund is going to rise or shrink and we don't know exactly how those offsets are going to look when we get them all in.

I suspect, however, our early work that we did suggested that this clearing house was going to need in excess of $2 billion in the default fund. That was where we started earlier this year. We've reached that number and I suspect that we're going to be up in that range. And as I mentioned in my prepared comments, that's just the amount of money to support the interdealer market that exists in credit. So that is reflective of the binary type of risk that these products have and it's why we decided to segregate this clearing house from futures. Even in Europe we have a separate default fund and separate contracts that govern the default fund separate from our energy business.

Scott A. Hill

And Daniel, the only thing I’d add is you have to remember the guarantee fund in this case is a much more dynamic guarantee fund and so you'll have some competing dynamics. As we add single name you could see some growth, but as credit spreads are tightening you'll see that number come down on a more dynamic basis than you would in most clearing houses.

Daniel Harris - Goldman Sachs

Thanks. That's actually really helpful and I'll just transition for another question on a different topic. Going back to what's on your slide, but what we track also, the Brent ADV year over year was up 20%, the WTI was up 3% in the third, just love to get your thoughts on that and thanks for the color.

Jeffrey C. Sprecher

It's really, I think, because Brent is used to price Asian oil and that's the long and short of it is that there's just been a tremendous growth going on in Asia and our customers hedging their Asian exposure whereas WTI is the US product and is reflective of the US economy.

Operator

We'll take our next question from Howard Chen of Credit Suisse.

Howard Chen - Credit Suisse

Good morning, everyone. Thanks for taking my questions. First, growth in your core commodities business continues to be really solid, Jeff, you mentioned that. And then Scott, you highlighted how you've been able to balance margins, returns, and growth, in deals like NYBOT and Credited. I guess if I wrap that all together, I know it's early, but when you look at your business mix today, do you think you're able to restore margins or returns to where your core commodities business is, and how do you broadly get there?

Scott A. Hill

Well look, Howard, I think what I'd point you to are the trends that you’ve seen. Our margins in the fourth quarter of 2008 were 47%; they were 55% in the quarter. We've increased them three quarters in a row. We've improved the margins in a labor-based commission-based business by nearly 20 points so I don’t think there's any question that relative to what volumes and revenues do, we have taken actions and continue to take actions to expand our margins. We're not going to take the Creditex brokerage business and turn that into a 65% business. It's just not the nature of the business. But as our futures business and our OTC business and our clearing businesses grow, we'll mix towards those higher margins and you’ll continue to see us expand margins accordingly.

Jeffrey C. Sprecher

And Howard, I would like to point out that we entered Creditex through a voice brokerage business and we're trying to manage it on behalf of our customers and our shareholders and we've really done some things with our brokers. We've gotten rid of low performing brokers and we've seen those people immediately hired by our competitors. We're getting away from trying to give these big guarantees that take the margins down in bad times and we're trying to incent people with stock-based compensation and other things that align their interest with our shareholders. We're trying to give those brokers electronic tools that increase their productivity and the company shares in that margin increase.

And so I'm quite proud of the people who we have working in our brokerage business. I look at some of our competitors and I'm dumbstruck at how they continue to operate in the bad times as if they were the good times, and that's not something that we're going to do. And so long term I hope we can sustain that. It's building a lot of loyalty in that brokerage team and I think that team realizes that change is afoot and the people who are really excited about being with us are people who want to be on the front of that change. They embrace using technology to increase their own earnings and they like the idea of having the upside of stock based compensation.

Howard Chen - Credit Suisse

Okay. Thanks, that is helpful color and makes sense to me. And Jeff, my followup, it looks like you've got a lot on your plate organically; part of the DNA of IC is doing strategic deals. What's the current appetite to do a transaction and what's the landscape look like in your mind?

Jeffrey C. Sprecher

Well amazingly, Scott's done a great job of managing our balance sheet and really giving us the tools that we have and the currency that we need to do deals. Our lending group has actually been coming to us wanting to lend more money to us and doing that in the bank market, not in the other debt market. And our stock has now been performing better as people get more visibility into the regulatory landscape and our own performance globally. So we do have the capacity to do it. I do not just want to get big. I mean, even when we went after the Board of Trade, you'll recall that the reason we did that is we thought we could use it as a vehicle to get into the over the counter clearing markets for interest rates and other derivatives. We found a different way into that market nonetheless. So that acquisition was never about scale. In fact, we were very open that we would not really be able to grow the treasury complex, and in fact I'm glad that we avoided it because the treasury complex was so highly levered to the securitization business which may be in trouble for quite some time.

So it's not about scale. It's about finding areas where we can really provide growth with our technology and the DNA that we have in the company and there are numerous opportunities out there and other business leaders and entrepreneurs who have actually approached us. One thing, Howard, we have created a vehicle here where a lot of the entrepreneurs who built their businesses are still with us and as a business builder myself I know how important it is to cater to people that need more resources and need a bigger scale, but still want to be involved in their businesses and we've done a very good job with that and they in turn have given results to our shareholders. So there are a lot of those out there and increasingly we're seeing that kind of acquirer.

Scott A. Hill

And Howard, that disciplined approach, I'd encourage you to take a look at any measure of return, return on invested capital, return on assets, return on equity, us versus our competitors, and consistently we are two to three times the return because of the disciplined approach we follow to picking the right acquisitions, acting on them, and then executing our integration strategies to bring them into ICE.

Howard Chen - Credit Suisse

Great. Thanks for the color and congrats and on the quarter.

Operator

And our next question comes from the line from Chris Allen of Pali Capital.

Chris Allen - Pali Capital

Good morning, guys. I just wanted to followup on Jeff's comments on the core commodity business in particular the over-the-counter energy where we've seen some nice growth in natural gas and electricity. Scott mentioned some of the catalysts there, but Jeff, if you could comment just in terms of the environment for the natural gas business right now, whether the storage issues really hold back activity levels going forward, what might be some positive catalysts to drive that business forward? That would be great.

Jeffrey C. Sprecher

Sure. What's interesting, and I think you're aware of it, is that our business does well when there's a lot of volatility. Volatility gets people to start to think about hedging in order to avoid that volatility in their own P&L and it attracts speculators that want to interface with the hedgers who have a view on where markets are going to go.

And there was a period earlier this year where there was a lot of talk about decommissioning natural gas wells and people that do technical analysis could see how much was being produced and how much was being stored and who demand projections were, but they had a hard time understanding how many rigs were going to go offline because that was part of the equation.

I think now that pricing bottomed in the $2 and something range and natural gas has increased in price, people now have a better understanding of how many rigs are going to leave the market and so it allows technicians to look at supply and demand again and you see them coming into hedging. So we feel pretty good about where the market is.

There are a lot of basis trades, as you know in other words different delivery points for natural gas and as the market is evolving you see growth in these various delivery points. One of the great things about our business is that we used to be very much about the Henry Hub natural gas swap and increasingly people are trading other delivery points and getting domain knowledge in how these local markets work and are hedging locally and that's driving a lot of growth.

Scott A. Hill

And just Chris, to put a point on the first part of your question, our power business in the quarter was nearly double what it was in the year ago quarter and our oil business is nearly four times larger. So even as we're starting to see the natural gas business pickup, power and oil has continued to be very strong performers in our OTC business.

Chris Allen - Pali Capital

Great. Thanks a lot, guys.

Operator

We'll take our next question from Mike Carrier of Deutsche Bank.

Mike Carrier - Deutsche Bank

Thanks, guys. Just a follow-up on that question, when you look at the drivers of growth in the energy OTC business, you've got a lot of the new products that you’ve launched, you've got the normal usage and volatility, and then you've got the trend of more and more of the volume that's in the over the counter market going from bilateral to the cleared side. So I guess when you see the products that are in the markets that you're in and you're looking at what's away from you, meaning not occurring at ICE or not being cleared, I guess, is there any way to size up the opportunity and what will drive more of those players onto ICE's platform?

Jeffrey C. Sprecher

I think the areas that we're focused on, and obviously competitors are focused on, is options. Just like in the equities market there's an increased use of options for controlling risk in commodities and so we have been working now for years on really increasing our technology and the domain knowledge that we have for the options business including acquiring a company called Yellow Jacket which has technology that we're now using for traders to input options trades into the clearing house.

The other thing that's going on, and Scott mentioned it, is that the oil business which is really a global business, has largely been uncleared. It's largely been traded, the couple of benchmark oil futures contracts with the rest of the market being done bilaterally. And there are a lot of things that come out of a barrel of oil, things you don't even think of, all of which are some kind of basis trade and exist in the swaps market. So holding our own clearing house now and having the domain knowledge and the control of the technology, we're putting more and more of the basis business in there.

And then lastly, when we started the company — well, Chuck Vice and I came out of the power industry and we really started ICE as a power company in the United States, and that market continues to evolve as there is continued deregulation, and deregulation in the sense that utilities are increasingly being responsible for managing their P&L and not being able to pass it through to their rate payers, and so there's continued hedging in the power market and we continue to build out a lot of unique functionality for power because it really is sort of at the heart of where we started the company.

Scott A. Hill

And interestingly, it's not just in the OTC business where we're seeing some of this happen, we're also seeing it on the futures side. If you look at the UK natural gas contract, we’ve seen our volumes grow significantly this year in our ICE Futures Europe business for UK natural gas as people want to bring those positions out of a traditionally bilaterally traded world into a cleared solution.

Mike Carrier - Deutsche Bank

Okay, thanks. And then, Scott, just on the non-operating items, anything unusual in there? It seemed like the expenses is a little lower.

Scott A. Hill

Yeah. There are a couple of dynamics we have below the operating income line. The first thing was the tax rate was a little higher than we've seen in the last couple of quarters as we had to react to some recent state law changes and some cleanup around acquisitions. And then that was mitigated somewhat by the fact that we had a little bit of a currency help this quarter versus we had a currency hurt last quarter, and we also had some interest expense reductions around some 1048 tax reversals.

So, a bunch of noise, but if you look at taxes and the other expenses combined, it was basically net neutral and leaves you staring right back at the operating results which were tremendous.

Mike Carrier - Deutsche Bank

Okay, thanks.

Operator

We'll take our last question from Jonathan Casteleyn with Susquehanna.

Jonathan Casteleyn - Susquehanna

Hi, good morning. I'm just wondering if there's any way to establish any market share in OTC energy, any way to scale your 1.25 million per day versus the broader analog business? I know it's difficult information to get a hold of, but just wondering from your vantage point if there's any way to provide that information.

Jeffrey C. Sprecher

We have the same difficulty you do which is it's very hard to size those markets and so we can only do it anecdotally by talking to our customers about what their business is. And frankly when we talk to our customers not everybody, as you can imagine, wants to volunteer their position to us so we piece together information.

We know that the oil business is big and it's global and it's largely uncleared within the over the counter space. We know that the options business is big and it's global and it's largely uncleared in all commodities. So it's just really, John, sticking our finger in the wind and saying let's go to where this bigness is. But it is very, very difficult and that's why I could never be a good equity analyst and you guys have a challenge on your hand.

Scott A. Hill

But what we do have visibility to, Jonathan, are our volumes, our key competitors' volumes and then some visibility into the bilateral world. We look at that share on a monthly basis and the trends across the products sets in power and oil particularly have all been up so we posted share gains across a lot of our OTC products, I think contributed to by the 150 new products that we've launched this year. So share trends for us across our OTC products have generally been on an upward bias for the year.

Jonathan Casteleyn - Susquehanna

Right. Okay, and then my followup question very quickly is, is there any direct benefit to the Creditex brokerage from the ownership of the clearing house or is it more of an industry benefit? And then just longer term, is there a way to think about the growth rate for the Creditex brokerage revenues?

Jeffrey C. Sprecher

Well, first of all the clearing house is open and so I don't want to alarm any competitors of ours. We take trades from any venue and we run that as a separate business, but we certainly have tremendous domain knowledge that we get by having people who are dealing directly with clients. We can see where things are trending, we can see where there are seemingly large products that we think are actually going to shrink in the long term and so it helps us position ourselves by having that knowledge.

I think the business — frankly what we're trying to do with our brokers is give them electronic tools to increase their productivity and that’s not so much related to clearing as it's related to the fact that at the core of this company we really are a technology company and the bulk of our employees are computer programmers and we have really built our business by helping to electronify and make markets more transparent and standardized and clear.

So it's putting some of the tools that we have from other venues and things that we know work in other markets into the hands of those brokers to empower them.

We also, I will tell you, have made a conscious effort to reach out to other brokers and provide the same kinds of things to others and so we have a much better relationship today with the interdealer space even though we compete with many of them now through Creditex. In a weird way it's given us visibility into what the challenges are in that market and we have embraced some of our competitors where we can and are working with them. And you can see it in the growth in our over the counter clearing business in energy and other commodities that we have really done a pretty good job of changing the dynamic of our relationship with our competitors.

Scott A. Hill

And it won't give you a number, Jonathan, but I think what Jeff said earlier is important. Customers are telling us they’re hiring, our brokers are starting to see more activity, and the industry is now a good solid six months through the transition to the more standardized different CDS contract that they're now trading. So the trends certainly point to a positive as you look to 2010, putting the number on that right now is still difficult.

Jonathan Casteleyn - Susquehanna

Understood. I appreciate the time, thank you.

Jeffrey C. Sprecher

Well unfortunately we have a hard stop and we have to leave. I think there are definitely people on the phone who wanted to ask us questions so let me apologize to you who have been hanging on the phone for not getting to you and we'll try to make a note of who we didn't get to and take your calls on the next earnings call, but thank you all very much for attending and we look forward to another good quarter. Thanks just again to our customers for hanging with us during these difficulties and again, congratulations to my colleagues on a really successful first year at ICE Clear Europe.

Operator

That concludes today's conference. Thank you for your participation.

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