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CME Group (NASDAQ:CME)

Q2 2014 Earnings Call

July 31, 2014 8:30 am ET

Executives

John C. Peschier - Managing Director of Investor Relations

Phupinder S. Gill - Chief Executive Officer, Director, Member of Executive Committee and Member of Strategic Steering Committee

James E. Parisi - Chief Financial Officer and Senior Managing Director of Finance & Corporate Development

Terrence A. Duffy - Executive Chairman, President, Chairman of Executive Committee and Member of Strategic Steering Committee

Bryan T. Durkin - Chief Operating Officer

Analysts

Kenneth B. Worthington - JP Morgan Chase & Co, Research Division

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Alex Kramm - UBS Investment Bank, Research Division

Kenneth Hill - Barclays Capital, Research Division

Michael Carrier - BofA Merrill Lynch, Research Division

Niamh Alexander - Keefe, Bruyette, & Woods, Inc., Research Division

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Jillian Miller - BMO Capital Markets U.S.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Chinedu Christian Onwugbolu - Crédit Suisse AG, Research Division

Robert Rutschow - CLSA Limited, Research Division

Gaston F. Ceron - Morningstar Inc., Research Division

Operator

Welcome to the CME Group Second Quarter 2014 Earnings Call. [Operator Instructions] At this time, I'll turn the call over to Mr. John Peschier. You may begin sir.

John C. Peschier

Good morning, and thank you, all, for joining us today. Gill and Jamie will spend a few minutes outlining the highlights of the quarter, and then we'll open up the call for your questions. Terry and Bryan are also on the call and will participate in the Q&A. Before they begin, I'll read the Safe Harbor language.

Statements made on this call and in the slides on our website that are not historical facts are forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or implied in any forward-looking statements. More detailed information about factors that may affect our performance may be found in our filings with the SEC and on the Investor Relations section of our website.

With that, I'd like to turn the call over to Gill.

Phupinder S. Gill

Thanks, John. Good morning, and thank you, all, for joining us today. I'm going to highlight CME Group's second quarter and then turn it over to Jamie to review our financials. So far this year, there has been a common theme across financial markets around the world, volatility in all asset classes is at trough levels. In addition, many market participants in a number of sectors, especially in finance, energy and commodities are still working through the ramification of the changing regulatory environment. As a result, market participants have reduced trading activity, and we saw an impact with lower-than-anticipated volumes in the second quarter after a good start to the year.

We had difficult comparisons to the same period of last year when market participants reacted to the Fed's comments about potential tapering of quantitative easing. While our overall volumes are down due to low volatility and tough comps, we generally outperformed other global derivatives exchanges. Our diversified product offering and focus on expanding our global customer base has helped us.

Let me start by discussing the interest rate product area. The market environment has been quite difficult as most of you know. To set the stage, rate volatility during Q2 was at a 7-year low. Fixed income desks were down about 20% compared to the prior year. Cash treasury activity was poor. Corporate issuance was mute -- muted, and year-to-date, European rate derivatives markets are down approximately 15%.

How are we faring in this difficult environment? Well, our rate open interest is up 30% since the start of the year and volume is up about 8% year-to-date, despite the difficult environment. We have an all-time record number of participants in our rate products as measured by the CFTC's large open interest holders report, with the latest report showing about 1,700 large holders, which is up 300 since the beginning of the year. We have nearly 500 institutions using our OTC clearing offering. CME's treasury futures activity as a percent of cash treasury volumes remain at a high level, with the rolling 3-month average reaching about 75% in June. We have seen a noticeable pickup in our Fed funds futures product, with July ADV up 40% compared to Q2 of this year. And we had over 103,000 contracts or about $515 billion in notional value traded on July 10, which is the first time Fed funds futures contract traded over 100,000 contracts in almost 2 years. Our team's hard work to highlight the benefits of utilizing exchange-traded rate futures has driven these standout results.

Overall, we continue to see positive economic signs potentially leading to a more traditional monetary policy. The U.S. economic expansion has continued to create jobs and bring down the unemployment rate. As a result, the Federal Reserve is on track to end its quantitative easing program in October of this year. Once QE has ended, the Fed's next decision is when to withdraw from its emergency near-zero target for the Fed funds rate and to start to nudge short-term rates higher. Our Fed funds futures contracts are currently implying a Fed move in mid-2015. As the debate intensifies over whether an economy that's in its fifth year of economic recovery and expansion requires emergency assistance from the Fed, many market participants are utilizing the Fed funds watch tool on the homepage of our website, which provides an excellent means to gauge the probability of a future Fed rate activity. This tool has been particularly active in the last 2 or 3 days.

Our main effort during the second quarter in OTC clearings was to continue to grow our global client base. Over 60 new clients started clearing with us in 2014, taking our total client universe to over 470 who have cleared since launch. This increase continues to support the strong momentum in our open interest growth, which is now $17 trillion, representing 53% of the dealer-to-client marketplace. We have also experienced an uptick in the usage of portfolio margining. We now have over 60 accounts benefiting from this sole solution, with portfolio capital savings ranging between 30% and 70%, with total risk reductions accounting for over $3.4 billion in initial margin savings.

Just recently, we have seen several influential and important clients take advantage of the portfolio margining offering. We have had a strong month of activity in July, with average daily notional cleared up about 19% from the second quarter.

In June, we launched Compression via Coupon Blending, which enables OTC clients to reduce the notional outstanding and line items of a cleared IRS portfolio. This patent pending innovation is the first automated and scalable compression solution available to all market participants and clients are actively testing the solution and analyzing the potential efficiencies they can gain.

Turning to our global picture. Our efforts to expand outside of the U.S. continue to take root. International volume accounted for 24% of the overall electronic trading volume, which is the highest level it has ever been. During the prior 5 quarters, this has ranged between 20% and 22%. The main driver of the increase came from activity in Europe, which was essentially flat, driven by the strength in equity and interest rates, while other regions, including North America, were down about 15% on average. We look to build on this strong performance by continuing to invest, to strengthen our globalization strategy.

Talking about investing outside of the U.S., we are very pleased to announce the acquisition of Trayport and FENICS from GFI Group yesterday. The transaction is expected to close by early next year, pending approvals by regulators and shareholders of GFI, as well as completion of customary closing conditions. The acquisition of these software businesses is an important part of further developing our presence in Europe, with a particular emphasis on globalizing our energy business, which has historically been more U.S.-centric.

Trayport's trading software is a central way in which brokers and traders, exchanges and clearing houses interact in Europe in the energy marketplace and creates a platform for further growth in Asia. Approximately 85% of European natural gas, power and coal trading activity in bilateral exchange-traded and OTC cleared markets take place on Trayport. Its business model is 90-plus percent subscription-based with a diversified client base. This will provide us with a nice recurring revenue stream, supplementing our primary transaction business. The acquisition gives CME Group a deeper relationship with a desirable set of commercial customers in the rapidly evolving European energy market.

We have had tremendous success with our coal offering working very closely with Trayport. Looking ahead, based on customer demand, we plan to launch European natural gas futures this year. That launch would be supported by both CME Group trading and the Trayport platforms.

FENICS also provides leading price discovery, analytics, risk management and OTC workflow connectivity services for global FX options. It has an extensive sell-side client base, particularly in Europe and Asia that will further complement CME Group's buy-side focus FX distribution and round out CME Group's participation in the broader FX ecosystem. As users of this ecosystem prepare for the pending OTC FX options clearing mandates in various regulatory jurisdictions, the connectivity of CME Group and FENICS will provide a conduit for OTC clients to access CME's OTC clearing and exchange-traded options. Regarding the financials of this transaction, Jamie will touch on that in a short while. This acquisition continues CME Group's European infrastructure investment following the launch of FX options and futures on CME Europe in April 2014.

Over the last few months, we are seeing a continued progression of activity and open interest, with average daily volume growing from just a few hundred contracts to over 2,000 contracts a day last week. In fact, last Thursday, July 24, it was a record day on CME Europe with over 3,200 contracts. We will continue to look for ways to leverage this investment by enhancing our FX product offering, as well as expanding the portfolio of asset classes that are offered in Europe.

Largely -- lastly, on the global front, in partnership with Thomson Reuters, we won the mandate from the LBMA and the OTC silver market participants to provide a new London silver benchmark pricing mechanism. Starting in August 15 of this year, CME Group will provide a new electronic transaction-based solution which will transform the selling of London OTC silver spot price. Our transparent transaction-based OTC auction platform combined with Thomson Reuters' independent benchmark administration services will provide a fully IOSCO-compliant, FCA-regulated solution to the London OTC bullion marketplace. Hosting and operating the silver fix on CME Group infrastructure will solidify and broaden CME Group's brand in the global precious metals market and serve as a key stepping stone in executing on our global precious metals strategy. Looking to expand on this, we have confirmed our intention to tender for the London gold benchmark, which will similarly transform the current twice daily price setting conference call into a transaction-based electronic auction solution.

In summary, we are focused on continuing to provide innovative products to our global client base and trying to drive revenue growth for the long term. At the same time, we are aware of the current market challenges and low volatility that we are seeing. As a result, we have intensified our focus on what we can control and how we can operate our business more efficiently. Our main goal is to position the company to maximize bottom line results as the market improves, while being very cognizant that we are in a challenging part of the economic cycle.

With that, I will turn the call over to Jamie to discuss the financials.

James E. Parisi

Thank you, Gill, and good morning, everyone. Before I start with the details, I wanted to make some high-level comments on the quarter and recent financial performance. While we're happy to see the diversity of our product line and customer base paying off during the volatility malaise we find ourselves in, we are keenly aware that our expense base, while exhibiting very controlled growth over the past several years, continues to demand our attention. To that end, we have refocused our teams on wringing out discretionary expenses where possible for the remainder of the year, and we're also looking for further efficiencies as we start to think about 2015 and beyond. For example, we offered a voluntary retirement program in Q2 and had between 2% and 3% participation, with most folks departing in Q3 and Q4.

In addition, we are reducing the number of people we plan to hire in 2014, while also curtailing travel and other discretionary expenses. Lastly, as we begin our 2015 budgeting process, we will take a hard look at further orienting our business to drive growth, as well as achieve greater efficiencies. In light of this, our guidance for the current year has been adjusted slightly. We are now forecasting pro forma expenses of $1.3 billion to $1.31 billion versus the $1.31 billion point estimate we had provided earlier.

Now I'll turn to the financial details for Q2. GAAP EPS was $0.79 for the quarter and adjusted EPS was $0.77. The largest of the pro forma adjustments was due to the positive conclusion of the MF Global situation for both our clients and for us. We recovered $14.5 million in the settlement, which was a portion of the fees they owed us. The full amount had been written-off in December 2011, so this recovery favorably impacted our GAAP results. Other adjustments this quarter included employee separation payments of $6 million in the compensation line for the voluntary exit incentive plan I mentioned, and we also adjusted for the Trayport and FENICS acquisition-related professional fees during the second quarter. Lastly, we have adjusted for FX fluctuations and deferred compensation revenue and expense. All these items are outlined in the reconciliation within our financial statements and the income statement trend on our website.

The rate per contract for the second quarter was $0.749, down from $0.767 last quarter. The main driver of the drop overall was an increase in the mix of lower-priced interest rate contracts. They represented 53% of total volume in Q2 versus 49% in Q1. We also saw a slightly higher proportion of trades from members this quarter. Similarly, within the interest rate RPC, we saw a higher portion of business from lower paying members during Q2. This trend also played out in our energy product line, in addition to a lower proportion of higher-priced ClearPort products.

OTC swaps revenue totaled $13.3 million, up 4% versus last year. In Q2, we captured about $136 per OTC trade, up from $128 in the prior quarter, and we had approximately 1,400 trades per day. I know someone will ask, so I figured I'd get it out of the way now. The average rate per million was also up from $1.66 in the prior quarter to $1.75 this quarter. As Gill mentioned, we continue to add new clients and believe this offering has help to strengthen our core interest rate franchise.

Q2 pro forma non-operating income was $8.4 million. As we mentioned in our last volume release, we recorded 2 BVMF dividends in second quarter 2014, which were paid on May 30 and June 27. These dividends, along with the dividend from our investment in the Mexican exchange approximated $9.7 million.

Interest expense is down $28 million from $34 million last quarter, reflecting the paydown of $750 million of debt in February of this year.

Turning to taxes. The effective rate for the quarter was 37.5% on a pro forma basis and was in line with our guidance for the year.

And now the balance sheet. We had approximately $1.1 billion in cash and marketable securities at the end of the quarter. Q2 tends to have a similar cash balance as Q1, due to the fact that U.S. tax law doesn't require any tax deposits in Q1, but requires 2 deposits in the second quarter and 1 deposit each in Q3 and Q4. We also paid $157 million in dividends in Q2. Lastly, during the second quarter, capital expenditures, net of leasehold improvement allowances, totaled $29 million.

I wanted to make a couple of comments on the transaction structure and financial impact of the acquisition of Trayport and FENICS. In a two-step transaction, CME Group will first acquire all the outstanding shares of GFI Group for $4.55 per share in an all-stock transaction valued at approximately $580 million and will assume $240 million in outstanding debt, resulting in overall enterprise value of approximately $820 million. Concurrently, with step 1, we will sell GFI's interdealer broker business to a private consortium led by current management for $165 million in cash. CME Group expects to retire the debt in 2015. In aggregate, the net consideration is approximately $655 million for the Trayport and FENICS businesses before certain tax benefits that will be achieved. The next impact on cash -- the net impact on cash in 2015 as a result of the transaction will be negligible and the transaction will not impact the payout of our 2014 annual variable dividend. The deal is accretive on a cash basis and could add approximately $0.03 to $0.04 to our annual dividend beyond 2015. In addition, the deal is expected to be neutral to earnings.

We recognize that we're on the sixth year of a tough operating environment, but we believe the seeds we have planted during this period are beginning to bear fruit, while we continue to actively manage our expense base and look for further opportunities to position our company for growth.

With that, we'd like to open up the call for your questions. [Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Ken Worthington with JPMorgan.

Kenneth B. Worthington - JP Morgan Chase & Co, Research Division

I guess, really on the transaction. Can you help us build the connection between owning kind of a trading software analytics in the workflow and your ability to kind of win futures business in Europe and kind of build out that franchise. Just -- I see what you bought, but I'm trying to just link it to building out the futures side of the business.

Phupinder S. Gill

Sure Ken. This is Gill. The whole important connection here for the soft -- between the software that we've bought and CME Group's presence in Europe is the connectivity to the client base. This is the central mechanism in which most, if not all, clients trade energy products in Europe. So having connectivity to them in a real estate-constrained desk world is probably the most important point here. I think once you get the connectivity into the client and understanding the client needs, whether it's futures or OTC and/or any kind of clearing needs that they might have actually builds on an ecosystem that's already in place and building on it in a capital efficient way if you include the clearing mechanisms that are out there. And finally, I would say, one of the major principles of the innovative thrust that this firm has always been known for is to get ideas for that very innovation from a client base. And here, you're looking at a client base that includes all the players in the ecosystem, whether they're trading cash, futures or simply the options or any other products in the energy ecosystem. You're looking at a client base that has a fresh perspective on the types of products they might want us to look at, other types of instrument that they're looking to actually clear.

Kenneth B. Worthington - JP Morgan Chase & Co, Research Division

Okay. And does it make it easier for you to launch new products? Or can you actually influence the decision on what they choose to trade? Like is it like the shelf and you get to say, "Hey, we're going to give our products better position on the shelf?" Or does it allow you just to put your products on the shelf and make it easier for people to see and trade?

Phupinder S. Gill

Sure. In the first instance, the clients are going to trade what they're going to trade based on the needs that they have. If we had a fuller understanding of those needs, we will be able to do exactly as you say. Our first priority here though is to continue the business that we bought as is, figure out what some of the pain points our clients might have, relieve those pain points to the extent that they have any, and then having that connectivity will lead to some of the results that you referred to, yes.

Operator

Our next question comes from Rich Repetto with Sandler O'Neill.

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

I guess, just have one question. I'm going to focus on the expenses, Jamie. And when you take a look, you mentioned some things that you're going to do in regards to the reduction in hiring and the travel, discretionary. But I'm just trying to see whether you could quantify a little bit more or at least going forward. Because if you look at that $1.3 billion to $1.31 billion, the estimates, even if you did $1.3 billion versus the one -- it's 76 basis points. In other words, is there -- when you're taking out expenses, is there more than just that of what you laid out in just the guidance here or maybe in next year?

James E. Parisi

I think first off, and just to reiterate that our long-run margin expansion, right, is the focus of the management here and the employees here, so we're going to continue that investment on the growth side. But as you're pointing out, expense control is also very vital. Now as you laid out the various actions we've taken so far, I did that in the script. And for the long run, I'd say, we're going to continue to challenge all of our teams to find ways to run this fairly complex organization in an efficient way as possible. So we're going to continue, Rich, to look for ways to reduce that expense base where we can. But it's -- I'd say it's just a bit early at this point to determine exactly or lay out exactly how we would do that. But it will be tied to orienting the firm for growth and, along that, we'll be able to become as efficient as we can.

Phupinder S. Gill

Rich, this is Gill. If I could just emphasize the point that Jamie made. I think if you look at the activity of CME Group over the last 5 years, in the face of an economic decline in the environment and of the regulatory changes that have essentially changed the business model for many of our clients and also changed the business approach for a company such as CME Group, we spent a lot of time investing in what those changes were going to be. We spent a lot of time investing in what we considered to be the continuing growth areas of CME Group, which are, to a large extent, outside of the U.S. And now the question for us, to Jamie's point is, how do we position the company for further growth from this point on? As Jamie said, we don't have much to share now, but the orientation that we are taking is no different than what we have over the last 5 years. I would say a lot of the investments are behind us, the positioning is now ahead of us.

Richard H. Repetto - Sandler O'Neill + Partners, L.P., Research Division

Got it. What I think -- I see the dilemma you're in. I think what would be helpful is just sort of a scenario. If volume stayed somewhat-- I'm not saying at these levels. Hopefully, they get higher than this. But lower, not far from here, if they stayed down, what would the expenses look like? I think that would help in the future, but anyway...

James E. Parisi

Rich, just -- I mean, just on that point, right? As you know, we've got a pretty fixed expense base. You've got some variable levers in there that will move with volume, whether it's the bonus or the license fees, but even those movements within a relevant range of volume movement aren't going to move all that much relative to the size of the expense base. That's the dilemma we are in when you have a company that has a high degree of operating leverage. So when you're in a low volatility environment like this, where volumes are going a little sideways, yes, that's a pain point for us, but it's also a great platform to have and work off of as volume starts to return to the business, and we start to grow again.

Operator

Our next question comes from Alex Kramm with UBS.

Alex Kramm - UBS Investment Bank, Research Division

Well, I guess, I got to use Rich's layup. Well, actually, I just want to go into one regulatory item which is the high-frequency trading, which obviously was a big focus last quarter. And I think a lot has been said and done since then. And I think people have somewhat moved on already. But I guess, maybe for Terry or Gill, I assume you've had a lot of meetings. There were a lot of public meetings. I'm sure you did a lot of your education around D.C. as well. So just wondering where you stand now that all is said and done. Is it still a big concern? Is there still some things that are out there that you need to focus on more? Or do you think we can largely move on here?

Terrence A. Duffy

I think what's important -- and it's Terry Duffy -- is that what we have done on high-frequency trading and all different types of trading, we didn't start educating regulators and legislators when Michael Lewis' book came out. We've been working on the way our markets work for a number of years, keeping people completely apprised and keeping it completely transparent. And I think that's really important. And when you look at some of the things that are being talked about as far as order types. Order types in the equity world -- I know Mr. [indiscernible] has been complaining about how many there are, but he owns an exchange that has 80 some on, he eliminated 14. We're still on the same 7 we had 25 years ago. And I think that's very important because that lends to the credibility of the marketplace in and of itself. Bryan and I had been spending a lot of time in D.C. together. And separately, I testified at the Senate Ag Committee on high-frequency trading about 2 months ago and then Bryan pitched it for me last week, this week in the House Financial Services Committee. So I think what we're hearing from a legislative process is, let's look at the overall structure of the market and all the participants, not just high-frequency trading. Their biggest focus has been on the equities market, not on the futures. And I think what's important for us is we are being transparent. I have made comments about dark pools when this first came out, and I got a little criticized because it's a block trading. I didn't mention the block trading because it's less than 5% of our overall ADV at the CME Group. So I do mention block trading right now. And if you take out the ClearPort, it's only about 2% of our ADV, so it's a very small part of our options exchange trading here. So I think that from that standpoint, educating regulators, working with legislators, I think we're in a very good spot, and we'll continue to do so. Bryan?

Bryan T. Durkin

Yes, just to reiterate what Terry said a little bit. The focus seems to be a bit more on the overall infrastructure. And I think people understand that technology is here to stay and innovation is here to stay, and so the focus has been a lot more on risk management protocols that either exist or don't exist in certain venues. And in the future side of the market, Terry and myself have reiterated how we've taken a leading action with regards to the automation of risk management protocols built-in to exchange's platforms, particularly ours. And we do everything in our power to get those points out there in the context of maintaining the integrity of the marketplace. And so I think you're going to see more and more of an emphasis on that aspect of the ecosystem.

Terrence A. Duffy

And just to add to this a little bit because it has been topical. I think when we look at volume incentives for our largest traders, they're available to everybody. And they are being a little misdirected with -- is their preferential pricing for high-frequency traders? What we do, do is give volume discounts to high traders. We don't give preferential trading or preferential pricing to high-frequency traders alone. It's open to everybody that participates at certain levels.

Operator

Our next question comes from Kenneth Hill from Barclays.

Kenneth Hill - Barclays Capital, Research Division

So Gill, I think earlier you spoke to some of the offerings you have on the compression margining side of the business. If you look online, you guys have a number of tools out there from like the DSF analytics tool, you've got the QuikStrike options tool. So I'm wondering what kind of customers you are finding are using these more? What kind of actual volume is it driving? And kind of how they can be tailored, I guess, going forward to align with some of your sales efforts, particularly as you grow the product base and grow geographically as well?

Phupinder S. Gill

Yes. I think one of the most important things you can do from a client's perspective is to look at things from their point of view. And this is a point that we made on this call maybe a couple of calls ago. And that focus on the client and the client needs have yielded the tools that you are seeing. The use of these tools are actually, to some extent, new. In other instances, new to the client's world. So it actually brings an efficiency that up to this point in time, they did not have in the bilateral world. The use of the tool also provides them with a sense of what the efficiencies might actually be if they went through with the various stages of contemplation that some of the clients are in with respect to the use of the markets here at CME Group. So on an overall basis, the portfolio of tools that we provide to our client base has the net effect of increasing their participation in our marketplace, not just simply for futures and options, but the resulting efficiencies that will come about if they also include swaps or other OTC products that they might have.

Operator

Our next question comes from Michael Carrier with Bank of America Merrill Lynch.

Michael Carrier - BofA Merrill Lynch, Research Division

Just on the European side, when I think about the exchange and clearing house, now the transaction with GFI. I guess, just when you look at the opportunity or the potential opportunity, can you -- I don't know if you can like size it or from a timing standpoint, what year do you think over the next 1, 2 or 3 years, you can -- you attempt to accomplish on just with the ultimate strategy?

Phupinder S. Gill

Yes, I'll start and then I'll ask anybody to add if they want to. If you look at the European landscape and, in particular, if you look at the regulatory environment there, it's still being -- for lack of a better term -- it's still taking shape with respect to when things are required to be cleared and when or if trading of OTC products would be required to come on online. As that environment shapes itself out over the course of the next few years, the opportunities that we have are essentially an open book with respect to what we see that clients might actually need. Currently, our plans, as we articulated in our talking point, is to expand through the other asset classes that we have, as well as looking for more products to list on the FX side. So we are taking a measured approach, but it is a growth strategy for us. The Trayport asset is part of that, too. And beyond Europe, this asset has the potential to expand our reach into Asia, where the FENICS tool is particularly strong.

Terrence A. Duffy

If I could just add to that. I think one of the most important factors here is, the clients that are currently on Trayport will not be disrupted in any, which way, shape or form. This business is going to be continually run the way it's been running today, which is very successfully. And, and if the market changes from a regulatory standpoint, we will adjust with those conditions as they come up. But otherwise, this acquisition was acquired for us to get into the gas and power and other business throughout Europe under the current structure that Trayport operates today.

James E. Parisi

And I just want to underline. In some of the comments Gill had made earlier in his presentation, that we are performing well in Europe in Q2 relative to the rest of the business. While other European exchange volumes are -- have been low in Q2, we saw ours come in relatively better. And when you look at what we're generating out of Europe today, we're probably in the neighborhood of $400 million or so a year in revenues today coming out of Europe. So we're working off of a good, solid base with this investment.

Bryan T. Durkin

And I would add to that based on the diversity of products that we have, you're seeing an ice uptake, particularly in the interest rate equity arena. You're also seeing a nice uptake across asset managers, hedge funds and in particular areas, proprietary groups, based on just the diversity of product lines that we offer. So that goes to the efficacy of our sales efforts and penetration.

Operator

Our next question comes from Niamh Alexander with KBW.

Niamh Alexander - Keefe, Bruyette, & Woods, Inc., Research Division

I'll ask my first question. Just with respect to, you did the Trayport FENICS deal yesterday. I think it's a really neat fit and gets you right there in front of the clients over in Europe, especially. But then, I'm hearing there's potentially a really good index complex that would be a great fit with CME, which I think it kind of behooves your team to look at to. But can you just remind me of the philosophy of paying out all your earnings versus weighing up, maybe stalling the annual variable for a bit if you see growth. Like help me think about how you weigh those?

James E. Parisi

I'm sorry, weighing investments versus our annual variable dividend?

Niamh Alexander - Keefe, Bruyette, & Woods, Inc., Research Division

Yes, acquisitions.

James E. Parisi

Well, I think you saw how we handled the deal that we just did, right? Where it was mostly a stock transaction. There's a minimal amount of cash that we're going to have to utilize in that. And we've said all along that it's called an annual variable dividend for a reason. It's going to vary up and down because of activity at the exchange and because of investments that we may choose to make in any given year. So -- and you saw that even after we had announced it in -- I think it was 2012. I think the following year, we did the Kansas City Board of Trade acquisition for all cash. So we're not going to shy away from investments that makes sense. But our -- overall, I'd say that our philosophy around M&A hasn't really changed. We'll be opportunistic, but we also don't see any major M&A out in the future. So it's going to enable us to return quite a bit of cash to our shareholders.

Niamh Alexander - Keefe, Bruyette, & Woods, Inc., Research Division

Are you seeing a little bit more in terms of the medium or small-sized stuff than you would have maybe a year ago?

James E. Parisi

I think we've seen a good deal flow coming across our desks pretty consistent over the years.

Operator

Our next question comes from Alex Blostein with Goldman Sachs.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

A question on RPCs for the quarter. I understand that overall, the mix will impact the bottom line RPC for the business, but it looks like some of the buckets, despite the fact that volumes were a little bit softer, RPC has come down as well, at least sequentially. And that's, I guess, after you guys have made some of the pricing adjustments that I thought would help. Any way you can try to calibrate that for us on how we should think about these numbers going forward?

James E. Parisi

Yes. Thank you, this is Jamie. The key there is going to be -- for this quarter, the member and nonmember mix. Remember, we have a highly differentiated fee structure where the liquidity providers are paying a very low fee and others are paying a significantly higher fee to use that liquidity. And so those who were paying the lower fee were a larger proportion of the business this year or this quarter, sorry, in total, and then also on interest rates and in energy as well. So that was a key driver on the rate side, and that will fluctuate up and down. And it was the same case, so if you look at the rolling 3 months from May to June in the interest rate side, Eurodollar. So there's a little bit of a product mix issue going on there where Eurodollars, which are a little lower fee then Treasuries, were a larger proportion in June than the month following out on that rolling 3 months. So it's really a mix factor here. It's not the underlying fee schedule that's having an impact.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Got it. But the fee schedule is fully phased-in at this point, right?

James E. Parisi

Correct.

Operator

Our next question comes from Jillian Miller with BMO Capital Markets.

Jillian Miller - BMO Capital Markets U.S.

I had a question on Trayport. It's a monopoly in an open-access system. And I'm just wondering if you've gotten any pushback from firms that are connected to Trayport that might be concerned about the fact that CME, which is viewed by some people in the industry as somewhat monopolistic and siloed, having control over the venue. Is there a risk of some attrition from the platform? Or do you think that the users of Trayport are pretty comfortable with the new ownership?

Phupinder S. Gill

Yes. We've had -- I'll start, and then some of the guys here have a direct contact with some of the clients. But from the feedback that I got has been a very positive response from the client base because it's an open-access system as you pointed out. I didn't understand the monopoly point about Trayport that you made. It's open access. Everybody comes in, into it. That will not change. That business model is one that works. And most importantly, it works from the client's point of view. And I think, to the extent that, that does change, it impacts the client, and that would not be good for the client. It will not be good for anybody who makes that one change. What we want to do with this platform is not to change it in any way, shape or form. It's got -- as Terry pointed out, the business model is very successful. We intend to run it as is. If there are any changes, it will be in addition, adding products that customers need. And we think that, that's a model that works. I honestly don't see a monopoly point here. It's a nice word though.

Jillian Miller - BMO Capital Markets U.S.

I just meant in the sense that 90% of the nat gas and power trading is going on through Trayport. So maybe monopoly is the wrong word, but it definitely has -- it's the largest way that people trade those products in Europe, by far.

Phupinder S. Gill

Right. But it's a facilitation of the trade. And it comes to a trade board, but it lands -- it's home is not necessarily there. It's a pass-through mechanism.

Jillian Miller - BMO Capital Markets U.S.

Right. I got it. And then on FENICS, it's primarily a data and analytics provider for FX options. But I'm just wondering if there is a potential there to move it to more like a connectivity network and price aggregation system for broader FX, kind of the same way that Trayport has become for energy? What are the longer-term plans, I guess, for FENICS?

Phupinder S. Gill

I think to the extent it makes sense, that's a path that FENICS can actually take. I think FENICS and its connectivity to the very large Asian banks is actually a very solid foundation to build upon because from a trading perspective and an analytical perspective, the tool is very strong. How to expand that use over a broader client base, either by the mechanisms that you listed or also by the same mechanisms in which they are distributed now makes entirely a lot of sense to us, but ultimately, it would be driven by simply client demand.

Operator

Our next question comes from Patrick O'Shaughnessy with Raymond James.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Curious to get your thoughts on why energy volatility is so low? I mean, if you look at the geopolitical stuff going on around the world between Iraq, Syria, Israel, Russia, one would think that energy volatility and, thus, energy trading volume should be higher. So what do you think is going on here?

Phupinder S. Gill

That's a damn good question Bryan. I haven't a damn good answer.

Terrence A. Duffy

I'll go -- and I'll jump onto that, too.

Phupinder S. Gill

But all that's good.

Bryan T. Durkin

I think part of it is that there's a really healthy macro crude supply trend that has evolved here in the U.S. And I do think that, that's had a bit of an impact in terms of the overall -- what you would expect from the impact of the geopolitical situation. There's also been other dynamics at stake here in the context of expectations for weather and where we are across the nation in the context of, it's a much cooler summer. And so, that's having a dampening effect in terms of prices. But I think a lot of these things are also positioning us for strength in the longer term because as infrastructure continues to evolve and there's development of new products and the utilization of new products in the context of liquefied natural gas and other components, it breeds opportunity for us to be out there and hopefully ahead of the game to respond to those changing dynamics. One of the things that we're excited to see is the performance of our natural gas volumes in general. And I think part of that has been through the introduction of our natural gas basis contracts about a year ago or so. By having that full complement of energy products, we have regained market share in that sector very specifically. And I think that, that's been due to the improved distribution with our CME Direct platform development, which is a screen that's being heavily used by natural gas participants, the broadened product offering, the full slate of natural gas basis contracts that we've introduced provides one-stop shopping for our trading environment. It's also been a beneficiary to our overall performance of our Henry Hub. 30% of the participants in our natural gas basis were primarily commercial. And some banks, I might add, have also increased their overall trading in natural gas, which is the Henry Hub contract.

Terrence A. Duffy

And I'll just add to that. Maybe just give a little political viewpoint on it. It seems to me that I have never seen so many different situations going on around the world between Iraq, Iran, Israel, Palestine, the fighting in the Gaza Strip, the lives being lost.

Phupinder S. Gill

Russia.

Terrence A. Duffy

What happened in Russia and sanctions potentially being put on, not putting on. The head of -- the UN Ambassador saying things contrary to the President of the United States. I think these are all confusing signals to any energy trader, and I would be afraid a little bit right now to trade it also. I think we'll get more certainty on the geopolitical stuff, and that's when I think you'll see the volatility come back into the marketplace. So when Europe, especially Germany, who counts on 40% of their energy coming from Russia, will she proceed with sanctions on Putin? Well, he's yet to decide who's going to take responsibility for the Malaysian jet yet. So I think these -- until some of these answers come out and when they do, and they will, I think you'll start to see the volatility really increase dramatically. But right now, I don't think a trader has any clue which way it's going to go because of the mixed messages geopolitically.

Operator

Our next question comes from Christian Bolu with Crédit Suisse.

Chinedu Christian Onwugbolu - Crédit Suisse AG, Research Division

So just given how large and diverse the FX market is, it would be helpful to get your perspective on the addressable market, addressable in terms for CME. And I believe the 2013 BIS FX number is of $5.3 trillion per day. It's probably unusually high just given a little bit of activity in the Japanese yen. So if we say the total FX market is -- trades $4 trillion per day, which is what was reported in 2010, how do we think about how much of that is addressable for CME?

Bryan T. Durkin

Well, a couple of things. I mean, we feel that we're very well positioned with our core FX business. It's -- well, we're dealing in a historically low volatility environment. If you take a look at, and you've alluded to this, our overall performance in contrast to the cash market. I mean, we're continuing to see that very positive and increasing trend. We've now captured, I think, 110% in the context of looking at our market share performance versus the cash market. As we continue to extend product offerings, and we've made the step to introduce foreign currencies in Europe, and that's where contracts in the context of the heavily traded stock market exists, we have positioned those products to trade in a very similar convention to how they're used to trading those products in the region. We've had -- while we were fairly slow to start with the introduction of the exchange, we're really happy with the pickup in volume. And we're seeing a 70% week-on-week increase in terms of that average trading volume. Now we're at about 2,500 contracts a week. Gill alluded to, we hit 3,200 contracts last week. We're seeing a nice increase in open interest. We also believe that the add-on of FENICS and bringing that into the mix provides a full complement of products and services to the overall foreign currency market, both from a futures and options perspective. The volume trend from yesterday was a positive indicator to us as well. I think you've been seeing that we've been trading in the range of 600,000 to 700,000 contracts. We exceeded 900,000 contracts yesterday. And I might add that yesterday was a very positive trend for the interest rate complex overall where we traded 18 million for almost 18,500,000 contracts. I think those indicators should be tied into some of the statements that Gill and Jamie and Terry alluded to earlier in terms of where the market thinks this whole situation with the Fed tightening is going to move and how soon that may move. So overall, I think the foreign currency positioning that we've undertaken is positive to further capture that market that you outlined.

Chinedu Christian Onwugbolu - Crédit Suisse AG, Research Division

That's fantastic color. I guess what I was just really trying to hit at is, of that, say, $4 trillion per day that's traded, is everything addressable to CME or just some segment of it? Just trying to -- subjecting the opportunity for you.

Phupinder S. Gill

I think as a general rule, the portion of the FX market that is spot, whatever that percentage is, maybe half, maybe a little bit less than half, would be the so-called traditional market opportunity as you might see from a futures and options world. If you take the FX ecosystem into account and you take the Basel capital rules that are out there, and in spite of the fact that there are certain carveouts here and there, it may make sense to some of our client base to, for example, clear some of the foreign exchange products that they have that are not necessarily classified as spot now. So it might include forwards. It might include options. And as those opportunities continue to expand in relation to what capital efficiencies might actually be, then the so-called addressable market that you referred to either for trading or clearing or both will continue to expand. But it's, again, coming down to what do our clients need? So we're very focused and happy and focused across all the asset classes with respect to what our client needs are. So if you took Bryan's point into account as to where the trends are, how we sit vis–à–vis other cash platforms that are there, I think we are covering a good portion of the so-called current addressable market. But on a going-forward basis, that entire notional value stream that's out there, depending on the capital efficiencies client might achieve, and you're talking about a cleared environment becoming more of the norm rather than the exception, you might see more opportunities for companies such as ourselves that have a very solid open interest pool for foreign exchange.

James E. Parisi

I think it's worth just pointing out real quick, right? When we're talking about the spot market, we're talking measured in trillions. So the addressable market potential is measured in trillions. And today, we're trading less than $150 billion a day on exchange. So there's quite a bit of room for us to look for ways to solve the customers' problems.

Operator

Our next question comes from Rob Rutschow with CLSA.

Robert Rutschow - CLSA Limited, Research Division

I wanted to just circle back to the expense question. I guess, first, your quarterly expenses were flat even though your revenues were down about $50 million. So one, is there any way to better align quarterly expenses with quarterly revenues? And then longer term, if we look over 3, 4 or 5-year period, expenses are up about 15% while revenues are flat. So at what point would you consider a more comprehensive and far-reaching cost-cutting program that would reduce expenses on an annual basis?

James E. Parisi

I can start. As I said earlier, Rob, it's a fairly fixed cost base. So it's -- there's not any magic to trying to tie expenses to the volumes. And that is, you're right, it's painful during periods like this, but it's also a source of opportunity when volumes do start to pick up. And whenever we think about the expense base, we are very careful to think about the muscle that's here. And we want to be careful that we don't cut into muscle during a lull, and then have to go back and add that muscle back later and incur more cost in doing so. I think there's a great degree of talent here, and we want to make sure that we manage it appropriately.

Operator

Our next question comes from Gaston Ceron with Morningstar Equity Research.

Gaston F. Ceron - Morningstar Inc., Research Division

I don't know if you mentioned this, but I just wanted to go back to the acquisitions. I wonder if you could talk a little bit about short-term and long-term expectations for revenue and margins on these businesses? And secondly, I wonder -- I wonder if you could talk a little bit about the performance of your index JV.

James E. Parisi

On Trayport, generally, their revenues have been or roughly in the neighborhood of $80 million. Operating margins in the mid-40s. FENICS, there isn't any data that's publicly available on them, but I'll say that their revenues are significantly smaller. It's a smaller business. Their margins are probably in the mid-20s. They've both been growing fairly strongly, I'd say, over the last several years. And they've demonstrated growth yet again year-to-date this year. So I think that's about all we can say on that. And then on the JV, the JV has been performing at or above expectations for us. We're very pleased with how that's played out.

Operator

Our next question comes from Alex Kramm with UBS.

Alex Kramm - UBS Investment Bank, Research Division

I figured I'd come in for a couple of follow-ups. Small ones, I think. On -- for you Jamie, I don't know if you commented on this, but the other line on the revenue side has been kind of trickling down, but it's also very volatile. So any color you can give us on how we should be thinking about this going forward? And then in the same kind of line of questions on market data, nice to see that actually tick up quarter-over-quarter, but any other color you can give us since the changes you've implemented? Obviously, the price hike, but also kind of like the new, I guess, trading screens having to pay now for the first time. Obviously, there's still more change at the end of the year, but maybe some of the changes, how they have impacted you so far?

James E. Parisi

Sure, let me start. On the market data side, yes, we did put that price increase in this year and so far -- and we've also eliminated the waivers beginning in -- eliminated new waivers beginning in March of this year. We're going to start charging for the waived terminal next year at about 50% of the rack rate. And so what we've seen in Q1, prior -- or I'd say in the last couple of years, each quarter, we would see a 1% or 2% decrease in the number of terminals. In Q1, that was less than -- a bit less than 1%. And in Q2 this year, we did see a small decrease in terminals. It was less than 0.5%. Though I think our strategy is starting to work in terms of eliminating those new waivers. So people, when they're coming in and they want to use our data, they're going to have to use a paid terminal. So that's, I think, very positive for us. And to the extent that we were able to keep the terminals flat for the rest of the year, if there were no more attrition, it would probably be somewhere in the neighborhood of -- that fee increase that we put in the beginning of the year is probably around $50 million in revenue. That's if the terminals were to stay flat. On the other revenue, one of the key things to think about there is, we've sold a couple of buildings over the last couple of years. So we've had a decrease in the revenue from the buildings because we leased out space in those buildings. We had some other --- last year, we had a Hurricane Sandy insurance reimbursement that we don't have this year. And some other one-off sort of events like some development fees from some of our partners, where we're codeveloping software, et cetera. So those are some of the drivers on that longer-term trend you're seeing on the other revenue.

Alex Kramm - UBS Investment Bank, Research Division

Okay. And just one follow-up, I'm going to ask a second one. You gave a lot of color on globalization, in particular on the European side, anything new you want to highlight in Asia? I think there's been a -- you highlighted in the past new FCM is coming online, in particular in China. I mean, any fruit that's bearing? Or any other ones we should be thinking about over the next few months that are going to contribute here?

Phupinder S. Gill

This is Gill. Those trends that we talked about in the past, they continue along the same path. I would say the interesting twist currently is the activity around the Shanghai Free-trade Zone. And CME Group was fortunate enough to participate last week, together with the U.S. Chamber of Commerce talking to the Chinese about various and some trade developments. And I think there are some opportunities that may come about for CME Group and other exchanges as a result of those chats. But the trend and the momentum continue to move in the right direction. There's a particular emphasis with respect to the free trade zone and the so-called internationalization of the R&D. And on that note, this is where the FENICS tools will become critically important as many of the largest Chinese banks already use that. And the opportunity to expand that tool as a risk management protocol for more and more clients will become very real for us, too.

Operator

Thank you so much, I turn the call back over to the speakers.

Phupinder S. Gill

All right, thank you very much, guys. Up to this point and time of the day, we have done 5 million contracts. So it looks like the events of just yesterday are doing some remarkable results for us. Thank you very much for your participation, and we look forward to talking to you next quarter. Thanks very much.

Operator

Thank you. And this does conclude today's conference. We thank you for your participation. At this time, you may disconnect your lines.

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Source: CME Group's (CME) CEO Phupinder Gill on Q2 2014 Results - Earnings Call Transcript

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