StoneX Group Inc (SNEX) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your International Assets second-quarter 2010 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). As a reminder, this is being recorded.

I would now like to turn the conference over to Mr. Bill Dunaway, Chief Financial Officer. Please go ahead, sir.

Good morning. My name is Bill Dunaway, the CFO of International Assets Holding Corporation. Welcome to our earnings conference call for the second quarter of fiscal 2010 ended March 31, 2010. After the market closed yesterday, International Assets issued a press release reporting its earnings for the fiscal second quarter of 2010. The press release is available on our website at www.INTLassets.com.

Additionally, we are conducting a live webcast of this call, which will also be available on our website after the call's conclusion.

Before getting underway, I would like to cover a couple housekeeping issues. On these conference calls and in the management discussion portions of our SEC filings, we present financial information on a non-GAAP basis in order to take into account marked-to-market adjustments in our commodities business. As discussed on previous conference call and in our filings, the requirements of accounting principles generally accepted in the US, which I will refer to as GAAP, to carry derivatives at fair market value but fiscal commodities inventory at the lower of cost or market value, may have a significant temporary impact on our reported earnings. Under GAAP, gains and losses on commodities inventory and derivatives, which the Company intends to be offsetting, are often recognized in different periods.

Additionally, GAAP does not require us to reflect changes in estimated values of forward commitments to purchase and sell commodities. For this reason, we believe that the GAAP numbers do not reflect the commercial results of our commodities business, and, therefore, the Company as a whole. Instead, we assess all of our businesses, as do our banks, on a fully marked-to-market basis in our daily and monthly internal financial reporting.

We also calculate commodity traded bonuses on the basis of fully marked-to-market results, not GAAP results.

Readers of our Form 10-Q filing should look at Item 2 in our Selected Summary Financial Information for a summary of both GAAP and non-GAAP information. This section also gives the reconciliation between GAAP and non-GAAP information that the SEC requires us to give. The Company will file its Form 10-Q for the second quarter ended March 31, 2010 with the SEC on Monday, May 17.

Please note that whenever we talk about an adjusted number on this call, we are talking about a non-GAAP number.

Secondly, we are required to advise you and all participants should note that the following discussion should be taken in conjunction with the most recent financial statements and notes thereto as well as the Form 10-Q to be filed with the SEC. This discussion may contain forward-looking statements within the meaning of Section 27-A of the Securities Act of 1933 and Section 21-E of the Securities Exchange Act of 1934.

These forward-looking statements involve known and unknown risks and uncertainties, which are detailed in our filings with the SEC. Although the Company believes that its forward-looking statements are based upon reasonable assumptions regarding its business and future market conditions, there can be no assurances that the Company's actual results will not differ materially from any results expressed or implied by the Company's forward-looking statements. The Company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Readers are cautioned that any forward-looking statements are not guarantees of future performance.

With that, I will now turn the call over Sean O'Connor, the Company's CEO.

Thanks, Bill, and good morning, everyone. For those of you that listened to our last conference call, my introductory comments are going to sound very similar. Our second fiscal quarter played out very much like our first quarter, faced the same challenging market conditions with low volatility, low interest rates and generally a lower level of trades.

We did see a dramatic spike in volatility post quarter end more recently, which I'm sure you all noticed. And of course, it's always difficult to predict whether this will last. Although in my view, the world has become a more unpredictable place, and volatility is likely to be higher rather than lower in the future.

In this challenging environment and with some change in composition, our core activities again produced a positive result but still well below our long-term expectations. However, our ability to produce a positive result stands in contrast to many of our peers, and I think is a testament to both our strong commercial client base and our diverse revenue streams and flexible cost structure.

As Bill mentioned, we will focus our attention and comments on the fully marked-to-market non-GAAP numbers, which we believe better represent the commercial reality. Bill will take you through the details, but perhaps I could give you a high-level summary of how we see things playing out in the quarter.

Our results are significantly below our target return on equity. For the quarter and for the year to date, our ROEs is roughly 8%.

As we have said in the past, we have set our minimum target at 15% with a desire to make greater than 20%. As we said on the last call, we're likely to end the 2010 fiscal year below our target range, but expect to reach or exceed that target in the medium-term.

Dealing first with our balance sheet and liquidity, which obviously is a key issue in the current environment, on a marked-to-market basis, we have long-term equity capital in excess of $250 million and total debt, including our subordinated convertible notes, of $95 million with significant undrawn but committed bank lines.

At quarter end, we held cash of $75 million, of which $[50] million was restricted. Net borrowings were therefore $20 million.

During the quarter, we secured a $[38] million increase in the syndicated loan to INTL commodities.

Over the six months for the current fiscal year, the period to date, we have repaid total debt of $87 million, and our overall balance sheet grew modestly during the quarter, largely due to a $230 million increase in segregated funds.

One of the issues we've been focusing on since the merger is how to optimize and maximize the potential interest earnings from our customer balances. We believe that being exposed to more volatile short-term interest rates, which drive a significant portion of our earnings, is not a sensible business strategy, nor is waiting for higher rates to create better earnings, a solution.

We also do not believe that an ad hoc interest rate approach is a good way to go. This will result in speculative decisions which invariably lead to a bad result. So we have put some thought into this and subsequent to the quarter end, we have implemented a new approach to managing our interest-rate exposure, and the resulting earnings using interest rate swaps. The objective is for us to invest the bulk of our customer segregated funds in high-quality, short-term investments and swap the resulting variable interest earnings into a more stable, medium-term interest stream at the holding company level.

The objective would be to invest in a strip of swaps that mature every quarter that allow us to achieve the two-year moving average of the two-year swap rate. Management believes that this will both increase and stabilize the interest earnings in the long term.

Under GAAP accounting, we will have to treat the swaps on a marked-to-market basis, which may lead to greater reported volatility of earnings, which is really a timing issue. However, as we've always said, we run the business of the best economic results irrespective of how accounting treats that result.

In terms of our earnings, a couple of brief highlights. Revenues were largely unchanged from the first quarter. Our total non-interest expenses reduced about 9% or $5 million from the first quarter. Of our expenses, 55% of them were variable.

During the quarter, we had two nonrecurring items which increased pretax earnings by a net $0.8 million, this being a gain on the result of the de-consolidating Agora-X, and some losses relating to positions taken over from customers in the CES business.

Our net marked-to-market earnings for the quarter were $4.4 million, up slightly from the first quarter. And when I'm saying the first quarter, that excludes the extraordinary loss relating to the tax adjustment on the purchase accounting.

In terms of segmental results, it's probably best to make comparisons against Q1 as the merger distorts the year-ago results. The CRM business, which is our biggest segment, had slightly lower revenues, but a slightly higher net contribution in Q1. The FX business was down 17% in revenues from Q1.

Securities, although down significantly from a year ago due to both lack of volumes and tighter spreads, had roughly a similar result as Q1. And Clearing was down due to losses resulting from closing off some of the customers and assuming their positions.

This was offset by a better result in the other segment and that's where we took the gain on the deconsolidation of Agora-X.

In the next couple of quarters, we will start to focus on operational areas which should result in some ongoing streamlining and efficiencies.

Now that we are through the initial post-merger integration, the executive's team is focusing their energies on the following strategic initiatives, where we have started to make some early progress but there's a lot more to be done. Firstly, expanding the customer base globally to take advantage of the current cycle where most competitors are not aggressively expanding and mid-sized companies and corporations are looking for assistance. Our impression is that while we have made progress, there's much to be done, and the opportunity is truly enormous, and we are virtually unopposed at this stage.

The second broad strategic initiative is building out and expanding our capabilities. We have a commercial customer base of some 5,000 commodity producers or users with an increasing expansion internationally. Currently, we are not optimizing the margin we make from these relationships, and our objective should be to internalize as much of the current margin as possible and expand the relationships where we can to derive more revenue.

So some sort of examples of what we actually have done during the last six months to move these two strategic initiatives forward, the acquisition of the RMI team, which was announced at the beginning of April, has now been completed. The team is in place. And they bring with them a large and stable new customer base, which we can leverage into other products.

Additionally, RMI brings us real expertise in the natural gas market, which we can in turn leverage through our customer base. RMI customers account for a significant portion of the natural gas usage in the US, giving us a real insight and expertise into this market.

Australia -- we are now fully staffed and operational. Pete Anderson and some of the senior product heads spent a number of weeks recently having seminars around Australia, which were attended by over 200 of the largest commodity companies there, and we received a very good reception.

Singapore -- some other existing team were sent for orientation to Kansas City to learn about the FCStone business and are now prospecting for clients in Southeast Asia. They've already identified some interesting and large prospects which we are currently trying to onboard.

Dubai -- we have a new futures team in place in our Dubai office. They too have completed a period of time in Kansas City. Their focus is on [softening] their commodity customers in the Middle East, India and surrounding regions, and trying to expand our relationships with our metals clients.

Europe -- we have received our Dublin license, and we are pushing into targeted agricultural industries and making good progress in signing up customers.

In Africa, this seems to be a large and untapped potential for us. We teamed up with one of our FX counterparty banks and held a conference in Kenya, as an example. And we had 100 of the largest commodity customers attending with most having real interest in doing business with less.

Nigeria has been fruitful with a number of the largest local companies showing interest. And these are very large entities, both in the agricultural and in the energy sector.

In Argentina, we established a cash grain capability in our Buenos Aries office, which is already operational and dealing with the largest producers in the region. We have also relocated a risk management person from the FCStone site to spearhead that initiative in the local market.

In Brazil, we hired a senior individual to head up our Brazil operations. This is a key hire for us and will allow us to properly capitalize on the tremendous opportunity we see there in the agricultural industry, as well as foreign exchange, trading and investment banking.

On the Clearing and Execution side, we have just recruited a head of sales for our clearing business and are looking to expand and upgrade our client base, focusing mainly on midsize funds and institutions, such as the foreign banks we already deal with on FX and other products. The individual we have hired has a track record of growing clearing businesses at a number of very large banks.

So that's kind of some of what we've been doing in terms of building out the client base.

In terms of the other strategic initiatives, which is really to build out and expand the capabilities, our broad strategy is as follows, and we believe we've made some initial progress on each of these initiatives.

Futures trading -- we have an excellent infrastructure, we are members of most exchanges and we have good expertise. But we need to expand this to the rest of the customer base. This is a relatively easy and quick win for us and we have made good progress on this.

Physical trading, we already do a lot of this on the metals side, and we have now started to push selectively into the soft commodities markets, where we have come across some compelling opportunities. We'll now continue to ramp up and deliver this capability selectively to customers and opportunities where we believe we can make superior returns.

On the OTC structured products and market making side, we want to build a company-wide capability across all markets we trade to enhance our customer relationships by offering value-added and customized products or by providing liquidity to customers in smaller niche markets, something we have done well in the international equities market.

On the structured product side, we are already selling these products to our commodity customers, so there's nothing new there. But we need to internalize more of the margin ourselves and become less reliant on other banks and counterparties. This will allow us to both internalize more of the margin we make, as well as increase the scope and breadth of the relationship by ensuring we become a key financial counterparty to our customers.

We would like to expand our FX capabilities to provide OTC forwards and option products to our growing customers in overseas markets. There's a big potential opportunity for this in places like Brazil and maybe some of the African markets.

In all markets, we're looking to use our capital to provide our clients with liquidity where we can make good returns for the risk. We have started doing this with success in some of the less liquid commodity markets and look forward to expanding into new opportunities.

And lastly, the last capability in terms of sort of the way we look at our business is corporate finance and advisory. We have 5,000 corporate customers, many of whom could use advice on their capital structure, structured bank finance, debt equity and perhaps even advisory mandates. We also possess deep industry knowledge of each of the commodity verticals and deal with most of the players in these markets.

We have some of this capability already in-house, but without much effort, have generated a significant number of mandates ad closed some of these. We are looking to expand this capability more broadly.

So, expanding these capabilities in the way we envisage, which is really what is really globally and across all product lines, is a big undertaking and will take some time to complete and we think will transform the Company. Good progress has already been made, but we need to move faster and establish ourselves. The potential for incremental revenue is enormous, and at the same time, we can broaden and deepen our customer relationships.

So to wrap up, business conditions continue to be difficult and that is reflected in our results. But it's also a very important time for us as we do the internal and external work necessary to take advantage of the full power of the Company's newly combined platform. We're managing the short term but carefully preparing for the long term, where we believe good opportunities to generate exceptional returns await us.

And I will hand you over to Bill, where he will go through the financial results in more detail. Bill?

Thank you, Sean. Let me remind everybody, as I said at the outset of the call, that the fully marked-to-market numbers are not in accordance of GAAP. The difference between the GAAP and fully marked-to-market numbers arise in our Commodity & Risk Management Services segment. In all other business segments, GAAP results and marked-to-market results are the same.

As Sean mentioned in his comments, the merger with FCStone occurred on the last day of fiscal 2009, so I will be discussing primarily the result of the second quarter of 2010 as compared to the first quarter of 2010 as year-over-year comparisons would not include FCStone's results for the prior year.

Total operating revenues under GAAP for the second quarter were $68 million as compared to $59.6 million for the first quarter of 2010. Adjusted operating revenues, which include the marked-to-market adjustment in our Commodity & Risk Management business, declined by $2 million from $65.2 million in the first quarter 2010 to $63.2 million in the second quarter, as the difficult economic environment continued, resulting in continued depressed levels of volume and volatility in virtually all segments.

Non-interest expenses declined $5.1 million to $53.7 million as compared to $58.8 million in the first quarter. Exhibiting the variable nature of our business model, this decline was primarily a result of a $3 million decline in Clearing and related expenses and a $1.3 million decline in variable compensation.

Of our total noninterest expenses, 45% were fixed and 55% were variable in the second quarter 2010 compared with 43% fixed and 57% variable in the first quarter.

Compensation and benefits made up 43% of total non-interest expenses in the second quarter compared with 42% in the first quarter.

Interest expense declined slightly in the second quarter to $2.3 million as compared to $2.5 million in the first quarter of the fiscal year as the Company utilized income tax refunds to repay $25 million in subordinated debt during the quarter.

Now I will discuss the results in our various operating segments. As a reminder, the Commodity & Risk Management Services segment, which is our largest segment, combines the FCStone CRM segment with International Assets' physical metals business. This segment now houses all of our commodities activities, including exchange traded futures and options, over-the-counter derivatives and physical trading.

Adjusted operating revenues of $28.7 million were relatively unchanged from the $29 million reported in the first quarter. Exchange traded volumes declined approximately 20% in our soft commodity business, which encompasses all of the activity in this segment outside of the metals, as compared to the first quarter. However, over-the-counter volumes, which have higher margins, increased by 28%, more than offsetting the exchange traded revenue decline.

Elevated prices in the precious metals markets continued to constrain customer activity. However, revenues increased over first-quarter levels. Activity in the base levels business continued to benefit from the effect of increased customer demand and rising prices. However, overall revenues declined as a result of a reduction in arbitrage opportunities.

Adjusted Commodity & Risk Management segment operating income declined about $1 million from $9.8 million in the first quarter to $8.8 million in the second. For the quarter ended March 31, 2010, average customer segregated balances were $398 million in this segment as compared to $406 in the first quarter. The foreign exchange segment consists of the International Assets global payments and trading activities, as well as the FCStone FX activities, which consist of customer Clearing and Execution of spot trading, as well as a proprietary operation arbitraging cash and futures on foreign currencies.

Operating revenues in the second quarter totaled $10.9 million compared to $13.1 million in the first quarter. Operating revenues in the Global Payments business increased about $0.5 million from $5.9 million to $6.4 million, driven by continued growth in customer volumes primarily with financial institutions.

Operating revenues in the proprietary arbitrage and customer clearing ForEx business declined $2.7 million from $7.2 million in the first quarter to $4.5 million in the second quarter, primarily as a result of a decline in market opportunities in the cash versus futures arbitrage market.

Segment operating income decreased from $6.2 million in the first quarter of 2010 to $5 million in the second quarter.

Operating revenues in the Securities segment, which is a combination of the equity market making and debt capital markets business, declined $300,000 to $5.1 million from the first to second quarters of 2010. Difficult conditions in the equity markets, including the lack of both volatility and volumes, contributed to a decline of $700,000 to $4 million in the second quarter. While debt capital market revenues grew by $400,000 to $1 million for the second quarter.

Securities segment income increased slightly from $1.4 million in the first quarter to $1.6 million in the second quarter, primarily as a result of lower Clearing and related expenses.

Clearing and Execution Services remains as the historically reported FCStone CES segment. Adjusted operating revenues in the quarter were $14.5 million in the second quarter as compared to $16.1 million in the first quarter of 2010.

Exchange traded volumes in this segment declined about 2% from the first quarter to 6.3 million contracts. Average customer deposits in this segment were $661 million for the second quarter, which was up from the $527 million in the first quarter. However, interest income on these deposits continue to be constrained by low short-term interest rates.

Revenues for this segment were negatively affected by a $1.9 million trading loss on positions acquired from an under margin Clearing customer.

CES segment income was $100,000 for the second quarter as compared to about $900,000 in the first quarter of 2010.

Finally, the Other segment includes Internationals' historical asset management group and FCStone's historical financial services segment. Adjusted operating revenues were $2.3 million in the second quarter as compared to $2.2 million in the first quarter. Assets under management were $412 million as compared to $355 million in the first quarter.

Segment operating income was about $1 million in the second quarter as compared to break-even in the first quarter of 2010.

As Sean mentioned earlier, second-quarter revenues often include the $2.7 million gain on the deconsolidation of Agora-X, following our sale of 65% of our ownership share. As a minority stakeholder, we will no longer be required to consolidate Agora-X's financial statements as we will record our continued 15% share of their operating results on the equity method.

On a GAAP basis, the net income attributable to common shareholders was $7.4 million for the second quarter as compared to a net loss of $4.2 million in the first quarter of 2010. Adjusted net income attributable to common shareholders was $4.4 million in the second quarter as compared to $2.7 million in the first quarter. The adjusted net income for the first quarter of $2.7 million excludes the effect of the extraordinary loss in the first quarter.

Looking at our balance sheet, at March 31, 2010, total assets were $1.7 billion compared with $1.4 billion at the end of December 2009. This increase was primarily a result of the increased level of customer assets on deposits in the CES segment.

The balance sheet remains very liquid with total cash and cash equivalents of $74.8 million. 90% of our assets consisted of cash, cash equivalents, deposits, and receivables from exchanges and counterparties, financial institutions and commodities. Our commodities inventory increased $8.3 million from the end of December 2009 to $115.2 million at the end of March, 2010, stayed at the lower of cost to market value.

Borrowings, excluding the $16.7 million of convertible notes and the subordinated debt of $5.5 million, were at $72.3 million at the end of March, as compared to $16.4 million at the end of December and $108.7 million at the end of September 2009.

With that, I would like to turn back to Sean to wrap up.

Thanks, Bill. So in summary, current trading conditions remain difficult, and our short-term profitability is not where we would like it to be. That said, we think we're at a really interesting phase where there is a major opportunity to expand our customer base and enhance our capabilities. This requires additional investment in overheads at a time when our earnings are at a low ebb. However, we believe that this is an opportunity to accelerate when most others are losing money and throttling back.

We're through the initial integration phase and are now focused on these growth initiatives, not only as they are a great opportunity, but we have the capital, liquidity, as well as the infrastructure and a more robust credit process to move quickly to take advantage of this opportunity. None of this is easy, nor will it happen overnight, but the clock is ticking and this opportunity will not last in this form for very long. Once markets settle down, there will be more competition and it will be harder.

Delivering on all of this massive potential is a huge task and will take a lot of effort and some luck to execute properly, and not all of our initiatives will necessarily be successful. The management team believes that we have an opportunity to build a unique customer-driven organization with an unmatched set of capabilities and an extensive global customer footprint capable of generating very high returns for our shareholders in the medium to long term.

So with that, I would like to turn it back to the operator to open the question-and-answer session. Operator?

Chris Donat, Sandler O'Neill.

So Sean, I appreciate the comments you had, your concluding comments there about how challenging this -- how big the opportunity is. Can you try to give us a little more color on how you're prioritizing these tasks, because it seems like you went through a wide range of geographies, a bunch of different asset classes, and you did comment that not all will succeed. Maybe give us a little color also on the thought process on where you will cut something off if it doesn't look like it's being successful as far as investing your time and resources into it?

Okay. Well, the first thing I think we have an enlarged management team now post merger. And I think one of the things we did at the outset was make sure that we sort of allocated tasks out, so we did have more capability to focus on more initiatives. And I think that's worked really well.

And beyond just the executive team, we have a good group in place, which are highly capable individuals. So I do think we have greater capacity to focus on more initiatives, but you're right. We've got a lot of stuff going on at the moment.

So, and I really see them in two broad categories. On the customer side, Pete Anderson and the guys in the field are really pushing that hard. To a certain extent that's a market opportunity we think and we really want to put the hammer down on that side.

From the International Assets side, we had some infrastructure in place in some of these key markets which we can easily leverage. FCStone has kind of the expertise and we're trying to bring those two things together.

And so far, we're really encouraged. We've probably met must be close to 1,000 new customers in the last six months in one shape or another, and now we've got to convert those customers and converting customers takes time. And the reality is we're probably going to have to put some more boots on the ground in some of these geographies to focus on the customer.

So we've got all our country heads, all our office heads focused on their region. There's a plan in place. We've got internal people are at a senior level coordinating that effect.

And our view is all these things is just patient and persistent. We never run the Company for the next quarter's earnings or the next two quarters' earnings. We're running this Company to build a big company that we think can be seriously profitable. But at the same time, we don't want to burn cash. So it's kind of a juggling act. So that's sort of on the customer side.

And we've got a bunch of people in place, the local office heads, all of that running that side of it.

On the capability side, that, to a certain extent, is probably a longer build because we have to change the capabilities we have internally, systems issues and so on. And we're making progress on all of those. But it could be six to 18 months before we have the pieces in place that allow us to deliver on that. So, and that's sort of the end that I'm focusing on with some other people.

So I hope that answers your question. We're prepared to give some of these initiatives a fair degree of time to see whether they play out, but we never swing for the fences. These are a lot of initiatives with a modest spend on each one of them. And if we really don't see them turning around in the six- to 12-month period and breaking even and at least showing some milestones being hit, we cut them.

So, and we're going to have some of those that just don't come through the way we think. But certainly the signs at the moment are that all of our initiatives are showing early promise and to a certain extent a probably greater potential than we envisaged.

So our real issue now is execution. Can we just kind of get it done at this point? So I don't know if that helps you, Chris; did that answer your question?

That actually is very helpful. So, just to make sure I get it, for example, the couple weeks Pete and the team spent in Australia, I assume that was a decent chunk of the 1,000 new customers you are talking about?

Yes, there were 200, 300 customers that when there. And to give you a sense of it, we sent sort of four of our senior people over there. We have one senior individual who has actually spent close to a month down there, just sitting with those guys. We've hired a local staff of people who are all experienced in the business. So that was a big initiative for us. Pete and team had to go camp down there.

We sent one of the guys from Kansas City who understands how FCStone does their business. He's been there for three months. But we're starting to see that ramp up now. And they're really excited. The morale is high down there and I think a fantastic opportunity.

And that, to a certain extent, has been replicated in our Singapore office, in our London office, in Buenos Aries, in Brazil.

And in each of these offices, we have a local infrastructure and local people who are capable of picking that initiative up and pushing it. What we need to do is support them with the strategy, the expertise from wherever that resides, and that's a challenging process. But that's really kind of what we've got to work on.

Okay. And as we think about the expenses associated with an initiative like you have in Australia, it is something that could be dialed back pretty quickly if you are not seeing success or dialed up?

Yes. I mean this is an investment in people. And at the end of the day, if it really doesn't work you're going to have to let people go. And typically our approach is to keep, on the people side, the fixed compensation low and compensate people with a direct variable incentive.

So, the reality is, it takes six to 12 months before you know. That's just the reality. And most of these initiatives are sort of three, four people. Australia is bigger than that. We have more like 10 down there. But in some of the other places, we've hired two, three people, and once that starts to work, we will add on two more people and so we will build it.

The first objective is get to break-even and prove the theory that you can expand in the way we envisage. And then once you're break-even, then it's just a question of ratcheting it up at that point.

Okay. And then, one other question is maybe for you, maybe for Bill. On the interest-rate swaps you're going to implement starting the current quarter we're in, the marked-to-market on that, will that appear with your other marked-to-market adjustments? Or (multiple speakers)

I'm not sure we'll be able to do that to tell you the truth. And we will have to figure out with Bill how we're going to give good disclosure on that. And it's something that we're going to leg into this over the next eight quarters. So it's going to take some time for this to ramp up. And our approach is to do it in a very methodical, disciplined basis. But there will be some volatility between kind of the marked-to-market and the GAAP results. And the question is, can we pull that out for you so you can analyze it separately. And we will come back to you on that.

Right. And then as you say you're being methodical about it, so we shouldn't expect a step function in terms of the rate on an economic basis you generate on a --

No, I mean it's really what we would like to do, just to sort of explain it simply. When fully implemented, we will have one-eighth of our seg funds invested every quarter at the then prevailing two-year swap rate. So as we lag into that we should have a moving average, a two-year moving average of the two-year swap rate. And, we will just keep rolling that. So that's sort of how it will work.

Now obviously there are some moving parts because our seg funds move around and stuff like that. But that's how we would like to manage it. So this isn't us sort of waking up one day saying, oh, we think this is a good rate; let's kind of invest some of our seg funds in this. We're doing it in a very methodical basis.

And an underlying principle for us is if you look at the stats, you earn a premium at the two-year curve in the region of 85 basis points with a 95% probability over the last 20 years. Now, and why leave all your money on the short end which is the most volatile end when, with a 95% probability over a 20-year period, you can get an 80 basis enhancement over whatever the short rate is at the time?

And the other thing is, it will lead to a less volatile overall rate because short rates are much more volatile than the two-year rates. Now, clearly, you could take this to an extreme and say let's do everything at 10 years. But our view was that's probably too extreme for us because we do have some movements in the seg funds balances, and the longer out you go, the harder it is to kind of balance everything out and deal with all the moving parts.

So those are the sort of a very fundamental kind of approach which we think is going to be a disciplined way of us enhancing and stabilizing our interest return for the long term. This isn't something we're just doing now. We aim to do this and continue doing this.

Okay. And then from a regulatory perspective, there is no specific constraint on how far out you could go. You could get 10 years in theory, right?

We could get 10 years in theory. And the other benefit which we didn't talk about is we're not doing our swaps at the SCM level because you do have capital haircuts at the SCM level. And what we were doing to a limited extent and what FCStone did before as they were investing in the FCM down the interest-rate curve. But you have pretty severe equity haircuts when you do that in the FCM. And we just thought that was too expensive in regulatory capital.

So our view was free up all your regulatory capital. Make sure you've got a maximum amount of regulatory capital. And then, replicate this through swaps at the holding company level where we don't have a regulatory haircut issue. And this has freed up $20 million, $30 million potentially of regulatory capital at the FCM.

Now we've got huge amount of excess regulatory capital, but we always want to make sure that we are running our businesses to provide for the most flexibility on regulatory capital. So that's the other benefit we get.

Okay. That's very helpful. Thanks, Sean.

Chris, just to clarify one thing on the marked-to-market. We call out the marked-to-market on the commodities business right now because that's non-GAAP.

Right.

For GAAP purposes, we're required to carry a lower cost to market. As Sean pointed out in his prepared comments, these derivatives will not -- that we're putting on in the interest rates -- will not qualify for hedge accounting. So for GAAP basis, they will be marked-to-market and on a period to period basis, so. And we will -- we can certainly talk to what that change in marked-to-market is. But it won't be called out separately in the adjusted numbers in the manner that our commodities business is because it will already be in the GAAP numbers, the marked-to-market movement there.

Okay. I think I got that one there.

Are there any other questions, operator?

Graeme Rein, Bares Capital.

Sean, have you seen anything from a regulatory standpoint that's especially worrisome, especially as it relates to the OTC markets you guys trade in? Any sort of centralized clearing? Anything on that front that would affect your business?

Other than just reading all the stuff makes my head hurt, actually, because it seems to change every time.

Just from a big picture point of view, clearly something is going to happen. There's going to be some changes and we will have to deal with those changes as will everyone in the industry.

I guess the way we think about it and the things we've got going for us is our core customer base is a commercial customer base that is looking to hedge a real commercial business. And I think a lot of what the regulators are trying to do outside of just I guess kind of the issue with derivatives, is also in the futures market there's an issue with speculation in the futures market. So there's sort of two things going on.

I think certainly the -- it seems like they want in some way curb or restrict speculation and hedge funds sort of pushing markets around and so on. And given that we have a real commercial business, I think we are in a good place as far as that goes. I think some of -- you may find that some of the changes may affect the speculative investors or the people who have speculative customer bases, primarily. So that's a good thing.

The second thing is, there's probably going to be more capital required generally in the business. The futures business or OTC business there's going to be more capital. We have a large amount of surplus capital available to us for this. So to a certain extent as that happens, that's not a major concern for us up front. I think that may be a major opportunity because I think some of this business is very fragmented. And if it gets driven to bigger shops that have more capital, that's probably going to be good for us. And I think what will happen is it will become a more profitable business, because as you consolidate the business, spreads will widen and we will make more money. And I guess the regulators really need to think about that.

The third thing is, we are truly a global business. We can domicile a balance sheet to do any one of our businesses in almost any location in the world. Our FX business runs off our London balance sheet. We could have business booked in our Singapore balance sheet. So we have sort of a flexible structure as far as that goes.

So I think we've got kind of a lot of things we can do to mitigate or deal with some of the regulation. So it's not -- it's not hugely scary to us from that point of view. But one doesn't know what's going to happen when there's a change, and a change is always disruptive. And I think there is a scenario that says it might be very good for us, actually. So we'll just have to wait and see.

But it's hard to try and set a strategy in advance for what regulators may or may not do. But we think we can handle most anything that comes down the pike. But we'll have to see what it is. I mean Pete is on the call. Pete, do you have any other comments on that?

I think the real issue is from a clarification standpoint, I think most OTC products are going to be cleared. And it's really -- we'll just have to define. And those are really vanilla look-alikes and we will really have to get clarification and definition as to what structured products mean. And that's just a process.

And over time, how it will affect us is yet to be seen. And if it does to too large an extent, than there's a lot of it can be done in the [physical] markets as well.

That's another thing I didn't mention. We're one of very few players out there who has the combination of capabilities I mentioned in our call. We do futures. We do OTC and structured products. We do physical and we do advisory. I don't really think there's a comparable company out there that can offer all of those capabilities. And we're not there with all those capabilities.

But on the physical side, it seems to us that any sort of regulation is going to allow you to deal with it outside of a regulatory framework if it's attached to a physical commercial contract. And we can do physical. So we're sort of in a unique position with our physical capabilities. So that's another thing we have going for us.

Okay. You mentioned -- obviously volatility has been up in the last week or two. Are you sensing conditions are changing or kind of just a blip on the radar? And then kind of the follow-up to that is, what sort of exposure do you have to what's going on in Europe? And how does that affect any one of your business units?

Well, it's interesting because a week before you had the Greece and the market disruption, I was watching the TV and they sort of said well the VIX has hit the ten-year low. And the only thing that I'm kicking myself was I didn't buy the VIX right there, because as soon as it hits the low, you know that something is going to happen.

So, the markets move in cycles, and I think clearly that the volatility is being dampened down as people have sort of hunkered down over the last crisis, but I don't think we're out of the woods yet. And it just seems to me the world is just generally a more uncertain and unpredictable place. And I think there's just going to be more volatility than there has been in the recent while.

Now, that will cycle through and we will have ups and downs in that. But volatility is typically good for us. The last week we saw a big spike in volumes and profitability for us. I mean volatility, not extreme volatility, but an increase in volatility is good for us.

In terms of our exposure, we don't have any real exposure in Europe. The one thing that could be a benefit is our cost base in London could go down in dollar terms as the pound comes down, so that might be helpful to us. But you know, we don't have any meaningful exposure. We don't run outright market positions. So we don't speculate in the markets. But volatility generally causes people to think more about their risk and causes them to want to do something about their risk. And that's what we want them to do, so.

Okay. And then the last thing, since the merger, you guys have sort of reported adjusted net income as opposed to adjusted EBITDA. Are you thinking about the business any differently or is -- you just kind of -- is adjusted EBITDA still the best way to evaluate sort of the operating performance?

Well, I don't know kind of how to say this properly, Graeme, but we've had kind of a long discussion with the SEC on that topic and we didn't win the debate. So, the SEC has reviewed our filings, and they've said that they do not want us to use any more pro formas, which is really showing FCStone and INTL combined historically. We think that it's fundamentally misleading not to show that to our shareholders, but they don't want us to do that.

And they've additionally told us they don't like is using an adjusted EBITDA number because they say EBITDA isn't a GAAP number and you're adjusting a non-GAAP number. And that's problematic from their point of view.

Our view is, would like to put as much information out there and allow you guys to draw your own conclusions. But unfortunately we have to deal with both accounting and SEC requirements, sometimes none of which make commonsense. But unfortunately that is just what we have to deal with.

Okay. Well thanks for taking my questions.

Any more questions, operator?

I'm not showing any other questions at this time.

Okay. Well, thanks, everyone, for joining our call. And we look forward to speaking with you more about what we're doing in three months' time. So thank you.

Ladies and gentlemen, this does conclude today's program. You may now disconnect and have a wonderful day.