In the second part of an interview John Davies, global head of exchange-traded products at S&P Dow Jones Indices, tells SRP about the impact of regulation, the deregulation of the offshore CNH segment and the firm’s plans in the APAC region.
Do you think the regulation around benchmarking will impact negatively the index market?
Regulation is like taxes – it is ultimately good for the end investors in that it ensures market participants strive to operate with integrity. In light of the Libor-rigging scandal and ongoing product mis-selling cases, regulators are very much concerned about the lack of transparency and conflicts of interest inherited within the indexing space. Regulation is challenging as it potentially changes the way index providers operate their businesses. For us it means further documentation for our procedures and processes, and [the requirement] to continuously separate the commercial side of our business from indexing, structuring and management. The challenge is to understand exactly the legal framework regulators are trying to put in place and the full implications for index companies on both a business and product level.
What has changed since the implementation of new rules?
The challenging regulatory landscape is one of the drivers that led to the creation of the Index Industry Association (IIA) a couple of years ago. This trade body has a mandate of promoting industry standards of best practice and educating investors on the attributes and roles of indices within the investment process. There is a distinction in the regulations that are applied to the investment product which use indices and it means index providers have to engineer their indices in a certain way that supports the product so that the product itself will be compliant. The other aspect of regulation is applied to index providers as a business with the latest one coming out at the beginning of July on how index businesses should be structured and operate in the area of due diligence, process documentation, auditing, valuation and so on.
What is your view on the upcoming benchmarking guidelines announced by Esma?
The new EU benchmark regulation will address concerns about the integrity and accuracy of benchmarks by regulating administrators of benchmarks, contributors to benchmarks and benchmark users. However, the adoption of the Volcker rules that prohibit banks from conducting certain proprietary investment activities with their own accounts will also have wider implications as banks running their own proprietary indices might need to reveal that part of the business and face much stricter oversight if not an outright ban. From that perspective, being fully independent and transparent in our business process in terms of pricing and calculation methods for our indices is indeed a huge advantage, not only for us as a business but also for our end clients.
Do you think the deregulation of the offshore CNH segment will create opportunities for the development of new CNH indices?
China in general is a growth area for the indexing business. The recent opening of onshore CNY derivative segment and relaxation on offshore CNH markets has been positive, in particular the increase in the quota of Renminbi Qualified Foreign Institutional Investors (RQFII) investments in Hong Kong, Singapore and Taiwan. The fact that they now allow RQFII products to be registered outside the mainland in London and New York is also very encouraging for us. International investors we work with are showing interest in developing products linked to onshore securities as opposed to creating indirect exposure through the FTSE A50 Index. Having direct access to A-shares and the local currency is what investors have been longing for. The mutual market access agreement between the Shanghai Stock Exchange (SSE) and Hong Kong Stock Exchange (HKEX) has in fact facilitated this development by allowing the transfer of funds across borders and more efficient capital resource deployment.
Is there a downside to this development?
We have been waiting many years for the mainland market to open up and despite recent bold steps towards deregulations the depth of market access is still relatively limited to warrant a massive strategic maneuvre by index providers. Also, it is still a quota-based system and strictly dependent on mainland policies adding an extra dimension of uncertainty. While there is certainly demand for structured products leveraging on the China theme, providers should be mindful not to flood the market with the same structures and run into over-capacity issues should the quota system reverse.
We have had a presence for many years in China and originally had a strategic partnership with CITIC Securities and we now have a full product range spanning H-shares and A-shares, with fixed income underlyings in the pipeline. From our client conversations we know that issuers of ETF and structured products are quite excited at the opportunities presented by CNH index products in Taiwan and China. Our strategy for the CNH segment is to work directly with product providers themselves and to provide them with the tools and building blocks that help them construct what is required in each local market.
Are there any particular markets where S&P Dow Jones is looking to increase its activity?
We take a holistic approach to our expansion in Asia. Australia, China, Hong Kong, India, Singapore and South Korea are indeed all key markets to us, and we expect to expand our reach and increase activity in all of these markets. For instance in Australia with the recent expansion of our team we aim to capitalise on the opportunities from the country’s massive superannuation fund segment, and in response to the recent change of regulations the financial adviser segment we have channel managers to actively engage in this particular segment. We have also developed good relationships with the Korea Exchange (KRX) via a number of partnership agreements and plan to further enhance this relationship and increase our indexing business there. We also work closely with the Bombay Stock Exchange (BSE) to build our capabilities in India, and we have a sizeable team in Hong Kong managing business development in the region. In South Asia, we have dramatically expanded our geographical footprints onto Malaysia, Philippines and Thailand.
What are your short-term plans in the region and what opportunities are you looking for?
Our strategy going forward is to leverage on our local market expertise and satellite infrastructure, where by default we have the core set of indices following some standard criteria such as market capitalisation methodology and all around it we have different versions based on different strategies and weighting criteria unique to the local markets. This approach can be applied to any market or across asset classes. We also think structured products are essential to our business thanks to the high issuance frequency and constant demand and production pattern. They are a very key part of our business and enable structuring possibilities to meet the diversity of investor needs – be it asset allocation, risk management or yield enhancement.