Following a recent meeting of the Index Industry Association (IIA) in London, SRP caught up with its chairman Alex Maturri (pictured) - who is also the chief executive officer at S&P Dow Jones Indices - and chief executive, Rick Redding, to discuss the trade's body most recent activities and the challenges and opportunities in the index market as a result of the upcoming regulatory overhaul.
The increasing pressure from regulators targeting conflicts of interest in the financial markets and the uncertainty around the impact of the new benchmarking rules have forced some investment banks to review and offload parts of their proprietary index businesses. The biggest trend [in the index market] is the fact that an increasing number of investors are moving away from some of the banks involved in the index business because the fear of the unknown around regulation, says Maturri.
"This has benefited independent index providers," he says. "Because of S&P DJI's business model investors feel more confident in what we offer than getting a similar product from a bank. We have seen already a number of banks lining up to offload their index business and some have already changed hands (Barclays/Bloomberg). We think this trend will continue and we're in a good position to capitalise on any opportunities arising in this segment to continue to capture market share."
According to Redding, banks are feeling the pressure of the regulatory overhaul but not only around benchmarks. "Banks are having to address many issues around their business model, and as we have seen the pressure has forced some banks to exit the index business or partnering with third party calculating agents to address the conflict of interest around creating indices for their own products."
The main consequence of this drive towards a regulated environment is the consolidation of the market, says Redding. "We believe this will continue. Regulation is needed to have a functioning market but regulators must be aware that over-regulating could impact investor choice and the competitive landscape could also be damaged," he says.
The number of regulatory issues under the radar of industry watchdogs and the ramifications of the different rules and regulations suggest that "this will continue for some time".
"We are moving from the discussion stage to the implementation stage around some of the main pieces of regulation. We will see how these new guidelines pan out and impact the industry as a whole," says Redding, adding that thee competitive pressure has also triggered a search for innovation over the last few years, "and that is a positive outcome".
Competition seems to be getting increasingly tight in the index market with the arrival of new players such as Bloomberg, and smaller niche-type providers such as Solactive, Finvex or Bluestar. "For us competition is healthy and keeps us on our game," says Maturri. "Some index providers have sat back and continued doing what they did with their licensing business. Some did not realise that to have a competitive edge in this market you have to be first to come to market with some of these concepts, you have to find the right partners and support what you do with research, white papers, etc."
According to Maturri, some of the most recent developments (Barclays keeping some parts of the index business and selling other parts to Bloomberg) are very interesting and no one knows how they are going to play out. "With some of the new entrants coming into the market (Bloomberg one of them) you don't know what their business models are going to be," says Maturri. "We have seen a shift in the equity index business which was pretty much run from the traditional side of the business model but in fixed income the business model is different and more focused on trading."
As a result, says Maturri, some of the providers had to establish how to make money in a different way. "It is not clear yet what direction some of the new players are going to take," says Maturri. "With consolidation there are always losers. Scale becomes more important because it gives you capabilities around research and distribution and those are very important elements to have a successful index business."
New entrants to the market have been welcomed from many quarters for their ability to tap into new opportunities very quickly and offer a competitive service, but there are issues around regulation that could put smaller firms at odds with new developments, and is important to establish who is offering what.
"The issue with small index providers is not about their ideas and unique IP, but about meeting regulatory burdens, the separation of functions, etc.," says Redding. "There is a cost for index providers to do business and smaller providers may find it difficult to meet some of the requirements. Regulator's starting point when they began to look into benchmarks was that all indexes are the same, like Libor, and we disagreed because they did not considered the different business models but they now understand that survey indexes are different to indexes priced on equities or from traded prices on regulated trading venues."
"We acknowledge that regulators have come a long way from their original approach of putting the whole index segment under the same light," says Maturri, pointing that the Iosco principles have been adjusted to clarify where the industry stands, "and regulators are now understanding what the role of independent index providers is".
According to Maturri, at the same time, banks have started to get rid of their index business or outsource some functions (third party calculation) to address conflict of interest. "One of the problems we found is that people have forgotten that these indexes started as benchmarks, and all of a sudden the indexes are getting confused with the products," says Maturri. "We have spent a significant amount of time demonstrating to regulators that products come on many different forms and are regulated different across jurisdictions, but a given underlying index will be the same regardless of the wrapper."
According to Maturri, the association has put a good deal of effort "in explaining to regulators that their focus should be on how the index is put together and what safeguards are in place".
"We think we have been successful in helping regulators understand how indexes are used in different market functions," says Maturri.
Regulation should not be a problem as long as you have legal certainty about what can you do and what not, but there are still issues to be addressed around cross-border implementation. "Most market players in the indexing industry are global institutions and we have seen some discrepancies between US and European firms," says Maturri. "It is becoming increasingly difficult for administrators to deal with the different approaches in different jurisdictions."
The amount of rules to comply with has also had an impact on innovation which "has been somehow limited because the cost of compliance to do due diligence on a good idea could be too high", according to Maturri.
"Regulation to stop products that only offer value to the issuer or the distributor being pushed is good for the market," says Maturri. "Fiduciary standards in this context makes sense. Products should not be sold on the basis that makes the issuer the highest possible money but on the basis that will help clients achieve their goals."
Reputational risk has also come to the fore and some financial services providers have already retreated or scale down their retail operations. "If regulation becomes too much of a barrier investors could move offshore and that would defeat the purpose of regulation," says Redding, adding that the mandate of the association is to cover all these issues. "There is also a danger of having an unlevelled playing field across the globe with different approaches. We do recognise the challenge for regulators to standardise some of the rules, and that's why we engage with them regularly."
According to Redding, however, the association's work and engagement with regulators will continue as "when it comes down to the detail it is very difficult to have a standard blanket-rule that is applied across markets".
"For example, the Iosco principles went through a process of consultation and evolution because the regulators found out that no country in Apac has a common whistle-blower provision, and that the rules in Europe and the US around whistle-blowers are different," says Redding. "The association is playing a key role in coordinating a message and delivering it with one voice, although the individual firms can continue engaging with the regulators to address their own concerns. Not every member of the association is going to agree on 100% of every issue because there are different business models, but having a trade body that represents the industry can only be positive not only because it can help to shed light on issues affecting the industry but can also educate."
Quality of benchmarks should not be seen as a one-off process, Iosco
Benchmark regulation release marks a dark day for transparency, Edhec
S&P DJI: Structured products are essential to our business
IIA outlines 'best practices', adds three members