Your ETF Is Masking an M&A Boom as Rule Favors Mega IndexersBy
EU regulations will require benchmark providers to register
Cost and labor to comply may fuel further consolidation
What’s the next big trend in passive investing? Index merger mania.
The wave of consolidation that’s washed over companies underpinning exchange-traded funds and indexed mutual funds increasingly looks like a fight to the death. And it’s all because of a new regulation that’s complicating the business of benchmarking.
Starting in January, indexes used within the European Union -- whether to operate passive ETFs or gauge the performance of active managers -- will be overseen by national regulators. So will the indexers themselves. That’s a huge compliance headache, adding costs to a business undergoing a sensitive fee compression. And it may push some providers to put themselves up for sale.
“If this becomes too onerous, you will force consolidation,” said Rick Redding, chief executive of the Index Industry Association, which represents independent benchmarkers. “You don’t want to wake up in 10 years and have just a handful of providers.”
The industry has already contracted significantly since 2014, when a tie-up between London Stock Exchange Group Plc and Russell Investments Ltd. created FTSE Russell, one of the largest global providers of indexes. Since then, Atlanta-based Intercontinental Exchange Inc. has bought Bank of America Merrill Lynch’s widely used bond indexes, while Bloomberg LP, the parent of Bloomberg News, has acquired Barclays Plc’s benchmarks. With a new batch of takeovers in the cards, investor choice could narrow even further.
Libor Scandal Reaction
“It may be a challenge for index providers with more limited scale,” said Waqas Samad, chief executive of fixed-income and multi-asset benchmarks at FTSE Russell. “When regulation comes to bear, you need to have some degree of investment and scale to be able to deal with it robustly. Otherwise it can become too costly a component of the operation.”
The rule isn’t intended to price companies out of the business. Rather, it was enacted in the wake of the Libor scandal and allegations that currency and commodity benchmarks were manipulated. The EU Benchmarks Regulation was designed to remove conflicts of interest and boost transparency.
But the rule has contributed to a growing sense that indexing ultimately will be the sole province of the mega indexers. This helps explain why UBS Group AG sold its convertible bond benchmarks to Thomson Reuters Corp. in 2014, HSBC Holdings Plc transferred its Asian bond indexes to Markit in January 2016, and Citigroup Inc. sold its fixed-income gauges in May.
“You stop some competition because, in the end, you need to be a big index shop to comply with everything,” said Steffen Scheuble, chief executive of Solactive AG, a Frankfurt-based indexer. “It’s a little bit prohibitive for smaller shops. My feeling is that there will be continued consolidation, but we should just keep in mind that there’s not an unlimited number of assets out there.”
Asset managers that have built their own indexes may however also have to think about spinning those off. ETF issuers including BlackRock Inc. and Charles Schwab Corp. have started self-indexed funds this year.
All companies that offer indexes within the EU must comply with the new rules. Those based in the bloc are required to register with, or seek authorization from, a national regulator to act as an index administrator. Meanwhile, those located outside the region must seek recognition as an administrator or have the indexes they offer in the region endorsed by an EU administrator. A list of approved administrators and indexes will be compiled by the European Securities and Markets Authority.
That kicks in this January, but established providers have time to get their houses in order. Those doing business before June 30, 2016, have until January 2020 to register with a regulator and can continue providing benchmarks -- including new gauges -- throughout the transition period.
Handful of Providers
The rules impose oversight and reporting responsibilities that vary depending on whether a benchmark is deemed critical, significant or non-significant. And give regulators the ability to punish offenders.
That’s a costly and labor-intensive proposition. Solactive created a new position for a chief risk officer earlier this year, hiring Christian Vollmuth to take responsibility for legal, compliance and regulatory affairs and appointing him to the management board. FTSE has directed its governance groups to look at it, according to Samad.
S&P Dow Jones Indices said it’s “focused on implementing any required changes.” And MSCI Inc. “has been actively monitoring these developments and engaging in dialogue with the relevant parties,” representatives for the two companies said, without giving further details.
Indexing’s Big Three -- FTSE, S&P Dow Jones and MSCI -- are already facing pressure to lower the licensing fees they typically charge funds to track their benchmarks. For smaller indexers that have less room to negotiate, the extra expense could prove fatal.
“It fundamentally changes that relationship between the product issuer and index provider,” said the IIA’s Rick Redding. And, with companies still rushing to comply, “there’s going to be a lot of conversations happening in December.”