Index Industry Association
Position statement on the European Commission proposal
for regulation of indices used as benchmarks
Over the past few decades, indexes have provided much needed transparency and cost efficiency into markets and asset classes that would have been otherwise inaccessible or opaque. Indices have proved to be fundamental to maintaining and growing a vibrant and robust global marketplace by being used as a reference in a wide range of investment products. The robust development of the ETF market based on the underlying indexes would not have been possible without independent benchmark administrators.
Institutional investors use indices as an information resource for obtaining reliable and clear updates on market developments and investment performance. Index-based products provide investors with new sources of diversification and access to asset classes normally unavailable to them. Markets benefit from the increased liquidity and investment that result from index-based products, which can be offered at lower cost to investors given these various uses. Benchmark administrators calculate and provide a diverse range of indices that differ in scope, methodology, and use.
An “ecosystem” of index investing has evolved over the decades and includes data providers, benchmark administrators, and product providers (including asset managers), providing investors with the most transparent, cost effective, and diverse set of investment opportunities. Independence in each of these functions provides the greatest protection for investors by reducing conflicts of interests. Creating and maintaining quality indexes requires an independent research function, robust governance, and strong operational and IT processes.
IIA believes the IBOR scandals have inappropriately skewed the discussion about indexes and caused many in the global regulatory community to view all indexes through the same lens as the IBORs.
1. Executive Summary
The IIA agrees that after the issues surrounding LIBOR and EURIBOR it is important to restore investors’ trust in the marketplace. IIA welcomes and supports the inclusion of benchmark manipulation in the framework of the Market Abuse Directive. IIA believes the IOSCO Principles for Financial Benchmarks made strides to address many of the concerns in a pragmatic, proportionate and measured fashion acknowledging the complexities and breadth of indexes. Many IIA members are currently taking steps to align their operations to the IOSCO Principles.
The Commission proposal, however, would regulate indexes much beyond the IOSCO Principles and would foster a major transformation of the industry in a way that would be detrimental to the interests of end investors. IIA’s concerns with the regulation include:
- Requiring data contributors to submit to legally binding codes of conduct (Article 9)
- Requiring all input data used to calculate benchmarks to be made publicly available immediately following publication of the benchmark (Article 16)
- Prohibiting indices published by third country administrators from being used by EU supervised entities unless the Commission has recognized the third country’s supervisory framework as equivalent to the Commission’s own rules (Article 20)
- Requiring registration and supervision of index administrators both by national competent authorities and under the coordination of ESMA is confusing and lacks clarity (Article 23)
- Imposing fines of up to 10 percent of total annual turnover, regardless of fault or negligence, in the event of a breach of the regulation (Article 31)
These provisions will cause index administrators, asset managers who provide products, and ultimately end-user investors to suffer reduced choice and more expense, for little tangible benefit.
Of significant concern is Article 16, which would require benchmark administrators to publish both the data they produce and the data that is contributed by third party data providers, for free and in the public domain. It thereby asks benchmark administrators to incur costs without the benefit of their intellectual property which is developed or acquired at significant cost and effort. Article 16 also impacts the intellectual property rights and confidentiality of data contributors globally, whose data is used in benchmark creation and calculation.
For reasons explained in the next section, the IIA is concerned that some provisions would not serve the intended purpose of ensuring that the index industry operates in a manner that is free of manipulation and protects investors and consumers. While the proposal captures many positive elements of index governance found in the IIA Best Practices, some of the provisions may hurt investor choice, without resolving the issues around conflicts of interests while leading to higher costs and less choice for investors. We have set forth below our concerns about the adverse impacts that the Commission’s proposal would have if adopted in its present form.
2. Detailed Analysis
a. Data Contribution
We are concerned that requiring benchmark administrators to impose burdensome requirements upon their data contributors would foster reluctance to contribute data to index administrators and could have an adverse impact on the robustness of the data available for use in connection with indices. IIA members already have processes in place to ensure that they use reputable data providers with proven track records. We are concerned that the provisions proposed by the Commission, notably the requirement to establish a legally binding code of conduct for unregulated data contributors, would disrupt our members’ existing contractual relationships with contributors (many of which are long-term) and create disincentives for contributors to enter such relationships.
Index administrators are unlikely to be able to impose these rules upon their contributors. For indices whose contributors are securities or commodity exchanges, those entities are already among the most regulated in the world. The relatively small customer base of index administrators could unlikely force significant changes. For indices whose contributors are not regulated, a legally binding code of conduct and wide redistribution would discourage the contributors’ participation in indices, thereby reducing the availability of data along with the transparency of the markets. This could be detrimental for the wide range of indices offered in Europe, which serves as the basis for European index-based investment products. Sources of data for such indices may not comply with the proposed regime.
b. Unlimited Transparency and Related IP Issues
The requirement for index administrators to publish all input data used to calculate their indexes could negatively impact the selection and quality of indices available for use by investors in the EU. It could also lead to discontinuation of currently provided benchmarks.
The requirement to publish input data is an unwarranted regulatory taking of proprietary data with commercial value. While input data is available from the contributors with the purchase of an appropriate license, the publication requirement would deprive contributors of the commercial value of their data and reduce their incentive to provide data for indices. We are concerned that many contributors would elect not to license data to index administrators if the consequence of doing so were a mandatory disclosure obligation that would eliminate other data licensing opportunities. This requirement is thus more likely to disrupt the effective functioning of the markets than to increase transparency. For indices whose constituents are not financial instruments, it may not be feasible to publish them all (e.g. millions of individual home prices underlie real estate indices).
Requiring publication of input data would be of no appreciable benefit to investors because the information necessary to inform their investment decisions is already provided by the financial product provider where the product references the given index. IIA believes investors should know the holdings in their investments, not the data going into them, which is unusable to them. The banks and asset managers who license the index data are better equipped to conduct the appropriate analysis of indexes. Publishing billions of points of data does not fulfill the mission of greater transparency, but creates data overload and confusion. The European Central Bank agrees with this assessment in its comments on benchmarks dated 8 January 2014. (ECB Opinion on the Benchmarks Regulation)
The effects of requiring the publication of index data into the public domain will lead to a reduction of the quality of indexes. Lesser independent indexes will be of inferior quality because of lower levels of research and strong IT and operational processes. This will lead to vertical integration or “self-indexing” by banks and asset managers who provide the products, thereby creating more of the same types of conflicts of interests EU regulators are trying to eliminate with the proposed IBOR regulation. It will also harm independent index administrators who operate without such conflicts because they do not participate in the markets they measure and issue financial products. A vertical model will also decrease transparency and cost efficiencies of markets. Each fund would end up needing to track its own benchmark, comparisons between funds would be reduced and performance assessment would become deficient; all to the detriment of end investors.
However, IIA’s Best Practices fully support the retention and sharing of data for regulatory purposes.
c. Third Country and Extra-Territoriality
In the proposed regulation, a supervised entity within the EU could not use a benchmark provided by a third country administrator unless the home country enacted regulations the Commission deemed “equivalent”. However, several global regulators, including the US, have already expressed their reluctance to issue binding regulations, which could result in European investors losing access to existing benchmarks that have been in use for decades.
The IIA supports an approach to the difficult issue of extra-territoriality by simply requiring index administrators outside the EU to certify compliance with IOSCO Principles to ESMA. This would ensure sound principles are being followed and would reduce the enormous administrative burden for both the European Commission and ESMA under the current proposal.
d. Registration Requirements
Beyond the extra-territoriality problem discussed above, the Commission’s proposal to require authorization of benchmark administrators and registration of financial products based on indices is confusing and onerous. Apart from creating confusion as to what powers would be delegated to national authorities as opposed to ESMA, such registration requirements will hinder the development of products demanded by the market.
IIA suggests streamlining the procedure in order to minimize the burdens and costs for the industry as well as for the authorities, while safeguarding the overview of the market by authorities. IIA proposes that ESMA fulfill the role of a “single point of contact” and that registration is required for the benchmark administrator rather than requiring registration of every individual benchmark, just like Alternative Investment Fund Managers are authorized instead of every Alternative Investment Fund. The objective is to ensure application of high-level standards in line with the IOSCO standards in the creation of the index. The crucial issue is that the benchmark administrator is registered with ESMA.
IIA is of the view that the powers granted to competent authorities in this section could have a harmful impact on innovation and competition. For instance, the power to demand phone records, freeze assets, and temporarily prohibit trading or professional activity – seemingly without due process for the benchmark administrator – would have a destabilizing effect for end-users of indices and drive up costs for investors. These customers would be left to wonder whether an administrative sanction might shut down an entire set of investment products when no actual issue with the index has been proven or adjudicated.
The fines that may be imposed upon a breach of the proposed rules – again without apparent due process – are extraordinary in size. A fine of “10% of [the index administrator’s] total annual turnover” would, for many administrators, amount to tens of millions of Euros, a disproportionate penalty for violation of an administrative rule. Moreover, the proposed rules appear to hold administrators strictly liable for breaches, with no limitation of sanctions to cases in which the administrator has been found negligent or otherwise at fault. These concerns are compounded by the fact that the legal instrument is a regulation, which is directly applicable and will not be implemented in national legislation.
The IIA suggests the adoption of the fundamental rights and due process provisions already in EU regulations in the Charter of Fundamental Rights of the European Union Articles 7,8, and 47 to this proposal. Also, an Article 32a could be adopted allowing for right of appeal.
The Index Industry Association (“IIA”) was founded to represent the global index industry and the needs of investors by developing and promoting practices that strengthen markets by advocating the highest level of ethics and integrity. Many of the leading independent index providers in the world are members of the IIA, including Barclays, the Chicago Booth Center for Research in Security Prices (CRSP), FTSE Group, Markit, MSCI Inc., NASDAQ OMX, Research Affiliates, Russell Investments, S&P Dow Jones Indices LLC, and STOXX Limited. IIA members calculate millions of indices for their clients, covering a number of different asset classes, including equities, fixed income, and commodities.
Part of the IIA’s mission is to consider ways to promote best practices for index providers, which makes it a natural supporter of appropriate and proportionate industry standards. (The IIA’s Best Practices can be found at www.indexindustry.org). Our members are dedicated to promoting transparency, sound operational practices, intellectual property rights, education, and effective index management practices.
IIA emphasizes that its members take the inputs for their indexes from a regulated exchange, or are constituted from actual market data from other sources, or consist of an objective estimate anchored by actual market information, as opposed to an estimate or opinion of a price at which a transaction might take place. Moreover, our members publicly make available methodologies, explain how their indices are created, calculated, or maintained. Therefore, the indexes published by members of the IIA differ fundamentally from the IBORs.