SPECIAL REPORT: SHARE INDICES


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market, which have significantly opened it to international institutional investors,” MSCI said in a blog written at the time of its inclusion in December 2020.


// THERE HAS BEEN A PROLIFERATION OF SPECIALIST INDICES WHICH ARE EASIER TO BEAT //


“These include the removal of


foreign-ownership restrictions on listed banks, simplification of requirements for investor registrations, improvement of the clearing and settlement mechanism to help prevent failed trades and an improved false-trade mechanism to limit brokers’ access to investors’ custody accounts.”


REGULATORY RUMBLINGS The US Securities and Exchange Commission (SEC) is assessing whether to tighten rules on index providers due to their growing influence on global asset management. The regulator, chaired by Gary


Gensler, is investigating whether companies such as MSCI, S&P Dow Jones Indices, and FTSE Russell should be reclassified from information providers to investment advisers, which could have profound implications for the way they are regulated. Such a change would mean index


providers could be treated the same way as fund managers under the Investment Advisers Act 1940. In a June 2022 statement, SEC


Commissioner Caroline A Crenshaw puts the question of reclassification to the public, speaking of the “prominent role” that index providers play in the asset management sector. Citing results from a global benchmark survey, she adds that in 2020 there were approximately three million indices, ranging in type from broad-based to narrow, customised, or bespoke for specific users. She points to their function as a


“measuring stick for fund or manager performance or compensation, or as guideposts in academic research”, adding that index providers “appear to exercise significant discretion in the performance of their services”, noting that they can determine which securities to include in


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the bucket of an index, “what weight each should be given, and how often those buckets should be reconstituted or rebalanced”. But Gareth Parker, chief indexing


officer at Morningstar, says it is inappropriate to consider index providers as investment advisers because they don’t make investment decisions; they provide benchmarks or tradeable products for issuers. “There are EU benchmark rules that


are extra-territorial, meaning they even impact US index providers, who have to be compliant with them. This means many index providers are already compliant with appropriate regulations that deal with issues such as data quality, conflicts of interest, competence of staff and other issues.” But some argue the relationship


between index providers and fund managers is becoming more intertwined, via the likes of bespoke thematic indexes created for specific fund managers.


A NEW DAWN Gone are the days when index providers mostly offered just broad-based indices for active managers to benchmark against and passive ones to track. Proponents of the explosion in the number of indices often cite the benefits to retail investors who, they state, can now access the types of strategies through passive funds and ETFs that would previously have only been accessible for wealthy individuals and institutions. Academics such as Daniel Broby,


however, argue that because the optimal index is hard to beat from an active management perspective, “there has been a proliferation of specialist indices which are easier to beat”. He says that the popular reason given for the creation of these is a desire for “bespoke investment strategies” but “it means that the index has moved from being an impartial measurement benchmark to one which is selectively chosen by fund management companies”. Essentially, Broby argues that over-


engineering of an index is being sold as positive for investors, because it offers them greater choice, but that these specialist indices are specifically created by fund management companies to make them easier to beat. The distinction between active and passive is often blurred. “The likes of


THE REVIEW MARCH 2023


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