Will regulation reshape the index industry?

As the song goes, ‘the times they are a-changing’ for index providers and users. In the past decade, we have seen the rise of various financial regulations, which have created more challenges for the index industry. Greater focus on risk reduction and compliance has led to a bigger impact on time, costs and resources. Sales of index units and third party contracting is happening more and more to help off-set these pressures.

In the wake of the LIBOR scandal, financial regulation fell under intense scrutiny. Since then, the way in which the index industry is regulated continues to have a dramatic effect on index providers and users.

What are the financial regulations affecting the index industry?

  • International Organization of Securities Commissions (IOSCO) best practice principles. Published in 2013, these principles include a Code of Conduct for index administrators covering governance, quality of benchmarks, methodology and accountability
  • The Fair and Effective Markets Review in the UK in 2014. Recommendations included seven key benchmarks including the SONIA, RONIA and London Gold Fixing, which became regulated
  • EU Benchmark Regulation (EUBR) was passed as a proposal in 2016 and is focused on implementing IOSCO’s principles, as well as requiring benchmark users to track, monitor, and be responsible for the use of EU benchmarks

When it comes to EUBR, this is being heralded as the first piece of global index regulation and may set the trend for regulation in various countries. With Brexit, the financial world is now bracing itself for the implications and how this will affect financial regulation. In terms of how the UK will negotiate with the EU, various options are currently under discussion including how financial regulation will be applied.

There are various risks that index users and providers need to be aware of. For index calculation, these include greater measures to reduce the risk to compliance, operational risk, and better management of cost controls and efficiencies. For index administration, a greater focus is needed to eliminate conflicts of interest and reduce the burden of compliance and the growing number of financial regulatory responsibilities.

Asset managers are likely to feel the impact, especially if they maintain indices used as benchmarks to measure fund performance, or if they have influence in determining the index composition, as any conflicts of interest will need to be removed.

Index providers will also feel this impact, especially if they are developing any bespoke indices for their clients due to a risk of a compliance breach. Investment banks providing custom indices will also fall under the regulation umbrella.

To off-set the growing challenges of financial regulation in the index industry, we are seeing specialist index service companies who can undertake various responsibilities and who are helping to relieve compliance pressures. However, it is well worth noting that EUBR makes it very clear that the index designer is still classified as the administrator. Another notable change has been the sale of index groups from investment banks as they seek to off-load regulatory risk. Banks are coming to realize that index calculation, as a business, is not a core activity, as opposed to trading.

How is your business affected by the growing burden of financial regulation? How are you managing in these changing times?

Read our new Industry Insights article where we summarise the various financial regulations coming into force, as well as the options available for index providers and asset managers.

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Bharat Kumar
Financial Services Posts
Neil Wardley
Managing Director, Financial Services Posts

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