Last Updated: 31 January 2023
The European Securities and Markets Stakeholder Group (SMSG), a consultative body that provides guidance to Europe’s securities market regulator, ESMA, has called for an approach to index regulation that balances the need for increased transparency with the protection of the intellectual property rights of index providers.
The regulation of financial market indices and benchmarks has been a hot topic since last year’s wave of revelations regarding the past rigging of LIBOR, a market-set benchmark for wholesale interest rates.
A number of banks, including Barclays, UBS and the Royal Bank of Scotland, have so far paid fines running into billions of dollars to settle LIBOR-related test cases brought by national prosecutors in the UK, US and Switzerland, while several other banks are thought to be in the cross-sights of regulators worldwide.
In its newly issued advice to Europe’s securities regulator, the SMSG recommends that index firms should operate according to universally agreed principles of good governance, sound methodology and transparency, in order to provide investors with the adequate level of protection and to limit risks of conflicts of interest and manipulation.
However, says the SMSG, differences in the nature of financial indices mean that a one-size-fits-all approach in index regulation should be avoided.
For larger index providers, says the SMSG, a governance-based approach to index regulation may be most appropriate. This would involve an independent committee overseeing the production of indices and benchmarks, with committee members including financial product issuers, as well as investors.
The committee would then be responsible for approving and vetting the rules governing the production of indices, subject to a clear audit trail.
But for smaller index firms, for whom the costs of setting up oversight committees might be prohibitive, a transparency-based approach might work best, says the SMSG. Under this approach, , index and benchmark providers would be required to disclose the methodology used for the calculation of benchmarks and indices, as well as the sources of data used, in order to enable external monitoring.
Whichever process is adopted, says the SMSG, regulators should pay particular care to the liquidity of the markets on which indices and benchmarks are based, in order to limit distortions and potential manipulations.
In its advice the SMSG expresses concern for the protection of retail investors buying index-based financial products, citing examples of poor or misleading information.
“Retail investor associations found examples of indexed UCITS—reported to the national supervisor and to the European Commission—where the index’s past performance is either missing or wrong,” the SMSG writes.
And it’s often impossible for smaller investors to verify the accuracy of indices’ past performance, says the SMSG, as index firms typically do not disclose such information to retail clients, and the key investor information document (KIID) that’s mandatory for all European retail funds typically gives no guidance on where to find such data.
Therefore, says the SMSG, the interim regulatory framework being set by ESMA should require that index firms grant clients access to data on past performance, as well as information on the methodology used to calculate indices and benchmarks.
However, adds the SMSG, a proper balance should be maintained between transparency and the need to protect index providers’ intellectual property (IP) rights.
“Transparency is a crucial policy goal and protection of IP should not in any circumstances serve as an excuse to prevent users from getting crucial information,” says the SMSG.
But “a balanced solution between the need for increased disclosure in respect to indices and benchmarks and the protection of IP rights is required,” the SMSG says in its guidance to Europe’s securities market regulator.