Are index providers the new credit rating agencies?
Several index providers gave Elon Musk’s SpaceX fast track access to their indices, which raises the question of how much power these companies have over the market and what parallels can be drawn (Jonathan Brady/PA Wire)
Good morning. A topic of discussion that was raised at the recent asset owner roundtable which we ran in London was ‘to what extent are index providers the new credit rating agencies’?
This discussion was obviously taking place in the shadow of the SpaceX IPO, which saw some providers give Elon Musk’s company fast track access to their index.
A couple of weeks later I stumbled upon the work of Johannes Petry, a political economist at Goethe University Frankfurt, who has dedicated quite a bit of time to studying market indices.
His view is quite firmly yes: “The role of index providers is quite similar to the one rating agencies play in the bond markets.”
“They make decisions which affect valuations on assets. The mechanisms are different but they play a similar role in their respective markets.”
The role of index providers has become “more prominent” because of the rise of passive investing following the 2008 financial crisis - to the extent Petry said they function as “a set of monopolies, almost”, though these operate mainly at a national level.
He said: “The US stock market is basically the S&P 500 so these decisions [on which companies to admit] are much more consequential.
“It is a completely different story when we get to the international level.”
Of course comparisons to credit rating agencies will bring back memories of the conflicts of interest that contributed to the financial crisis (rating mortgage-backed securities accurately versus pleasing clients who needed high ratings to sell them to investors, for those who haven’t seen The Big Short).
And perhaps you could make a comparison between this and the fast tracking of certain popular tech stocks into an equity index.
When I made this comparison, Petry politely distanced himself from it - though he agreed fast tracking was “a negative development”.
He said: “I think what is important to keep in mind is that the actual influence will be relatively small because most indices are calculated based on free float rather than market cap. That will determine their weighting in the index and I think it will be relatively small.”
Indeed SpaceX’s free float is about 5 per cent.
Petry suggested that in fact the incentive for an index ran in the opposite direction to credit rating agencies in the pre-2008 era, since their incentives run towards accuracy.
He said: “Index providers will want to provide an index which asset managers think is reliable.”
