Institutional investors remain dissatisfied with the levels of transparency offered by index providers, according to a survey conducted by EDHEC-Risk Institute.

Noël Amenc, Director of EDHEC-Risk Institute.

This key finding comes at a time when indices are gaining in prominence and importance as more and more investors adopt a passive-based approach to investing, most notably via index-linked exchange-traded funds (ETFs).

Between August and November 2013, the Paris-based institution surveyed 109 institutional investors from across Europe, including Europe’s largest pension and reserve funds, insurance and provident institutions and their asset management subsidiaries, to document their expectations and requirements with respect to index transparency and take stock of their perceptions of, and the extent of their support for, the main directions of the ongoing regulatory debate on indexing and financial benchmarks.

The survey found that:

• Investors consider the provision of index transparency to be logical and indispensable. An overwhelming majority of respondents (85.2%) identify transparency as the best mitigator of conflicts of interest and only 12% view good index governance as sufficient to deal with these conflicts.
• Transparency is currently inadequate and seen to be so by investors. Only around a third of respondents are very (4.6%) or somewhat satisfied (30.3%) with the current level of transparency in the indexing industry. This perception is consistent with EDHEC-Risk Institute’s observations since, with a single exception, the index providers analysed as part of the study do not give access to the historical constituents of the indices, and for a significant number of smart beta indices, the methodologies described do not allow the indices to be replicated. Ultimately, 79.8% of respondents consider that the adequate level of index transparency is one allowing for historical (43.1%) or historical and live (36.7%) replication and only a tiny number (2.8%) are satisfied with disclosures designed to impart an understanding of the objectives and key construction principles of indices.
• There is a strong conviction that the rise of strategy indices makes transparency even more important (77.1% vs 11%) and that opacity undermines the credibility of reported track records (80.8% vs. 17.4%), in particular for new forms of indices.
• Transparency does not harm the interests of index providers because it develops trust and accelerates the adoption of new indices. It does not lead to free services and lack of revenues. There are legal and contractual tools to defend index providers against the unauthorised use of their methodologies and data. In addition, the European regulator, ESMA, has limited the transparency of constituents and weightings to the periods preceding the last rebalancing, which avoids front running and enables providers to conserve their replication service business. Transparency should not be monetised through opacity as it is a precondition to the proper selling and suitable uses of indices.
• Investors give very strong support (70.6% vs. 21.1%) to the proposal that ESMA’s transparency rules should be extended to non-UCITS products and mandates.

Commenting on the survey, Noël Amenc, Director of EDHEC-Risk Institute, said: “Transparency guarantees the efficiency of an index market that is becoming increasingly complex and sophisticated. The market needs to form opinions by sharing information and expertise. It is difficult to accept index providers conducting most of their marketing either with the idea of being a market reference, in the case of cap-weighted indices, or with simulated historical track records of outperformance, in the case of smart beta indices, without giving markets the means to check and question the representativity or the outperformance.”