In 1883, journalists Charles Dow and Edward Jones started a newsletter, the Customers Afternoon Letter, which aggregated pricing information and other updates for traders at the New York Stock Exchange.

Five years later, the paper rebranded, and The Wall Street Journal was born, with Dow as its first editor. In 1896, the paper began to publish daily the Dow Jones Industrial Average, the first of several indices in its stable. These were humble origins for the index and benchmarks industry, which has become a complex, multifaceted space whose products are knit into the fabric of all financial markets.

Easily the greatest use case for indexes—and the greatest bonanza for providers—was the rise of passively-managed investment funds since the turn of the last century. But there are many other use cases. Benchmarks and indexes are widely used on the buy side and sell side to track the performance of a fund, or for smart beta strategies that drive alpha from factors (such as volatility) for structured products. There are indexes for everything from equities to crypto to works of art, and providers can build you a custom one.

Market dynamics—the big investment banks selling off their indexes to the exchanges, intense M&A in the market data space—have helped to create a space that is dominated by three big names: the S&P Dow Jones; FTSE Russell, owned by the London Stock Exchange Group; and MSCI, which is dominant in the ESG industry. These are high-margin, resilient businesses, that even now, in times of economic downturn, are faring well. And the market is growing. Management consultancy Opimas has just put out a report—Index Data: A High-Margin Business with Room for Disruption—in which it estimates that, globally, spending on indices is going to reach $6.3 billion this year, with the industry growing at around 13% annually.

Not everyone is happy, though. Market data consumers have complained for years that a lack of competitiveness among index providers has accreted into an effective oligopoly, with few pricing controls. A cursory search of the WatersTechnology archives, for example, turns up this opinion piece from 2014 referring to the “hidden tax” of index data from 2014; or this one from 2011, stating that index data and benchmarks are getting more costly and complex. Consumers say that the data providers cement their dominance by locking customers into complex, opaque contracts, hitting them with unexpected fees, and requiring that customers give up historic data when they terminate their contracts. The connection between the price of the product and what it costs to provide is becoming more tenuous, they say.

Suzannah Balluffi, an analyst at research firm Opimas and the author of the report, says that opacity of costs was a major complaint of users she interviewed during her research. They told her that pricing increases aren’t straightforward percentage increases. “It’s not so much that they [the provider] will say, ‘We’re going to add a 10% price increase.’ It’s more that they’ll say, ‘We see that your fund administrator is now using the index data, so we’re going to add some fees there,’” she tells WatersTechnology.

Index providers also slap on extra costs for licensing if a client uses the data in, for example, a branch of its business in another country, Balluffi adds. Thus contracts increase in complexity over time, with users struggling to keep track of what they owe, and losing insight into precisely from which aspect of their usage increasing costs are coming.

Subscribers of indexes are especially locked in to using big-name providers because of the brand recognition that they command. This is true of many industries, but it’s particularly strong in indexes, and makes switching to new products difficult for reputational reasons. One of the reasons the well-established index providers have done so well is that they are trusted household names.

Fund managers especially rely on the reassurance of a big brand name, Balluffi says. “A fund manager depends on the index provider; it’s a crucial part of the day-to-day operations. If they were to turn to another index provider—let’s say a new entrant—they could be putting their business at risk. They must be able to receive and distribute index information on a timely basis, and with accuracy.”

Because of the legal and operational implications, a fund might be reluctant to switch to a startup, and willing to pay a premium for data from a provider that’s well-established and trustworthy and that they’ve worked with before, she adds.

“Indices are a financial kite mark,” says Mike Carrodus, CEO and founder of Substantive Research. A “kite mark”, for US readers, is a heart-shaped quality trademark that can be found on certain products in the UK, particularly safety gear. “Financial products must be measured against something that people can trust. And trust is about brand in the modern world. Brand is the shortcut to being confident about the underlying process,” Carrodus says.

Substantive Research aims to provide subscribers with independent benchmarks of what they are spending on research and data relative to their peers. Substantive began with research after Mifid II unbundling disrupted the industry in the EU, and has since looked at index providers, rating agencies, as well as pricing and reference data providers.

The move to passives has entrenched this brand recognition element of the index industry’s power, Carrodus says. “There are so many people now exposed to core index products. If you have a vanilla, passive product, those people are going to want a recognizable benchmark measuring the performance of that product.”

In response to consumers’ complaints, index providers say their products are fairly priced, considering that they are high-quality and objective. Providers of the big-name indexes say they are built in accordance with global standards on transparency and soundness, and in line with local regulations like the EU’s Benchmark Regulation. 

Indexes also have marginal costs. Providers perform regular recalculations, to reflect evolutions in the dynamics of the economy and the markets. The Russell Indexes, for instance, are rebalanced on the fourth Friday of June every year, the provider reconstituting them fully every year. The S&P 500 index is rebalanced four times a year, with the rebalancing committee meeting monthly to make smaller changes.

Benchmark providers also say that competition in their industry is fierce and barriers to entry are low, pointing to the fact that smaller providers are gaining market share, especially in ESG products, and the fact that data products are easy to replicate.

Watchdogs sit up

Whatever the merits of either side’s arguments, the Financial Conduct Authority has taken notice of consumers’ complaints. The FCA, which unusually for a regulator has a competition mandate, is currently engaged in a process of examining the use of wholesale data in general, including benchmarks in particular. In 2020, the UK financial watchdog published a call for input on these topics, and in January of this year, published a summary of the feedback it received. At the same time, it pledged to conduct a market study over the course of this past summer, which is ongoing, on how competition is working between benchmark providers.

Carrodus says this is a study that could have international implications. The FCA’s competition mandate is a rare power for a regulator to wield, and if it decides that market participants’ concerns are justified and takes steps to stimulate a fairer environment, other regulators around the globe are likely to take notice.

On the other side of the pond, the Securities Exchange Commission has also signaled an interest in regulating indexes, albeit from a very different set of concerns to the FCA. The SEC is worried more about transparency and reliability. In a move that has dismayed data providers, comments from the regulator indicate that it is considering regulating them as investment advisors. 

This is an approach that could inadvertently make the industry less competitive, Balluffi says: the increased compliance burden could be stifling to new entrants.

Consumers and producers of indexes and benchmarks will be watching these regulatory developments closely over the coming year, when the regulators’ stances should solidify to some degree. Some providers even expect a proposed rule from the SEC as early as year-end.

But there is a trend in this industry that signals that disruption might be coming from new businesses gaining ground after all, Opimas’ Balluffi says. While they’re not making as much in revenue as larger providers, the revenues of smaller players like Solactive, Bita, and Merqube are growing at faster rates than those of the incumbents.

As she writes in the report, the index market is big and growing, plus there is plenty of opportunity to compete on innovation, as many legacy providers tend to rely on older tech.

“While quite a few start-ups have tried and ultimately failed, we do see above-market revenue growth for the smaller players that have persevered, and below-market growth for industry giants. This would indicate that smaller players are slowly eating away at the market share of their larger competitors,” the report says.

Balluffi concedes that disruption is not easy, however. “If a new entrant wants to compete successfully in this space, they must prove themselves to be a reliable data provider. And that’s not just in terms of the data being accurate. They must also deliver the data in a timely manner and in the correct format, in compliance with any applicable benchmark regulations,” she says.

“There is also the issue of brand awareness. If an index provider wants to sell their index—not just as pricing data, but to help a fund manager market a fund—it must build that brand notoriety, and that takes time.”

Perhaps the next year could see these smaller firms take hold of more of the market; perhaps the FCA will intervene with measures that work in their favor. Or it could be that 10 years from now, consumers are making the same complaints in the pages of WatersTechnology.