Opening Cross: License and Registration: Arresting Index ‘Misuse'

Just as most of us follow the benchmark indexes that underlie our investments and retirements, exchanges and data vendors - not just the major index providers - are also spending a lot of time and effort tracking and expanding their range of indexes and index-related products.

For example, the BATS Exchange announced last week the first anniversary of its BATS 1,000 index, and the availability of its index data over the Consolidated Tape Association's feed. Thomson Reuters launched an index business last year, which it has since expanded this year, while CME Group acquired the majority of Dow Jones index business earlier this year.

One reason for the current popularity of indexes, their derivatives and exchange-traded funds is that they offer something of a flight to safety for investors seeking respectable returns while minimizing exposure to risk.

But a sticking point has been the issue of whether index values constitute public information, and whether exchanges can list derivatives on any index without licensing the index itself.

A court last week banned the International Securities Exchange from listing options on the S&P 500 and Dow Jones Industrial Average, which are licensed exclusively to the Chicago Board Options Exchange (the ruling also prohibits the Options Clearing Corp. from clearing options on those indexes that were not traded on CBOE). CBOE, Standard & Poor's and Dow Jones Indexes (now part of CME Group) sued ISE in 2006, after ISE sought a court judgement to allow the exchange to trade options based on the same indexes in competition, which the index providers called "free-riding" on their intellectual property (IMD, Nov. 20, 2006).

Technically, the fight isn't over yet: An ISE spokesperson says the exchange believes the verdict is "incorrect based on the facts and applicable law in this case," and will appeal the decision.

Interestingly, the other precedent in this area took the opposite view, when German courts last year allowed Commerzbank to create structured products linked to ISE parent Deutsche Börse's DAX index without a license. Observers suggested that - so long as Commerzbank didn't infringe the DAX trademark brand - the index values compiled from underlying equities are considered public record.

However, the main attraction of products based on a particular index is the brand value of that index. Replicating an index under a different name is like selling the generic version of a brand-name drug: it may not be the name that consumers ask for at the pharmacy counter, but it provides the same treatment, usually at a cheaper price, promoting competition, and - in theory - continued research and development by the big-name brands to improve their products. Would direct competition on instruments based on the same indexes result in more intense competition between venues and better deals for end-users? Almost certainly. But index providers and exchanges also have the right to license their data exclusively to give themselves a competitive differentiator.

Even if the decision had favored ISE, the venue that licenses the index has potentially far greater resources and opportunities to create exclusive, value-added products than one synthesizing or obtaining only a subset of index data. For example, index provider FTSE recently hired John White from State Street to create a Content Services group that will produce analytics and value-added content around its core index data (IMD, May 21).

By creating more value and commoditizing the publicly available aspect of indexes, these added-value data components could become the more valuable aspects of index data over time, marginalizing any future disputes among exchanges over the basic index values themselves.