For super funds and their advisers

Benchmark blip reboots index debate


Index operators could face tighter regulatory controls in the US after a major provider copped a multi-million dollar fine last week.

In a settlement announced last Monday (May 17), the Securities and Exchange Commission (SEC) fined S&P Dow Jones Indices (S&P DJI) US$9 million (A$11.6 million), alleging a hidden feature in one of the firm’s key volatility benchmarks triggered pricing errors on a particularly choppy day in February 2018.

According to a SEC release, a previously undisclosed ‘auto-hold’ kicked into action during a period of “unprecedented” volatility on February 5, 2018, that saw the S&P 500 VIX Short Term Futures Index ER spew out “stale” data to underlying investment product providers.

Notably, the Credit Suisse VelocityShares inverse exchange-traded note (known as XIV), which referenced the S&P DJI index, racked up huge losses for investors on day in question and closed a month later.

The SEC alleged that S&P DJI should have disclosed to investors that the volatility index included an ‘Auto Hold’ feature that froze the reported benchmark value once it breached a certain value. On February 5, 2018, the underlying CBOE Volatility Index spiked 115 per cent, setting off the Auto Hold button on the S&P DJI benchmark that held the value static for periods between about 4-5pm on the day.

“While the Auto Hold was in place freezing the values being published to the market, XIV’s indicative value breached a key metric, which provided XIV’s issuer the right to accelerate all outstanding notes,” the SEC finding says. “According to the SEC’s order, XIV therefore had an economic value that was substantially lower than what had been publicly reported and was at risk of being accelerated by its issuer.”

Adriana Robertson

Daniel Michael, SEC complex financial instruments unit enforcement division chief, said index suppliers “play a crucial role in the financial markets”.

 “When index providers license their indices for the issuance of securities, as S&P DJI did here, they must ensure that the disclosure of critical features of their products as well as the publication of real-time values are accurate,” Michael said.

The case also reignited calls for greater regulatory oversight of the increasingly influential index provider sector that now sets the investment rules for trillions of dollars of passively managed assets, the Financial Times (FT) reported.

Hester Peirce, one of five political appointees to the SEC governing body, told the FT that the latest incident raised the question of “whether a regulatory framework for index providers was appropriate and, if so, what it should look like”.

“I am open to exploring the need for and propriety of such a framework,” Peirce said.

Earlier this year a paper published by the University of Virginia School of Law argued that index providers should be regulated like investment managers in the US.

The study – authored by legal academics Paul Mahoney and Adriana Robertson – says: “The rise of index funds means that for a multi-trillion-dollar portion of the fund market, the portfolio allocation decisions are made not by the fund’s nominal investment advisor, but rather by an index provider, which is compensated for its efforts through a licensing fee.

“This is a major development in the fund industry that in many ways parallels the rise of mutual fund sub-advisers [such as multi-managers].”

While S&P DJI neither admitted nor denied the SEC charges the firm signed a ‘cease-and-desist’ order in addition to coughing up the US$9 million fine.

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