US index operators could face tighter regulation in the wake of a US$9 million fine handed to S&P Dow Jones Indices (S&P DJI).
The Securities and Exchange Commission (SEC) on May 17, fined the New York-based firm “for failures relating to a previously undisclosed quality control feature of one of its volatility-related indices, which led S&P DJI to publish and disseminate stale index values during a period of unprecedented volatility.”
According to the SEC, the S&P DJI should have disclosed to investors that its S&P 500 VIX Short Term Futures Index ER contained an “auto hold” feature that caused its value to remain static for more than an hour on a particularly choppy day in 2018, (Feb.5) even as the underlying CBOE Volatility Index (“VIX”) was spiking 115% higher, damaging the ability of those using the indices to make profitable decisions.
Notably,Credit Suisse’s VelocityShares Daily Inverse VIX Short-Term Exchange-Traded Notes (“XIV Notes”), whose value was dependent on the S&P DJI index, racked up huge losses for investors on day in question and closed a month later. Investors in the XIV Notes have estimated that the drop caused $1.8 billion of losses.
“Index providers like S&P DJI play a crucial role in the financial markets,” said Daniel Michael, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit. “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.”
SEC Commissioner Hester Peirce told the Financial Times that the case 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,” the American lawyer specializing in financial market regulation told the London-based newspaper.
Currently, index firms remain exempt from investment adviser regulation in the US as merely information ‘publishers’ but face some regulation in the European Union.
In January, a report by the University of Virginia School of Law (UVS) argued that index providers should face the same regulatory hurdles as investment managers. “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,” the legal paper authored by legal academics Paul Mahoney and Adriana Robertson says. “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].”
S&P DJI is a joint venture between S&P Global Inc which owns a majority, and Chicago-based CME Group Inc.