Market index providers like
The Securities and Exchange Commission is exploring whether index providers, model portfolio providers, and pricing services—which are responsible for directing trillions of dollars’ worth of investments—should be regulated more like money managers rather than data managers.
The SEC raised concerns about “specialized indexes” that focus on targeted areas like environmental, social and governance issues in a broad information request in June. Specialized index providers often exercise significant discretion in creating and adjusting their models and also provide varying degrees of customization for clients—criteria that could require them to register as investment advisers, the SEC said.
Such a move would give the SEC more tools to combat greenwashing—the misleading or false marketing of funds as sustainable or socially responsible—and potential conflicts of interest. It could also provide investors with more transparency over the fees associated with ESG funds, which tend to be higher than for standard funds.
“The index providers would have to take greater care and be more cautious about how they design ESG or any other index for that matter,” said John Coates, a Harvard Law professor who previously served as the acting director for the Division of Corporate Finance and general counsel at the SEC.
MSCI, S&P Dow Jones Indices,
More broadly, MSCI said it plans to respond to the SEC’s request for information. S&P Dow Jones Indices said it regularly engages with regulators and policymakers on “the robust governance regime and control framework” it has established for the “independence, transparency and integrity” of its benchmarks.
Bloomberg LP, the parent company of Bloomberg Law, is also the parent company of Bloomberg Index Services Limited, which administers indexes that compete with indexes from other providers.
Index providers have seized on the growing popularity of sustainable investments in recent years, producing scores of ESG-related indexes that asset managers can pay to license for use in their exchange-traded funds and mutual funds. The number of indexes that measure ESG metrics increased by a record 43% globally in 2021, according to the Index Industry Association.
Revenue in the global index industry climbed by nearly a quarter to $5 billion in 2021, Burton-Taylor International Consulting said in a recent report. ESG indexes saw the fastest growth, with revenue up by more than 80% from a year earlier.
Specialized indexes have become a flashpoint in Washington, as regulators and lawmakers raise concerns about the largely unregulated power they wield over global markets. Index providers aren’t required to publicly disclose information on the methodology they use to construct an index, including the “ESG ratings” they often use to determine which securities are added or dropped.
“That brings up the whole question of what does it mean to be environmental? How do you balance environmental with social and so on?” said Adriana Robertson, a professor at the University of Chicago Law School whose research on whether index providers act as investment advisers was cited in the SEC request for information. “It just drags that whole debate into the index provider space.”
Some indexes follow a combination of rules—such as thresholds for market capitalization, liquidity, or profitability—while others are designed at the discretion of an index committee. Fund managers can even ask index providers to tailor indexes to fit certain criteria.
Index providers would have a fiduciary duty to act in the best interest of clients, and disclose any conflicts of interest, if the SEC determines they should register under the Investment Advisers Act of 1940. ESG-focused indexes would also be subject to inspections by the SEC Division of Examinations, which has outlined ESG as a top compliance risk.
The SEC didn’t respond to a request for comment.
Some index providers could face SEC examinations right away because the division tends to prioritize newly-registered entities and those it views as high risk, said Gail Bernstein, general counsel at the Investment Adviser Association.
“If all these indexes were suddenly to become registered, the SEC would probably want to go in, in pretty short order, and see, what do these businesses look like? What are they doing? How are they trying to comply with this new framework?” Bernstein said.
Index providers that create specialized ESG indexes could even face separate anti-greenwashing rules if they were forced to register as investment advisers, according to Robert Jackson, a New York University law professor who served as an SEC commissioner between 2018 and 2020.
“They’re making a claim that these indexes are different from a non-ESG indexes,” Jackson said. “I think if you’re an index provider that claims to make decisions on that basis, you should expect the SEC to hold you to your bargain with investors.”
The SEC rolled out a proposal this year that would require funds to make “specific disclosures in fund prospectuses, annual reports, and adviser brochures based on the ESG strategies they pursue.”
A separate SEC proposal would require more funds that use ESG or other names that “suggest a focus in a particular type of investment” to invest at least 80% of the value of their assets in those investments. That would likely drive funds away from ESG indexes that don’t meet that requirement.
“If these index providers are regulated as advisers, either with the full-blown Advisers Act regime or with a more tailored version, they would presumably also be subject to these rules,” Robertson added.
The SEC is challenging the longstanding view that index providers play a passive role in markets, a stance that has allowed them to largely avoid regulations that asset managers and other registered investment advisers must follow.
Index and financial data providers who push back against the SEC are expected to point to Lowe v. SEC, a 1985 Supreme Court decision that held that newspapers and some other publishers were excluded from the Investment Advisers Act.
The publisher’s exclusion covers “bona fide” publishers who provide impersonal and disinterested advice that is circulated on a regular basis, rather than in response to market developments.
Index providers have historically concluded that they they can rely on the exclusion “even if they meet the definition of investment adviser,” the SEC said in its request for information. But “new business models” have emerged since Lowe was decided, the agency said, which “may raise investment adviser status issues.”
‘Costly and Problematic’
SEC registration would raise costs for index providers and the funds they work with, which could be passed down to investors through higher fees, industry players say.
Fund managers could also face more ESG-related regulations if index providers became registered investment advisers. Under the Investment Company Act of 1940, the SEC requires funds to provide detailed disclosures about the investment advisers they work with.
The funds would have to get board and shareholder approval to hire or change index providers who are registered investment advisers. That could lead to costly proxy campaigns and discourage funds from making improvements, according to Matthew Thornton, associate general counsel at the Investment Company Institute.
“As you expand the ‘investment adviser’ definition to include other entities, it does create more work for a board with arguably not much in the way of benefits,” Thornton said. Adding them could prove “costly and problematic,” he said.
In an annual 10-K filed with the SEC last year, MSCI said it believed the products and services outside of its investment management subsidiary “do not constitute or provide investment advice” under the Advisers Act. New regulations, though, could “cause this status to change,” it said.
“To the extent that our clients are subject to increased regulation, we may be indirectly impacted and could incur increased costs that could have a negative impact on the profitability of certain products,” MSCI said.