The index business used to be very straightforward and dominated by a relatively small number of third-party providers. Those well-known index creators provided benchmark indices, and some taste of exotica, and sometimes delved into a little light calculation work. Running the numbers was a remunerative sideline for the index providers as the struggle with fees and competition kicked in – the index providers also offered an extra element of independence to the whole process.
But now there has been a sea change, inspired by the banks’ creation of more of their own customised strategies carefully wrapped in index form. Strategy indices has proven to be one of the best places to be in banking in the last three or four years, especially as the credit crisis drags on. The art of designing these indices – which offer all the requisite regulator fodder of transparency, ease of use and (at least in theory) liquidity – has become a case of mechanising some quite complicated strategies, many of which were first used by hedge funds.
Geared up and now with some place to go, banks have maintained and enhanced their indices businesses, increasing complexity or simply the name recognition of the strategies. The result is indices on the environment, mergers and acquisitions, emerging markets, hedge fund strategies, and foreign exchange, and now there is a developing series based on volatility.
This investment in the index business would not be complete in the current financial environment without some part of it coming to the attention of regulators. But here there is a need for caution rather than fear. Regulators have set their beady eyes on high-frequency trading and that would appear to be the only target for impending legislation within the European Union. There is a case to suggest that strategy indices will be pulled into this regulatory maelstrom, but so far no-one appears worried about damage to the business.