Opening Cross: S&P-CME Deal Highlights True Value of Indexes

Max Bowie, editor, Inside Market Data

McGraw-Hill and CME Group announced a surprising deal Friday, Nov. 4, as Inside Market Data went to press—a joint venture combining S&P’s index business with Dow Jones Indexes, which is majority-owned by CME, to allow the companies to grow their respective index businesses faster than they could alone, and to leverage each other’s expertise around distribution infrastructures and the creation of new products.

But what will this deal mean for the industry? Firstly, is it a good sign that S&P wants to take on such a substantial index business, or a bad sign that CME apparently wants to divest a large portion of it less than two years after acquiring the majority of Dow Jones Indexes and announcing grand plans to use the indexes business to commercialize its data assets with passive fund managers and leverage CME’s distribution infrastructure (IMD, Feb. 12, 2010).

Indeed, why would CME want to give up any of the business? The exchange just closed a bumper third quarter, with group revenues rising 19 percent to $874 million, operating income jumping 29 percent over Q3 last year to $572 million, and earnings per share up 30 percent. In fact, the exchange cited revenue growth in its Index Services business for a six percent rise in its market data and information services revenues to $107 million.

Larry Tabb, founder and chief executive of research firm Tabb Group, says the answer may simply be that a tight bond with S&P—from which CME licenses the underlying index for its e-mini futures contracts—is more important than owning a standalone index business.

Secondly, what will this mean for clients? The scale of the new venture will surely provide cost synergies for the provider(s), but will any savings translate into lower costs for clients, or be reinvested into creating truly innovative products? Certainly data professionals complain that past mergers have failed to deliver promised savings, though they might settle for knowing that they were paying for greater investment in R&D into products that will yield lower risk and higher returns in a market quickly becoming saturated with increasingly-granular products.

A third question is whether regulators will want to take a closer look at the deal, which will combine the two largest index providers against MSCI, FTSE and Russell Investments, and whether the authorities might feel the deal will negatively impact competition among index providers—already difficult, as index licensing professionals say it can be hard to chop-and-change providers without making other changes, since providers don’t have directly-interchangeable products, and investors often seek out investments based on what a fund is benchmarked against.

However, Tabb doubts regulators will be concerned. “Indexes aren’t really substitutable…. There hasn’t been any competition before, so I don’t see there being any more or less as a result of this.”

A fourth is whether this is a sign that exchanges with index subsidiaries feel that the market is becoming over-saturated with regional and international providers, making it hard to fully exploit their offering and differentiate themselves, even though these businesses contribute to data revenues.

But that doesn’t mean indexes are going out of fashion: One area where indexes have seen substantial activity in recent years is in emerging markets, such as India, the Middle East and parts of Asia-Pacific, where investors use them as a relatively low-risk way to gain exposure to the potential higher returns of growth markets during the financial downturn elsewhere.

And with investment continuing to pour into the region—as I’m sure we’ll hear at this week’s Asia-Pacific Financial Information Conference in Hong Kong—demand for these products isn’t going away anytime soon, meaning that S&P may have struck a very productive deal for itself.

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