Opening Cross: The Dow Isn’t the Only Index on the Rise

With algorithmic trading expanding among an increasingly sophisticated buy side, and growing popularity of investment products like exchange-traded funds to provide exposure to diverse  asset classes and geographies, one might be forgiven for thinking that indexes and associated data would be in decline. Hardly.

In the largest of a spate of index-related announcements last week, the five members of the BRICS Exchange Alliance—BM&F Bovespa, Micex-RTS, the Bombay Stock Exchange, Hong Kong Exchanges and Clearing, and the Johannesburg Stock Exchange—said they will begin cross-listing futures on their benchmark equity indexes, to provide exposure to each other’s markets, and create more liquidity across the markets overall.

But more complex arrangements around who can list what mean an increased administration burden for index providers. Hence last week, MSCI, S&P Indexes and FTSE announced the formation of the Index Industry Association, a non-profit trade body dedicated to educating investors and advocating for index users and providers.

Part of the group’s mission will no doubt be to educate the industry about the increasingly sophisticated types of indexes being created to meet investor demand for benchmarks that also deliver alpha. For example, the Chicago Board Options Exchange’s VIX volatility index  (aka the “fear index”) has found itself an often-quoted standard during the recent volatility. And now, CBOE isn’t just creating contracts on different versions of the VIX, like the futures and options that will soon begin trading on the CBOE Crude Oil ETF Volatility Index (The exchange has created 12 volatility indexes, a volatility strategy index, and—in conjunction with its CBOE Futures Exchange—six volatility products since 2011), but has created a “VIX of VIX” index that tracks its primary volatility index. And while one would hope to avoid a repeat of last summer’s excessive volatility, the increasing automation of over-the-counter asset classes will lead to more volatility.

Deutsche Börse and actuarial consultancy Hymans Robertson have even launched a series of Xpect-Club Vita longevity indexes to provide an alternative to longevity swaps that help pension funds hedge against the impact of a generation of pensioners living—and hence drawing a pension—longer than ever before.

But with increasingly complex index products, there’s an increasing danger of errors and complications. For example, Nasdaq OMX issued three separate notifications last week about third-party index products distributed via the exchange’s delivery mechanisms. One announced the delayed launch of the Pimco Short-Term High Yield Corporate Bond Index Source ETF—delayed at Pimco’s request—via Nasdaq’s Global Index Data Service (GIDS), while the others advised clients that its third-party index calculator had revised closing index values for certain Russell indexes, which Nasdaq distributes via its RussellTick service.

As new indexes rise in importance as proxies for sophisticated strategies, these kinds of delays or errors (neither of them Nasdaq’s fault, I hasten to add) will become unacceptable—though on the other hand, as this shift occurs, there will be less reliance on closing values and more focus on streaming levels, requiring index providers to re-engineer the way they calculate and disseminate indexes for modern, low-latency trading environments. But it also requires consumers to be ready for change. For example, Nasdaq last week delayed the go-live of its GIDS 2.0 service from May until August after clients warned they may not be ready to adapt to the new platform.

As indexes continue to evolve, firms will not only have to deal with the complexities of capturing and handling new volumes of data, but also potentially complex commercial policies and licensing, and more sophisticated client demands for index products that meet their needs. And ultimately, that means firms will need equally sophisticated index experts to manage their index consumption.