The Fiduciary Duty of Product Issuers

The Fiduciary Duty of Product Issuers

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It’s clear from recent comments by regulators and those closely associated with regulators that index providers are going to come under increased scrutiny in the near future. This will partly be in the area of fee charging, but two other areas mentioned most often are in assessing where the responsibility falls for index rebalance / calculation errors, and whether product issuers are absolving themselves of fiduciary responsibility when they use benchmarks – especially custom benchmarks.

The former point seems unlikely to require much deliberation. The concept of each index having an administrator, responsible for ensuring all aspects of index management and calculation, is clearly established in the various benchmarks regulations. No matter who calculates an index, it must be the administrator that carries the ultimate responsibility for errors and the consequences thereof. One assumes there will be an increasing focus on the accuracy of index calculation agents.

Hopefully the latter area can be addressed directly and comprehensively by the index industry, in order to head off regulatory moves in this space. The expressed concern is that by working with an index provider to devise a benchmark, then issuing a product tracking that index, the product issuer no longer holds a meaningful role in ensuring the money invested in that product is being properly invested.

It is worth pointing out that this charge is a somewhat contrary one to the position regulators have often taken; which is that independent calculation / administration of indices (as opposed to active management or the use of “in house” indices) – is a positive step that removes many of the conflicts of interest that would otherwise exist within a manager, such as when they have own-account positions in index constituents, and could (in theory) use their control over the index to manipulate the benchmark.

 

Anyway, we would argue that the base charge – that managers could be outsourcing fiduciary duty – may be true of some, and is a question worthy of consideration. However, where both the manager and the index provider have the appropriate expertise both in the management and governance of indices / index-based products and in their underlying designs, we would suggest it isn’t, at least where the benchmarks regulations apply. These – the  EU benchmarks regulation and the incoming UK benchmarks regulation – make clear that the administrator of a benchmark has a duty to ensure the index remains true to the “economic interest”, and that issuers (and any stakeholders) have the power to question whether the benchmark does indeed remain so, through the obligatory published complaints processes that all regulated administrators are required to have. Where the index provider and the product issuer come together to design an index for use within the ambit of the regulations, ensuring that it is fit for the purpose of tracking the performance of the index’ defined “economic interest”, and when they are then willing to clearly stand behind that methodology, then it seems to us that the fiduciary duty – with respect to that fund – has been fulfilled. If regulators feel that the issuer should have an ongoing role, then that can be via the benchmark “oversight function”, in which they could participate, at least in a suitably conflicts-managed way.

Gareth Parker, Chairman & Chief Indexing Officer, Moorgate Benchmarks

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