FTSE aiming to thrive under new benchmark regulation

On September 3, the FTSE 100 reached a milestone, touching a 14-year intraday high and capping a remarkable recovery from its post-financial crisis lows. Two weeks earlier, FTSE announced that exchange-traded funds (ETFs) tracking its China indexes had reached $20 billion in assets under management (AUM). Ask any index watcher which news is more significant, and they will probably point to China.

Chinese equities are seemingly the apple of every investor's eye. A China-tracking ETF from iShares is now among the 50 largest ETFs in the US, for example. FTSE was quick to offer access to the country, launching a series of indexes in 2001 that tracked Chinese A-shares, B-shares, H-shares, red chips, P-chips and Hong Kong stocks. Two of its offerings, the FTSE China 25 index (which on September 19 became the China 50 index) and the FTSE China A50 index, have become widely followed benchmarks.

"We have a large operations centre in Hong Kong and a fantastic sales team across Asia that markets and sells our China-focused products," says Sudir Raju, London-based head of exchange-traded product relationships at FTSE. "A couple of our biggest ETFs are listed in Hong Kong." Raju is referring to the CSOP FTSE China A50 ETF and the iShares FTSE A50 China Index ETF, which have more than $5 billion and $8 billion in AUM, respectively.

Begun as a joint venture between the Financial Times and the London Stock Exchange, FTSE became a wholly owned subsidiary of London Stock Exchange Group in 2011. It calculates more than 250,000 indexes across 60 series covering more than 80 countries and is now the fourth-largest provider of indexes for ETFs, up from ninth in 2011. The company's developed markets index range has $53 billion in AUM, while the figure for its emerging market series is $51 billion.

FTSE is also a major provider of indexes for structured products and its main clients issue into markets such as Switzerland, Germany and France. "Our structured product clients use our flagship indexes such as the FTSE UK index series and the FTSE Epra/Nareit Global Real Estate indexes," says Raju. "We are also seeing some interest in the FTSE China 50 index."

Do banks wish to be regulated as an index business, or do they want to use an established provider that has strong governance and regulatory structures in place?

In addition to the China theme, FTSE has been at the forefront of many investment trends over the years. Since it launched the FTSE4Good index series in 2001, interest in environmental, social and governance (ESG) investing has swelled. At an event in September to discuss the findings of the 2014 Global carbon budget report, a fixed-income banker estimated the size of the green bond market today at "not far off" $50 billion. In June, FTSE debuted its FTSE Developed ex Fossil Fuels Index Series, a market-cap weighted index that excludes companies from the FTSE Developed index that have revenue or reserve exposure to fossil fuels.

"Five to 10 years ago, environmental indexes were a thematic exposure," says Raju. "Today, policy discussions at various government agencies and businesses will allow these benchmarks to migrate from a thematic to a core allocation." The FTSE4Good Index Series tracks companies with strong ESG policies, making it a good entry point into the sector, he says. The FTSE Environmental Markets Index Series is more focused on firms involved in environmental business activities such as renewable and alternative energy.

Factor investing is another trend that is gaining traction, particularly among institutional investors following sophisticated asset allocation strategies. In August, FTSE launched the FTSE Global Factor Index Series, which place factor overlays on the FTSE Developed and FTSE Emerging Markets series. Six single-factor indexes cover illiquidity, momentum, quality, size, value and volatility stocks. The next step will be to apply the factor overlays to smart beta weightings, an approach already being explored by smaller outfits such as ERI Scientific Beta, part of the Edhec-Risk Institute. FTSE was an early mover in the alternatively weighted index space and partnered with California-based Research Affiliates in 2005 to launch the fundamentally weighted FTSE RAFI index series.

FTSE recently affirmed its compliance with the International Organization of Securities Commissions' (Iosco) Principles for Financial Benchmarks, a global initiative to define best practice for index providers. In the wake of scandals around benchmark manipulation, the international regulatory community has made it a goal to formulate principles that address conflicts of interest, transparency and openness in the benchmark-setting process. "FTSE supports and welcomes future regulation of the sector," says Raju. The company hired KPMG to audit its adherence to the Iosco framework. The European Securities and Markets Authority has also published guidelines on index governance.

Raju says new regulations have dramatically altered the indexing landscape. But rather than chafing under it, he says tougher regulation only strengthens the case for independent providers to be stewards of the world's financial benchmarks, rather than financial institutions. "The question for banks is do they wish to be regulated as an index business, or do they want to use an established index provider that has strong structures in place from a governance and regulatory perspective?"