Academics shed harsh light on the makeup of the S&P index – .

Academics shed harsh light on the makeup of the S&P index – .

For some listed companies, becoming a member of a major stock index is like joining an exclusive club, the recognition of years of hard work. But a trio of academics this week speculated on another way to get in: a shortcut that involves hard cash.

A working paper released by the National Bureau of Economic Research argued that companies that buy credit ratings from S&P Global’s rating business had a statistically significant impact on the likelihood of being added to the S&P 500, the American blue chip benchmark index managed by another subsidiary. , S&P Dow Jones Indices.

S&P strongly denied the findings of the document, titled “Is Stock Index Membership For Sale?” “, Calling it” defective “. He said his two units “are separate businesses with policies and procedures to ensure they are operated independently of each other.”

The report nevertheless drew attention to the dual role of S&P. As Shang-Jin Wei, a finance professor at Columbia University and one of the co-authors of the NBER article, said, “The objectivity of a major stock index is extremely important.”

The credit rating agency is extremely influential. It was widely criticized for its role in the 2008 financial crisis, giving high marks to specialist subprime loan pools, but for more than a decade it has remained one of the top rating agencies helping debt investors assess the creditworthiness of companies.

The S&P 500 is one of the most followed and prestigious indexes in the world, tracing its history back to the boom in the US stock market of the 1920s. About $ 13.5 billion in assets directly follow or are compared to the S&P 500, making the index compiler a traffic policeman determining the flow of money to investors.

S&P recognizes the risks that something could shake investor confidence in the benchmark equity index.

“For me, I think it’s a real opportunity for the [S&P 500] committee to have additional rules that make it more transparent like the other indices. It would help them avoid that type of claim, ”said Laurence Black, a former index designer who now runs The Index Standard, a specialist consulting firm.

S&P Dow Jones separates its analysis and sales teams in order to protect the integrity of its indices. The company is also managed as a joint venture between S&P Global and CME Group, the US derivatives exchange, although S&P Global has a 73 percent stake.

David Blitzer, who chaired S&P’s index committee for more than two decades until 2019, said it would have been impossible for rating purchases to have any impact on who joins the index.

“When I chaired the Index Committee, I was prohibited from speaking to anyone about S&P Ratings without legal counsel present. . . even if a company’s CFO bought more ratings, the index committee would never know, ”he said.

The paper argued that many companies “seem to believe buying S&P ratings. . . is useful to their chance of being added to the index ”. The academics analyzed rating purchase information from S & P’s own database, as well as data from other vendors, including Moody’s and the Center for Research in Security Prices at the University of Chicago.

Academics found that potential candidates to join the S&P 500 increased their purchases of S&P ratings when it was known there was an opening in the index, such as when two existing members agreed to a merger. Meanwhile, there was a sharp drop in purchases by foreign companies when S&P changed its rules to prevent them from joining the index in 2002. In either case, there was no similar change in the prices. rating purchases from S & P’s biggest rival, Moody’s. S&P countered that the document “contains a number of misleading and inaccurate statements about the S&P 500, its methodology and eligibility rules, and the impact of inclusion in the index.”

S&P competes with competitors such as MSCI, FTSE Russell and Morningstar to offer investors what they see as a “truer” reflection of the stock market. It’s an industry worth more than $ 4 billion a year, according to Burton Taylor International Consulting, and S & P’s 25% market share places it slightly ahead of MSCI and FTSE Russell. For S&P Global, index activity only represents 13% of its revenues; credit scores are half.

David Blitzer, former chairman of S&P Dow Jones Indices © Jin Lee / Bloomberg

Experts said the S&P 500’s unique approach to choosing its components, with an element of discretion, made it particularly vulnerable to suspicion or misunderstanding.

Black of The Index Standard said the S&P 500 is “a real anomaly compared to other benchmarks” such as the FTSE Russell 1000, which is based almost entirely on market capitalization.

Although it is widely treated as a proxy for the largest US companies, the S&P 500 does not include the 500 largest stocks in the US market.

Instead, they are what S&P Dow Jones calls “top companies from top industries”. In general, companies must have a market capitalization of at least $ 13 billion and meet minimum standards of profitability and liquidity. Ultimately, membership is at the discretion of a committee made up of full-time employees of S&P Dow Jones Indices, which meets once a month. It takes what he calls an “informed approach,” which allows for quick adjustments when a company’s financial position or general market conditions change, he says.

“It talks about a problem they have. Although they have this level of opacity, there will always be this suspicion, ”said Gareth Parker, chairman of Moorgate Benchmarks, a UK subsidiary of Morningstar.

The NBER paper underscored the extent of discretion exercised by S & P’s index committee. He said about a third of additions between 2015 and 2018 did not meet at least one of the criteria published by S&P, despite hundreds of alternative candidates more clearly following the rules. He added that these “discretionary” additions tended to perform worse after joining the index than “rule-based” additions.

S&P says it is difficult to predict which companies will be added to the index is one of the advantages of the committee system, which helps prevent hedge funds from trading on expected changes before announcements.

He also downplayed the impact on companies of entering his index, arguing in a recent report that the increased liquidity was contributing to a “structural decline” in the additional stock price gains generated after being added to the index. S&P 500.

Even so, the results could still prompt US regulators to take further action. S&P has been criticized on several occasions for potential conflicts of interest in its rating business. In 2015, he paid a $ 1.4 billion settlement with the US Department of Justice after being accused of inflating the ratings he gave to mortgage derivatives to win business with his rivals in the United States. ‘Approaching the 2008 financial crisis. The SEC also accused him of “a series of violations of federal securities law” which continued for several years afterwards.

US regulators do not have the same powers as the UK or the EU to govern benchmarks. Nevertheless, they retain some ability to regulate “through the back door” as they oversee financial products and their prospectuses. Industry professionals say their scrutiny of index providers has increased in recent years.

“The SEC has focused a lot on quality, methodology and conflicts of interest. This gives new impetus to benchmark regulation in the United States, ”said Parker of Moorgate. The SEC declined to comment.

When asked if S&P could do more to build confidence in its products by providing more transparency, a senior executive replied “we are probably already doing all we can.”

Blitzer said the newspaper “will annoy some of my old colleagues,” but he hoped the discussion about it “would fade” in no time. If not, S&P will need to step up its efforts to retaliate.

“The S&P 500 lives on its reputation – you and I could build an index of 500 stocks this afternoon, but we wouldn’t have the brand, reputation and history of the S&P,” Blitzer said.


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