Steering capital: the growing private authority of index providers in the age of passive asset management

Abstract

Since the global financial crisis, there is a massive shift of assets towards index funds. Rather than picking stocks, index funds replicate stock indices such as the S&P 500. But where do these indices actually come from? This paper analyzes the politico-economic role of index providers, a small group of highly profitable firms including MSCI, S&P DJI, and FTSE Russell, and develops a research agenda from an IPE perspective. We argue that these index providers have become actors that exercise growing private authority as they steer investments through the indices they create and maintain. While technical expertise is a precondition, their brand is the primary source of index provider authority, which is entrenched through network externalities. Rather than a purely technical exercise, constructing indices is inherently political. Which companies or countries are included into an index or excluded (i.e. receive investment in-or outflows) is based on criteria defined by index providers, thereby setting standards for corporate governance and investor access. Hence, in this new age of passive asset management index providers are becoming gatekeepers that exert de facto regulatory power and thus may have important effects on corporate governance and the economic policies of countries.

Same same, but different: Varieties of capital markets, Chinese state capitalism and the global financial order

“…The establishment of the Stock Connects between Hong Kong Stock Exchange (HKEx), SSE and SZSE in 2014 and 2016 marked a turning point. 42 Especially as this was crucial for MSCI's decisions to include Chinese A-shares into its Emerging Market indices, a milestone in the opening process and an 'accolade' for China's aspiration to becoming a global financial power (Petry et al, 2019). This index inclusion was a boon for China's integration into global markets.…”

The new permanent universal owners: Index funds, patient capital, and the distinction between feeble and forceful stewardship

“…In contrast, low-cost index tracking is the dominant business model for BlackRock, Vanguard, and State Street. They only divest when the composition of an index changes, and this is decided primarily by the three major index providers MSCI, FTSE Russell, and S&P Dow Jones Indices who in turn have now become private authorities of sorts (Petry et al, 2019). Also, we consider firms such as CalPERS not as truly universal owners, because even though they held a large quantity of small stakes in hundreds of listed American corporations, they did not hold the entire stock market in their portfolio, as the Big Three practically do.…”

“…We believe that the ongoing debates on the rise of passive investing (see for instance Braun, 2016;Bebchuk & Hirst, 2018;Haberly et al, 2019;Jahnke 2019aJahnke , 2019bPetry et al, 2019) do not yet fully appreciate the transformative and potentially disruptive undercurrent that comes with the money mass-migration into the Big Three as Permanent Universal Owners. For instance, a growing body of literature in the fields of law and economics is concerned with the increase in 'horizontal shareholding' (Elhauge, 2016) -which means that competing listed firms now often have the same 'common owners' (Schmalz, 2018;Backus et al, 2019), such as index funds or other large investors (e.g.…”

“…Institutions as well as private investors are increasingly shifting money from actively managed mutual funds to passively managed index funds (Bebchuk & Hirst, 2018Fichtner et al, 2017). Index funds replicate established stock indexes, such as the American S&P 500 or the British FTSE 100 while minimizing investor fees (Petry et al, 2019). Because they do not actively buy and sell stocks based on expected future earnings but merely follow the market this is called passive asset management.…”

Mergers and Acquisitions of ESG Firms: Towards a New Financial Infrastructure?

“…and Campbell Verduyn 2019; Braun 2018; Petry et al 2019 on infrastructures).The Need for an Aggregated DatasetAcademics(Avetisyan and Hockerts 2017;Escrig-Olmedo et al 2019), industry reports(Novethic 2013; …”