Time to Break the Canadian Index Monopoly

Effective benchmarks are a critical for the Canadian capital markets.  And their governance is important as recognized by IOSCO.  At NEO, we have witnessed first-hand the issues that can occur when a benchmark administrator has commercial interests that conflict with the interests of investors and public companies.  It leads to anti-competitive behaviour.

The S&P/TSX 60 Index and S&P/TSX Composite Index (“the S&P/TSX Indices”) have over time become synonymous with national indices. There are hundreds of billions of dollars of assets out there that are utilizing these indices in some way. Yet, S&P/TSX Indices operate without any formal securities regulation or oversight.

The end result? The incumbent exchange makes decisions for these indices that are in its best interest, not in the best interest of public companies and their shareholders, and not for investors looking for broad Canadian exposure.

This has to change and we applaud the regulators for recognizing the need for benchmark oversight.

The need for regulatory oversight

The Canadian Securities Administrators are currently examining how to develop a regulatory regime for benchmarks and their administrators, contributors and users.

At NEO, we believe the S&P/TSX indices should be regulated benchmarks as shared in our comment letter to the regulators.  Millions of Canadian investors frequently invest in products directly tracking these indices.  Investment advisors commonly use these indices as a performance benchmark, as do asset managers. These indices are a general depiction of the strength of the Canadian economy, each viewed as a significant tracker of the performance of Canadian public companies.

The core of their proposal is to acknowledge the central role certain critical benchmarks play in the Canadian market, and to give regulators the ability to intervene if administrators are acting badly.

And they are.  As administrators of the S&P/TSX Indices, Standard and Poor’s and the TSX are directly contravening the IOSCO Principles for Financial Benchmarks.  We have found three major breaches of these principles, established to address conflicts of interest and foster transparency and openness:

1. The TSX has substantial influence over the S&P/TSX Indices composition, including pricing and voting on index constituents. This allows them to protect its own listing venue and promote its own listings, which is considered benchmark manipulation. Yet, this conflict of interest is not disclosed as the TSX is not considered an administrator.
2. It is mandated that the constituents of the S&P/TSX Indices must be listed on the TSX. This directly contravenes the IOSCO Principle of generic and non-exclusive benchmark design.  If companies from other Canadian exchanges are ignored, how can the index reliably represent the economic realities of the Canadian capital markets?
3. The S&P/TSX Indices pricing is solely based on data collected from TSX, but the underlying securities have volumes from all Canadian trading marketplaces. This means the indices are only a partial representation of the underlying securities and are subject to calculation issues should the TSX experience an outrage like it did on April 28, 2018.

Not only are the S&P/TSX Indices contravening IOSCO Principles, the TSX is acting in direct conflict with its Recognition Order as a stock exchange. The TSX recognition order put provisions in place to reflect TMX Group’s market power to ensure it would not use differential pricing or tied selling to preference its own venues. Preventing the S&P/TSX Indices from including securities listed on other Canadian stock exchanges is clearly not respecting the spirit of the Recognition Order. And is extremely anti-competitive.

The practice of restricting the constituents of these benchmarks to only those listed on the TSX needs to be urgently addressed.  In its place, an objective methodology must be used.  When an investor chooses the S&P/TSX Indices to benchmark against, the listing exchange should be irrelevant.  We have to look no further than the United States to see this.  The S&P 500 is not tied to one specific U.S. stock exchange.

The TSX is leveraging its market power and acting in an extremely anti-competitive manner.  No company currently included in the S&P/TSX Indices is able to list elsewhere than on the TSX without being removed from the indices.  It also becomes a major decision-making factor for any company who wants to be included in an S&P/TSX Index.  They will have to weigh the pros and cons of not being eligible for a benchmark index with being listed on what may be a better exchange for its shareholders.

This hinders stock exchange competition which is bad for the Canadian capital markets as a whole.

Checks and balances are needed to address these issues and minimize the risk that commercial interests of the TSX are being put ahead of the interest of investors and public companies.  A more democratic governance model is the only way forward for exchange-agnostic benchmarks and their obvious benefits to come to fruition.