ARC on FTSE controversy: should indices be free goods?

In recent weeks the trade press has seen a lively debate on the issue of index licence charges, sparked off by the FTSE Group approaching a number of small and medium sized wealth managers for payment in relation to the use of FTSE indices on client valuations and marketing documentation.

The terms of use are clear – all FTSE index data is for information and personal use only. But is it fair for a leading player in the financial market index oligopoly to charge wealth management firms for quoting performance numbers that are freely available and ubiquitous?

Economists identify 'free goods' as those that are both needed by society and available without limit.

In other words, a free good should be available in as great a quantity as desired, at zero (or close to zero) opportunity cost to society.

It could easily be argued that index creation falls into this category. The marginal cost of production is close to zero and once created the marginal cost of distribution is also close to zero.

However, capitalism recognises that if there is no profit to be derived from an activity, there is little incentive for that activity to be undertaken. Thus, intellectual property rights, patents and copyright laws allow entrepreneurs who create free goods the opportunity to benefit from their exploitation. Without such protections, there would be little incentive for resources to be allocated to such activities.

So a balance needs to be struck between protecting intellectual property rights and regulating exploitation of free goods. By choosing to charge fees that users deem excessive, FTSE Group runs the risk that either their market share will be eroded by a competitor or government will regulate. But there is a more invidious potential outcome for FTSE Group – that innovation delivers a free alternative.

In recent years index-tracking funds such as exchange traded funds (ETFs) have become increasingly popular and prolific. These funds operate under product licences from index providers and performance tracks a selected index – for example tracking the UK equity market are: iShares FTSE 100; SPDR FTSE UK All Share; and Lyxor FTSE All Share. Such ETFs provide a net of expenses performance benchmark for private clients and a realistic 'passive' investment alternative.

If the wealth management industry were to use ETFs rather than the underlying target indices for benchmarking, index providers would be forced to target their charging model towards those who directly benefit rather than incidental consumers.

One of the greatest impacts on the private client wealth management industry is that usage of the FTSE Apcims indices appears to fall within the charging net. For many private client wealth managers these indices have historically been used as a peer group performance proxy. Faced with a charge for usage, what alternatives are available?