April 29, 2008
I would like to comment on File Number S7-07-08.
While I am still in internal debate over whether the entire rule change is good or bad for the industry, there is one element of the proposed rule that is of direct concern and will have a profound negative effect specifically on entrepreneurs and small businesses involved with indexes.
Specifically on page 33 in section B5 regarding "Affiliated Index Providers"
The rule mandating a firewall between ETF provider and the index manager has created an opportunity for small and entrepreneurial firms to use its internal knowledge and experiences to design indexes and bring it to market by licensing it to an ETF provider. We are one such company that has done just that.
However, the elimination of the firewall between ETF provider and the index manager could lead to ETF providers moving management of the indexes for their best performing funds in-house while leaving the indexes of weaker performing funds to outside index management.
For example, let's say ETF Provider has two funds, A which has attracted $1 billion in assets and B with $50 million in AUM. ETF Provider realizes that at 5 basis points they are paying the small indexer of Fund A $500,000 per year for its management, so they hire an internal employee for $100k and change the underlying index to reflect a new in-house one similar in concept to that which they were using. The cost to keep a 3rd party indexer for Fund B is only $25,000 per year so they allow that one to remain knowing that once it grows to a certain size they can eliminate the small indexer and bring the management in-house. This would effectively eliminate the ability of the small indexer to spread its costs over multiple products which help pay for the development and operation of new and innovative indexes and benchmarks.
The elimination of the firewall would have a disproportionate effect on small and entrepreneurial indexers. Companies such as SP and Dow Jones have indexes whose names are already long established into the marketplace and the value is more in the name of the product that what the underlying index actually does. (ie. there is large cap and there is the SP500). These companies also yield significant weight making it unlikely that an ETF provider would bring the management of an index from one of their indexes in-house. If doing so means that the large index provider would refuse to license or renew the licenses on their indexes to that ETF provider, then this could have a mateiral impact on the ETF provider.
In comparison, small and entrepreneurial index providers have no such power over the ETF provider and can be cast aside should this rule eliminating the firewall between ETF provider and the index manager take place.
Even if one argues that the fund managers won't bring the indexes in-house, there are still benefits to keeping the firewall in place. Just the other day, a fund manager looking to enter the ETF business learned that they were not permitted to develop an index governing their fund in-house, so it was recommended that they contact our organization to work with them. Because of the rule, we now have a new client, a new index, and likely a new revenue stream which can be used to hire additional employees.
Thank you for your time,
Scott Sacknoff, President
SPADE Indexes
1725 'I' Street, NW Suite 300
Washington, DC 20006
Tel: (202) 349-3917
www.spadeindex.com