Investors and regulators need to focus on risks of benchmark-linked investments – report



An investor-focused trade group is calling on investors and U.S. regulators to pay closer attention to indexes.

Healthy Markets, an investor-focused non-profit organization whose members include several large public pension funds, issued a report Thursday that said, “while benchmark-linked investments have flourished across a wide range of assets, so too have their risks.” The U.S. regulatory framework “is ill-equipped to address the risks and conflicts of interest posed by benchmark-linked investing,” said the report, “Benchmark-Linked Investments: Managing Risks and Conflicts of Interest.”

Investors might view benchmark-linked investing as a relatively easy way to gain unique financial exposures but have not generally recognized that returns might be affected by conflicts of interest and insufficient data in markets where products “that have been manipulated are in the hundreds of trillions of dollars.” Benchmark-linked investment products can reduce complexity and transaction costs, but “also introduce significant risks for investors and the markets overall,” the report said.

With regulators in other countries implementing standards, “U.S. regulators should not shy away from ensuring that financial products within their jurisdiction are linked to benchmarks that are consistent with basic standards designed to mitigate risks and conflicts of interest.”

The report offers both investors and regulators a practical framework for managing risks and conflicts of interests in benchmark-linked investment products.

“We recommend that investors in these products conduct due diligence so they understand how the indexes work and the conflicts of interest,” said Tyler Gellasch, Healthy Markets executive director, in an interview. “We recommend their regulators enhance obligations on the firms creating and selling financial products to ensure the integrity of the benchmark they are relying on.”

Regulators at the SEC and Commodity Futures Trading Commission could take several approaches, Mr. Gellasch said, including a roundtable and possible rule-making.

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