Indexing Pivotal in S&P Global's Rebound From Crisis Scandal

By Ben Eisen and Alexander Osipovich Features Dow Jones Newswires

Once vilified for its role in the financial crisis, S&P Global Inc. is emerging as one of the biggest beneficiaries of the rise of passive investing.

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The New York-based financial-information giant collects a tiny fee from every investor that buys an exchange-traded fund tied to one of its market indexes. Total assets in those products topped $1 trillion in December, the firm said, double from just three years earlier. S&P is now roughly twice as large an indexer as its next biggest rival, MSCI Inc., according to data from ETFGI, a London-based research and consultancy firm on ETF trends.

Just seven years ago, S&P was in the hot seat. Former executives were grilled on Capitol Hill over why the firm gave top-notch AAA ratings to toxic mortgage-backed securities. Congress passed the Dodd-Frank Act, partly in a bid to dislodge the big debt-rating firms from their position at the heart of the U.S. financial system.

Those efforts failed. S&P still doles out nearly half of the debt ratings issued in the U.S, according to the latest Securities and Exchange Commission data. A boom in corporate-debt issuance has helped power S&P Global's stock up 27% over the past year, to $131.52 on Friday, including a 22% rise so far in 2017 that has topped the benchmark S&P 500 index that bears the company's name. In October 2008, the stock traded as low as $17.15.

Critics fault regulators for failing to do more to shake up the clubby ratings industry, where the Big Three firms of S&P, Moody's Corp. and Fitch Ratings Inc. are paid by the companies whose debt they rate. Rating fees have helped underpin S&P's expansion in recent years.

"For the SEC to have let it sit there for all these years is beyond disgraceful," said Alan Blinder, who was vice chairman of the Federal Reserve in the 1990s.

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S&P Global says that the "issuer pays" model allows them to make ratings available for public scrutiny free of charge, and that conflicts are addressed by separating analysis from business activities. An SEC report from December cites improved processes for firms' oversight of credit ratings, such as increased documentation.

The company has also restructured and rebranded itself, spinning off its education unit in 2012 and shedding its old name, McGraw Hill Financial Inc., in April 2016.

Ratings, along with commodities, data and analytics, account for the lion's share of S&P Global's revenue. But indexing has grown the fastest since 2012. The unit, known as S&P Dow Jones Indices, and owned in part by CME Group Inc., boasted adjusted operating margins of 65% last year. The firm is scheduled to report earnings for the first three months of the year on April 25.

Indexes have been around since 1896, when the Dow Jones Industrial Average, now an S&P-owned index, was introduced. But S&P Global wasn't predestined to be an index giant.

In 2011, when Jana Partners LLC and the Ontario Teachers' Pension Plan called for changes at the company, then named McGraw-Hill Cos., the activist investors proposed turning the index unit into a stand-alone company. S&P held on to the business.

Dow Jones & Co., a unit of Wall Street Journal parent company News Corp, completed a sale of its stake in S&P's index business in 2013. Two representatives of the Journal still help determine the composition of the Dow industrials, one of S&P's indexes.

Indexes have gained a higher profile in the past few years as ETFs have surged in popularity. The world's largest ETF, the S&P 500-tracking SPDR fund, now has more than $230 billion in assets. S&P Dow Jones Indices collects a licensing fee that averages out to 0.0303% of the assets that an investor holds in the fund each year, which is around a third of the fund's net expenses, according to its prospectus.

S&P Dow Jones Indices collects licensing fees from exchanges such as CME and CBOE Holdings Inc. that offer futures and options based on S&P indexes. It also makes money by calculating the value of indexes and developing custom benchmarks.

Competition is heating up as upstart index providers offer cheaper alternatives for ETF issuers that don't need a highly recognizable brand like S&P's. Solactive AG, for example, has a flat rate for its indexes, typically seeking to charge smaller fees than its larger competitors.

"Globally you have, let's say 20 big, massive, branded indices that are really hard to replace," such as the S&P 500, said Steffen Scheuble, chief executive at Solactive. "We don't go after them. Nevertheless, everything beyond that, of course we are trying to get that business."

Eric Ervin, chief executive officer at Reality Shares Inc., met with S&P Dow Jones Indices in 2012 when he was starting his firm and looking to launch dividend-focused ETFs. After the meeting, he decided he could do the same work himself at a lower cost.

"It's been a smart decision for us," he said, adding that he estimates savings of about $100,000 a year for every $100 million in assets.

S&P executives say one of the main areas of S&P's growth will be in international markets. In Latin American and other regions, the firm believes that brand-name indexes will be key to helping build trust in the markets.

"Being global for us is really important," said Douglas Peterson, S&P Global's chief executive said in an interview last month.

Write to Ben Eisen at ben.eisen@wsj.com and Alexander Osipovich at alexander.osipovich@dowjones.com

(END) Dow Jones Newswires

April 23, 2017 07:14 ET (11:14 GMT)