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News
Is Stock Index Membership for Sale?: You may not be the type of person who seeks out & reads newly released academic research. That’s okay - most people aren’t. Despite the flood of new papers published every month, the above piece from the National Bureau of Economic Research merits your full attention.
The research concerns S&P Global, the behemoth ratings & index provider in the midst of a $44 billion mega-merger with IHS Markit, which makes some frankly alarming claims. Here are the high level assertions:
97% of company additions to the S&P 500 are not explained by S&P Global’s published rules for index inclusion. An internal committee within S&P Global has heavy discretionary influence over which companies get included in the world’s largest & most consequential index.
There is a statistically significant relationship between large firms increasing their purchases of S&P Global credit ratings & having a higher chance of being chosen for inclusion in the S&P 500. Moody’s ratings data does not show this same relationship.
Companies looking to become included the S&P 500 index purchase more S&P credit ratings when the benchmark has an open spot.
When S&P Global changed their rules to exclude foreign firms from S&P 500 consideration in 2002, those firms reduced their purchases of S&P credit ratings.
All this data leads us to believe that conflicts of interest are present between S&P Global’s Ratings & Index unit, where influence in one product is used to generate sales in the other. Is this wrong or illegal? I’m unsure.
Let’s revisit a basic question - what is the S&P 500? Why does the world link $12 trillion of assets to this benchmark? The market generally accepts that the S&P 500 represents the top 500 companies listed on a US exchange. S&P Global has built a rock-solid brand around this principle. Despite this, there are no strict rules that dictate what the “top 500 companies” are - as long as S&P Global maintains their index’s reputation, they can include or exclude whoever they want & keep their dominant market power.
Is S&P Global breaking any laws by favoring credit rating clients for index inclusion? Probably not. Does this practice damage their brand value? It certainly could over time.
As a reminder, S&P Global generates ~$1B in annual revenue from its Index unit & ~$4B from its Ratings unit, making Ratings a more financially important business by a factor of ~4x. Their Index business is structured as a joint venture co-owned by S&P Global & CME, the exchange that houses the e-mini S&P 500 futures market.
Coinbase announces NFT waitlist, following lead of rivals Binance and FTX: Noot noot! NFTs have taken over the crypto world since the summer of 2021. Opensea, the largest NFT exchange on the Ethereum blockchain, raised $100M at a $1.5 billion valuation earlier this year. NFT trading volumes have surged & are now attracting the interest of mature, centralized crypto exchanges. Binance began the trend with the launch of its own platform in June, followed by FTX in early October. Now Coinbase has jumped in.
I find this news important for a few reasons. One, Coinbase is the largest US crypto exchange with 68 million users and prolific visibility in rich, developed economies. Coinbase’s NFT platform will likely convert thousands, if not millions of users into first-time digital art collectors. I think this will have big implications for NFTs as an asset class but also for Coinbase’s business. Just like retail Bitcoin trading earned high transaction fees when it was first set up, NFT trading fees are sure to be extremely high relative to other developed products. Capturing more revenue from the same speculative, price-indifferent crypto user has been a winning strategy in the past that has propelled Coinbase to the valuation it holds today. NFTs are this strategy’s next evolution.
Second, I’m curious to see how Coinbase’s listing standards differ from other exchanges. Opensea faced backlash recently when an employee insider trading scandal was uncovered, prompting a closer look at the relationship between NFT developers & exchange staff. Other marketplaces openly accept exclusivity deals with certain projects & are not regulated against corruption or manipulation in any way. Will Coinbase’s conflict of interest policies be more transparent?
Regardless, I find the news to be a bullish sign for both Coinbase & the broader NFT market.
My latest paid post is live - The House that Sam Built: Part II takes a deep look at the history, strategy & business model of FTX amid its recent push into the US. Subscribers get immediate access to this post and a deep archive of past exchange & market structure research.
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Other Stories I’m Reading
Trumid secures additional $208 million in funding round
S&P's $44 bln IHS deal set to win EU antitrust approval
CME Says It May Introduce 20-Year Treasury Futures Contracts
An SEC Rule Was Meant to Protect Individual Investors. Chaos Ensued.
FactSet acquires Boston-headquartered Cobalt Software
My Twitter thread on options market structure
Chart of the Week
Death. Taxes. BlackRock beating earnings.
Larry Fink’s giant asset management company reported earnings on 10/13 and surprised to the upside once again. Revenue grew +16% YoY, op income grew +11% and EPS grew +23%, which is quite impressive for a company BlackRock’s size. Management highlighted a combination of equity market strength, net inflows across its product suite & strong ESG fund demand as the quarter’s catalyst. Although AUM didn’t grow QoQ BlackRock still boasts $9.5 trillion in total assets, a truly mind boggling number for one firm to control.
As I’ve said in the past, a good quarter for BlackRock is typically a promising sign for MSCI, the index provider with BlackRock’s iShares ETF business as its largest client. As long as equity markets keep calmly trending upward & ESG demand remains, I expect Larry Fink & his shareholders to keep chuckling as they cash larger & larger checks:
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Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this newsletter, I am long ICE, CME, TW, NDAQ, BLK, COIN and VIRT. I am also long Solana.