Asset managers need to engage in the current regulatory debate on whether index funds undermine competition in concentrated industries like airlines. If they don’t, they risk having to deal with remedies that not only seek to solve an issue that is unproven but could also risk undermining the very existence of index funds themselves.
Index-trackers or ‘passive funds’ are low-cost funds which replicate the performance of a market or benchmark. These funds are popular, with those managed by Blackrock, Vanguard, State Street and Fidelity now amongst the largest shareholders of many publicly traded companies worldwide. A recent OECD study found that institutional investors own 41% of global market capitalisation, with far higher figures for the US (72%) and the UK (63%). However, the success of index-trackers, as well as large active funds, has prompted a question: does their ownership of such a substantial share of multiple companies, often in the same industry, create market power and undermine competition? The answer is not settled and the transatlantic debate is hot.
A nascent academic economics literature has attracted significant attention for suggesting that funds owning stakes in competing companies (termed ‘common ownership’) could raise competition concerns. Specifically, the concerns centre on the idea that common ownership of companies in concentrated industries might soften incentives for those companies to compete, thereby raising prices. Some studies claim to have found evidence of this happening in practice in industries such as airlines and banking.
This has prompted a debate about whether further investigation and intervention by antitrust enforcers is required. We have analysed the recent academic literature that underpins the concerns, and while the simple intuition behind the issue is sound, in practice, given the real-world features of the asset management sector, in our view we are a long way from establishing that common ownership is in fact a competition problem.
Properly evaluating the evidence is important because some influential commentators are proposing major policy responses. These include far-reaching restrictions on permissible equity holdings, such as calls to limit institutional investors to owning stock in only one company within an oligopolistic industry, and calls to change merger control such that acquisitions of even small levels of stock are reviewed. Even if it is deemed that there is a competition issue, whether these proposals are on balance likely to do more good than harm is not clear, since the downsides could be significant. Indeed, our view is that there are a wide range of problems with the key current proposals. For example, they could have a severe impact on the ability of passive (and potentially other) investment products to operate and deliver the benefits that they are designed for. Ultimately the current proposals could threaten the existence of index-trackers, which could have a substantial effect on end investors.
Given the potential downsides of certain policy interventions that are being considered, we think it is important that policymakers evaluate carefully the evidence before taking any measures forward. Market participants also have an important role to play in considering the concerns raised carefully and engaging constructively with regulators. It is not clear what forums will exist for responding to actual regulatory proposals. Firms should therefore be vigilant to see how the debate evolves, and should consider being proactive to help shape the debate, and ensure that any regulatory intervention is proportionate to the harm (if any).
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