[This article was previously published on our sister site, IndexUniverse.eu.]

Index providers have benefited handsomely from the growth of the worldwide ETF business and the general trend towards passive, index-based investing. But, just as ETF fees are under pressure from the increasing competition provided by new market entrants, so too are index providers’ traditional licensing fee models, which may have to be rewritten after a recent ruling by the German Federal Supreme Court.

The court ruling relates to an ongoing dispute between Commerzbank and the German Stock Exchange, Deutsche Boerse, over licensing fees. Earlier this decade Commerzbank issued index certificates (a type of warrant) based on the DAX (the benchmark German equity index) but then argued that it did not need to pay fees to Deutsche Boerse, the compiler and owner of the index, to do so. Deutsche Boerse, on the other hand, maintains that Commerzbank’s use of the DAX name in its index certificates constitutes an unfair use of the exchange’s trademark rights.

While an initial judgement in the Frankfurt regional court in 2005 prohibited Commerzbank from using the DAX name on its certificates on the grounds of unfair competition, subsequent rulings by the Frankfurt Higher Regional Court in 2007 and the Federal Supreme Court in April this year reversed this stance and found in favour of the bank.

A spokesman for the Deutsche Boerse told IndexUniverse.eu that the exchange is awaiting the full written judgement by the Supreme Court (due in the autumn) before making any comment on the ruling. Commerzbank also declined to comment.

Potential Repercussions

The court ruling, if applied to other index-tracking products such as ETFs, could have major repercussions. While the precise licence fee models used by index providers in the ETF market are generally not disclosed, a senior industry source told IndexUniverse.eu that a fee of 5-10 basis points for licensing an index to an ETF provider is typical. If expressed as a percentage of the fund’s total expense ratio, the fee usually falls in the 12-25% range.

Given that the weighted average total expense ratio on a European ETF is around 30 basis points, according to Barclays Global Investors, these ranges are broadly equivalent, he said. He added that licensing deals at the upper end of these scales might grant exclusive use of a particular index to an ETF provider, something that was quite common in the early days of the ETF market but less so now that there are many more issuers involved.

If applied to the US$166 billion that Barclays Global Investors calculates was invested in European ETFs at the end of the June quarter, this implies an annual revenue stream of US$83-166 million for index providers—and that is only from European exchange-traded funds. According to BGI, global ETF assets now total US$789 billion, so a similar fee scale could imply revenues in excess of half a billion dollars a year for the index licensors.

In practice, index fees on the largest US ETFs appear to be slightly below the quoted range. In an article published last summer in Intellectual Property Litigation, New York-based lawyer Jonathan Mazer points out that the SPDR, the largest US equity ETF, disclosed in its 2007 accounts that it pays 3.5 basis points a year to Standard & Poor’s for use of its S&P 500 index. Nevertheless, it is clear that hundreds of millions of dollars in revenues are at stake for index providers.

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