A study by the FCA found that investors may pay higher rates for wholesale data due to a concentrated market, with typically three key players dominating most of the space.
The FCA stated that wholesale providers, including areas such as benchmarks, credit ratings and market data vendors (MDVs), faced “limited competition” within the industries, with barriers to entry for new businesses due to network effects. In turn, profit margins for the top providers from 2017-2022 were at least 30%, with some hitting margins over 60%.
Across credit rating agencies, Moody’s Investors Service, S&P Global Ratings, and Fitch Ratings make up 99% of revenue for data feeds. The FCA’s report estimated that the profit margins for the top three data affiliates could be 45%.
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“Using ratings data from the three largest CRAs is essential for many investors for comprehensive coverage of markets for investment strategy and regulatory requirements (particularly capital requirements calculations),” the FCA stated in its findings.
“Many investors require potential investments to have ratings from at least two CRAs. This creates a situation where data users need to multi-source data from multiple credit ratings data affiliates to ensure coverage and completeness of data. This feature of demand limits the scope for users to substitute between data providers.”
Benchmarks faced similar limitations to CRAs, with the industry typically choosing just a few benchmarks to rely on, the report stated. Indicators such as the FTSE 100 and S&P 500 have become dominant in this space, and while the FCA stated investors “demand use of established benchmarks”, they have “limited visibility over price and quality of different benchmarks”. Some 70% of respondents said they were satisfied with the industry benchmark, while 64% said it would be difficult to compare the prices or suitability of a product.
“For benchmarks used to price financial contracts strong network effects mean the market usually tips in favour of one industry standard benchmark. Using a benchmark reduces transaction costs by providing parties with a common basis for establishing the price or contract terms. This makes it easier to trade and increases liquidity in the market,” the report explained.
“As liquidity increases with many products being linked to the benchmark, other market participants also adopt the same benchmark. This process can continue until all existing and new market participants use the same benchmark. Once a benchmark becomes the industry standard, it is unlikely to be displaced.”
While the FCA found that users did have options when it came to MDVs, with over half believing there were credible alternatives, the FCA did report a recent consolidation of the market in the past five years. Respondents also noted some difficulties with switching providers, with 70% saying that switching would be challenging.
The FCA said it did not plan to set in practice a direct regulation of wholesale data, but would consider whether regulations could be changed to provide transparent, fair and reasonable data.
