Index Providers: Whales Behind the Scenes of ETFs

Most ETFs passively replicate the performance of an index that is constructed and maintained by an index provider. We show that index providers wield strong market power and charge large markups to ETFs, which are passed on to investors through management fees. We document three stylized facts about index providers: (i) the ETF indexing market is highly concentrated; (ii) when choosing ETFs, investors care about the identities of index providers, although index providers explain little variation in ETF returns; and (iii) about one-third of all ETF management fees are paid as index licensing fees to index providers. Using a structural model that incorporates two-tiered competition between index providers for ETFs and between ETFs for investors, we estimate that 60% of licensing fees are markups charged by index providers. Eliminating index providers’ market power can reduce ETF management fees by 30%.