The Giant Awakens – NASDAQ OMX

Index providers like S&P Dow Jones (or formerly known as S&P and Dow Jones), MSCI, Russell-Jadwa, and FTSE have played an instrumental and pioneering role in developing and promoting Islamic banking and finance globally. However, one late and a vital entrant to service this important industry is NASDAQ OMX, known throughout the world as the first electronic stock exchange, but for purposes of this article, one of the world’s largest indexers.

NASDAQ OMX entered the market with a bang by launching two Shari’a indices in 2010. These indices were jointly launched with Edbiz Consulting and are known as Edbiz-NASDAQ- 100 Sharia Index [N100SI] and Edbiz-NASDAQ Stockholm Benchmark Sharia Index [OMXSBSharia]. The Edbiz -NASDAQ Sharia Index Family has seven Sharia indices in total, based on The NASDAQ-100 [NDX] and OMX Stockholm Benchmark [OMXSB]. NDX and OMXSB are followed globally and hence bring an opportunity for customers interested in maintaining Islamic investment portfolios. These portfolios offer the risk and return profile of the top 100 domestic and international stocks based on market capitalisation listed on The NASDAQ Stock Market, and the largest and most traded securities in Sweden. The indices were a result of the vision and drive of John Jacobs, Executive Vice President at NASDAQ OMX, and Robert Hughes, Vice President, who understood the timely importance of this niche market.

As of February 2014, NASDAQ OMX operates in 26 markets spanning 6 continents. The group owns three clearing houses and five central securities depositories thus making it the largest exchange company globally. NASDAQ OMX is also home to 3,600 companies listed on its exchanges, with total market capitalisation of more than US$ 7 trillion. NASDAQ OMX technology supports equities, options, fixed income, derivatives, commodities, futures and structured products. Most of the markets trade equities, while six of the markets trade options, derivatives, fixed income and commodities. From a global perspective, NASDAQ OMX trades 1 in 10 securities of the world and is also the largest liquidity house for US equities. The technology of NASDAQ OMX is trusted by 80 exchanges (marketplaces) in 50 countries around the world (including growth in emerging and developed economies). NASDAQ OMX also takes pride in hosting and designing indexes, including benchmark families developed in accordance with changing market conditions. So far, NASDAQ OMX has more than 41,000 indexes that provide coverage of various asset classes, countries and industries. NASDAQ OMX helps banks and financial institutions including fund managers (including ETF providers) and private investors in influencing and tracking investment strategies. Further, it not only provides comprehensive insight into the global market but it differentiates itself by its process and competitive pricing as compared to other indexes.

What does NASDAQ offer and what makes it different?

Indexing – NASDAQ OMX is a full-service Index provider with diverse indexes covering all asset classes. The Global Indexes division is prepared with an index solution for any market. In addition, they provide independent, third-party custom index services and design solutions to financial organizations worldwide. Their capabilities allow the client to set unique parameters based on regions, sectors, theme, taxes, regulatory constraints, calculation methods or specific investment strategies to create the exact index needed.

• Listing – It is a premier listing exchange for approximately 3,600 industry-leading companies from more than 50 countries, representing all industry sectors and many of the world’s most well-known and innovative brands.
• Trading – NASDAQ OMX is one of the largest ETF exchange based on volume. Deep liquidity and transparency are at the core of its trading venue.
• Data Dissemination – NASDAQ OMX Global Data Products provide millions of traders and investors all over the world with strategic advantages, including superior speed, transparency, depth and flexibility of data management and delivery.
• Superior Technology – NASDAQ is renowned for its high-performance INET technology and has proven reliability with 99.99+% uptime. NASDAQ is known for its unsurpassed speed and tested capacity to execute trades quickly and efficiently.

Who uses the indices and why?

NASDAQ’s client base spans the entire spectrum of the financial services industry including big investment banks, portfolio managers pursuing passive investment strategies, commercial banks, and insurance companies located in the Americas, Europe, and Asia. Further, they also license their indexes to asset managers and financial entities that distribute a variety of financial instruments that closely track their indexes with the purpose of achieving investment results that generally correspond to the performance of their indexes, such as ETFs, mutual funds, UITs, annuities and other portfolio-based products. Index options, futures, and other derivatives based on NASDAQ OMX indexes are available to institutional and individual investors to be used for risk management.

Indices are a gauge of market health, be it reflective of the broader economy or a specific sector – such as technologies. Indexes allow institutional and individual investors to track day-to-day changes as well as long-term trends in the economy and the financial markets. They are used as benchmarks, a standard by which economic sectors and investment portfolios are measured. They bring clarity to market participants and help them with investment decision-making.

NASDAQ OMX’s index creation process is driven by demand and developments in the global economy. Objectivity is crucial to the creation of a robust index. The perspective of the investor remains the cornerstone to the formulation and an investor has to be certain the index is truly reflective of the general economy or segment. NASDAQ OMX adopts a methodology that looks at ways to measure segments or sectors of economic models in a fashion that is transparent and based on rules with an emphasis on investing, trading, and philosophy.

The never-ending journey began….

NASDAQ began in 1971 as the National Association of Securities Dealers (NASD), which wanted to create a market for investors to buy and sell securities on a computerised and fast system. This meant moving away from a system that required manual work and was largely inefficient. Technology had advanced to a level where it could assist in closing the price gaps. National Association of Securities Dealers Automated Quotation (NASDAQ) went live on February 8, 1971, with quotes for 2500 over-the-counter (OTC) securities. NASDAQ takes pride in being the pioneer of this shift, and benefited from the first mover advantage.

NASDAQ proudly associates itself with some well-known, well-established and well-led organisations of today. However, this was not always the case. During the early periods these companies were new entrants to the market and were growth companies rather than established companies. NASDAQ gave an opportunity to such companies for the first time to raise capital, an opportunity that was not known to such companies prior to that. These companies are still listed on NASDAQ exchange and include household names such as Microsoft, Apple, Cisco, and Intel. Further, this can be regarded as part of NASDAQ’s Corporate Social Responsibility (CSR) as such companies provide employment to countless people in society. It can be easily said that NASDAQ believes in not only growing itself, but creating an environment where organisations associated with it can also succeed and achieve their objectives. The NASDAQ OMX Group, as it is known today, was a result of its separation from NASD in 2006 and a merger with the Scandinavian exchange group OMX in 2007. This further strengthened its association, support, and commitment to technology and innovation across the markets globally.

The NASDAQ OMX Group provides transformative technologies for the entire life cycle of a trade, from risk management to trading to clearing to observation. Institutions and individual investors rely on NASDAQ’s reliable, pioneering technology, rule-based index construction, and comprehensive index services to facilitate investment, trading, risk management, and benchmarking activities. During 2011, NASDAQ OMX licensees reported issuing at least 8,500 structured products linked to NASDAQ OMX indexes with a notional value exceeding $1.4 trillion in 24 countries. NASDAQ OMX indexes are widely used as benchmarks by plan sponsors, financial institutions and individual investors.

Over the years, NASDAQ has accomplished many milestones.

NASDAQ OMX enters the Islamic finance space

It was the growing demand for Islamic financial solutions that persuaded NASDAQ OMX to launch its two Sharia-compliant indices at the height of the financial crisis. The Sharia indices were launched in collaboration with Edbiz Consulting who specialises in the Islamic banking and finance industry and hence have been branded accordingly [Edbiz-NASDAQ]. Edbiz Consulting acts as a Sharia advisor to the indices. Mr Jacobs is of the view that as Islamic finance industry continues to grow there are more tools to accurately measure the performance of this sector.

The Edbiz NASDAQ OMX Sharia Index family brings a new set of tools to those interested in measuring Islamic economic sectors and maintaining Islamic investment portfolios. They offer Sharia-compliant solutions beyond the most basic Islamic equity funds. This index family is comprised of securities that meet Sharia requirements as prescribed by the Accounting and Auditing Organisation for Islamic Financial Institutions (AAOIFI). Edbiz Consulting screens and monitors the portfolio on a quarterly basis. There are two stages to a Sharia review process: business screening and financial screening. Business screens remove securities whose primary activities are not in compliance with Sharia (alcohol, gaming, tobacco, pork, arms, interest-based banks and financial institutions, and entertainment). Financial screens remove securities whose line of business is Sharia compliant, but their capital structure is not, i.e., there is a large component of its capital structure that involves payment or charging of interest. Sharia opines that if a company has a large amount of debt on its balance sheet, the likelihood is that the company is paying interest on it. Similarly if a company has a large portion of interest-bearing receivables, they must be receiving interest on it. Such activities also enhance the riskiness of these securities. Further, through Sharia review, companies involved in multiple businesses may also be screened out, if their revenue from Sharia non-compliant businesses is significant (usually 5%).

NASDAQ OMX’s leadership and capabilities in technology play an important role in the Islamic finance industry. The NASDAQ OMX index creation process and rules-based, objective methodology, coupled with unparalleled market visibility stand tall against other index providers.

The Edbiz-NASDAQ 100 Sharia index replicates the performance of the NASDAQ-100, which includes the top 100 domestic and international non-financial securities, based on market capitalisation listed on The NASDAQ Stock Market. Each quarter, Edbiz Consulting receives the portfolio from NASDAQ, which then gets Sharia screened. On average, about 65% of the portfolio of The NASDAQ-100 is Sharia-compliant. The Edbiz-NASDAQ Stockholm Benchmark Sharia index replicates the performance of OMX Stockholm Benchmark, which is composed of 80 to 100 of the largest and most traded stocks on Sweden’s stock exchange (which serves as an indicator of the overall performance of NASDAQ OMX Stockholm Market). The index currency is Swedish Krona (SEK). As the index also includes financials stocks, after the Sharia review, nearly half of the stocks are regarded as Sharia-compliant.

The Sharia indices are used to track Islamic economic sectors and maintain Islamic investment portfolios, while gaining exposure to the largest domestic and international securities listed on The NASDAQ-100 and the Swedish market. Institutional and individual investors are interested, as are plan sponsors, asset managers and financial entities that distribute financial products such as ETFs, options and other derivatives.

Performance speaks for itself

While the availability and tapping into a virgin space is one thing, what gives competitive advantage over another organisation offering similar services to investors and stakeholders is the performance. The diagram below highlights the performance of the NASDAQ-100 against NASDAQ-100 Total Return. As mentioned above, the NASDAQ-100 index is a non-financial index and hence does not include any financial security. Industries that form part of the index are Basic Materials, Consumer Goods, Consumer Services, Health Care, Industrials, Oil & Gas, Technology, and Telecommunications. The industry that carries the highest weight among the eight industries is Technology. Two of the most recent entrants on the NASDAQ-100 were Facebook and Vimpelcom and as of January 2014, Edbiz- NASDAQ-100 Sharia index invested above 50% in the technology industry. It is followed by Consumer Services and Health Care, which account for approx. 21% and 19% respectively.

The NASDAQ OMX Stockholm Sharia index has invested in 10 industries of which Industrial has the largest weight. As of December 2013 Industrial accounted for about 40% of the index. Other industries include Basic Material, Consumer Services, and Consumer Goods.

The NASDAQ OMX 100 Sharia indices have recently outperformed the NASDAQ-100 and NASDAQ-100 Total Return Index. This may be due to exclusion of highly leveraged organisations or whose business was not in compliance with Sharia and hence did not become the part of the Sharia indexes. It can be assumed that such companies have performed adversely and hence pulled the performance of the NASDAQ-100 down.

With regard to the NASDAQ OMX Stockholm benchmark, which has outperformed the Sharia indices, this may be primarily due to the financial securities that have peformed better. This can be due to the affect of the recent financial crises and improving confidence in the European countries or markets.

Comparing the performance of Edbiz –NASDAQ 100 Sharia and Dow Jones Islamic Index

The Dow Jones Islamic Market US Index measures the US universe of investable equities that pass Dow Jones’ proprietary screens for Sharia compliance. The selection universe for the DJIM US Index includes the components of the US benchmark index, which covers approximately 95% of the float-adjusted market capitalization of the underlying market.

The correlation between the Edbiz- NASDAQ-100 Sharia TR Index and the Dow Jones Islamic Market US TR Index is 95.5%. As one would expect with a high correlation, both indexes have moved very much in tandem with one another over the past two years. Returns have been almost identical at 33.65% and 33.62% with NASDAQ edging out Dow Jones.

With such a solid foundation, there is no way an institution like NASDAQ OMX will experience a nose dive. It has entered the Islamic finance space where ample opportunities exist and with the development of the overall industry, sophisticated investors and stakeholders of indices will be interested in the leadership qualities of NASDAQ OMX. For about five years, NASDAQ’s commitment to this important market is clear, and there is an interest to enhance the indices on the supply side. Indices will be developed based on important industries and geographical locations like the Far East and the Middle East, which will not only assist in acting as a benchmark for the industry but also as a barometer for investors who wish to structure important products and services.

The NASDAQ OMX story has been a successful one so far in the conventional world, and there is no doubt that it has all the capabilities to repeat its success in the Islamic finance industry.