We wish to discuss area of interest index methodology tweaks | USAEMALL.com

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Earlier this week, the London Stock Exchange Group’s indexing business FTSE Russell announced some subtle but interesting changes to its rule book. Index methodology might not be everyone’s cuppa, but give it a try.

From September onwards, its various UK indices will admit companies with dollar and euro-denominated shares, rather than just the sterling-denominated ones permitted by the current regime.

FTSE Russell will also make it easier for companies to be admitted quickly into its flagship UK indices. Before, companies needed a £2bn market cap to be eligible for a “fast entry”, but this will be lowered to £1bn, and the relative ranking requirement will also be relaxed

Here’s the new wording of FTSE Russell’s Fast Entry Threshold rule:

If an IPO company ranks 225th or above based on the close price on the first day of unconditional dealings; and has an investable market capitalisation of GBP 1bn; then the company, if otherwise eligible, will be placed in the FTSE 100 or FTSE 250, as appropriate (ranking at or above the index review auto-include thresholds, of 90th or 325th, respectively), after the close on its fifth day of trading. Concurrently, the lowest rank constituent will be deleted from the applicable index and associated membership changes implemented.

Can these moves halt the LSExodus and restore the London’s capital markets vim of yore? No, obviously not. C’mon. The great stock market listing migration is driven by yawning valuations differentials and the multinational operations of many modern companies. Slight rule book fiddles aren’t enough to dent those forces.

Nor are these revolutionary moves. FTSE Russell will still require a company to be of “UK nationality” and be listed on the LSE to make it into the FTSE 100 or 250. At the moment there isn’t a single company that would be affected by allowing dollar or denominated securities to be included in the FTSE benchmarks.

FTSE previously did allow euro and dollar listings, but scrapped this in 2014 because “negligible exposure to non-Sterling traded securities at that time led to unnecessary currency risk within the derivative markets”. Companies could still list in dollars or euros after that, they just weren’t eligible for main market inclusion.

Even the new Fast Entry Threshold would only have affected 11 companies historically, and only three of them would under the revised rules have been eligible for the FTSE 100 at the time of their listing. (Royal Mail, Worldpay and ConvaTec).

However, it could help at the margins, and shows that the LSE is capable of moving beyond blaming the financial media and pension funds in its effort to regain its mojo. Moreover, it has plenty of other levers and knobs it could twist and pull that cumulatively might add up.

Speeding up index inclusion will make the process a bit more attractive to companies, and facilitating dollar and euro listings could potentially entice a few companies whose businesses are anyway international. As David Sol, global head of policy at FTSE Russell, said in the methodology review statement:

We regularly look at the methodology of our indices to ensure they continue to represent the underlying market and sectors. This includes our recent review of the FTSE UK Index Series, where the companies included are inextricably intertwined with the companies that list on the London Stock Exchange. Whilst there will be no immediate impact on the index composition, these two changes will give the FTSE UK Index Series a timely and more accurate representation of companies that can list in London today and in the future.

But for Alphaville the really interesting thing is how this once again highlights how tricky the indexing business is. The whole thing is a minefield of metaphysical questions.

What makes a “UK company”? As FTSE Russell points out in its accompanying FAQ, about 86 per cent of all revenues generated by companies in the FTSE 100 actually come from overseas. What makes a tech company? Amazon is often classified as a “consumer discretionary” stock, and therefore doesn’t appear in tech ETFs, while Meta and Alphabet do, despite being classified as “communication” stocks. Is Brookfield a Canadian or US company? It recently moved its headquarters to New York to secure US index inclusion, but its parent and centre of gravity remains in Toronto.

These are all super-nerdy, mega-niche questions, but in a world where benchmarks matter more and more, they can end up having a fairly sizeable impact.

Further reading:
— Index providers are massively dull — and massively profitable (FTAV)
— The index providers are quietly building up enormous powers (FT)
— ‘Volmageddon’ fine may hint to era of stricter index regulation (FT)