Pulling In Opposite Directions
September 27, 2012
[This article previously appeared on our sister site, IndexUniverse.eu.]
Amongst other sources of revenue, listing fees provide a major income stream for stock exchanges. Meanwhile, the index providers that are often owned by exchanges are under pressure from investors to ensure tighter governance rules. The resulting tensions aren’t that visible, but they are mounting.
The recent announcement by the UK government that it intends to ease listing rules for perceived “high-growth” companies comes at a sensitive time. It’s not just that Indonesian mining entity Bumi has just announced major financial irregularities, causing the company’s shares to register a near-90 percent decline in little more than a year. There are also broader concerns from many investors that listing standards were relaxed too far during the boom and in fact need to head towards a tightening, not loosening. For index investors, this debate carries a particular resonance.
Bumi was one of a large crop of resource companies with primarily non-UK operations that have chosen to list their shares in London in the last few years, taking advantage of a liberal regulatory regime that allows large companies from all over the world to obtain a so-called premium listing on the London Stock Exchange (LSE) with as little of 5 percent of their share capital available for public trading.
Bumi got its premium listing last July, with the exchange trumpeting that this listing status ensures being made subject “to the highest regulatory standards”. The LSE also advertised that a premium listing ensures eligibility for the “internationally recognised and tracked FTSE indices”. The LSE owned half of FTSE at the time of Bumi’s listing, let’s remember, while this February it took full control of the index firm in a deal worth £450 million.
Recent events at Bumi pose a major question mark over the LSE’s claim about regulatory standards, but the firm’s premium listing indeed made it eligible for FTSE membership. It didn’t quite make it into the FTSE 100 index of the LSE’s largest companies, but it joined and still remains in the FTSE 250 index (from where it will probably be ejected at the next index review as a result of its share price decline).
But pressure from the institutional investor users of FTSE indices has resulted in the index firm deciding earlier this year to set a higher minimum free float requirement for UK-incorporated companies to gain index eligibility—25 percent—than is currently set by the regulator as a prerequisite for UK premium listing status.
“A premium listing...is a necessary, but insufficient, condition for entry into the UK Series,” FTSE’s chief executive, Mark Makepeace, reminded us in a recent letter to the FT. “FTSE’s free float requirement is driven by governance considerations, as determined by our customers,” Makepeace stressed in the letter.
If you find the rules on listing standards confusing, you’re not the only one. The UK Listing Authority (UKLA), which is part of the securities market regulator, the FSA, already sets different requirements for so-called premium and standard listing categories. As we mentioned earlier, the LSE, supported by the government, is now proposing a third listing category for perceived high-growth start-ups. Meanwhile an index firm that’s now fully part of the exchange requires a premium listing for inclusion in its domestic share benchmarks and also sets its own standards for the minimum free float of companies listed on the exchange. Got that?
But you can’t escape the obvious potential tensions between the exchange owner, which has a clear commercial interest in generating as much listings revenue as possible, and the index provider that has to cater to a set of constituents with very different concerns. Makepeace told me in an interview earlier this year that the policy groups who set FTSE’s index standards have to be independent, but he conceded that the commercial interests of FTSE and the LSE are not completely in sync (though he said they’re better aligned than before).
With an ever-increasing pot of money following index-based investment strategies, it’s also clear that companies have been motivated to list their shares in locations and on exchanges that promise them index entry and a guaranteed level of buying interest from passive funds. The smaller the percentage of your share capital that you can get away with listing and the greater the popularity of the index, the greater the potential boost to your share price if you view the whole process of going public as an opportunity to cash in at the expense of the broader shareholding public.
The recent case of Nasdaq’s relaxation of its “seasoning rules” for Facebook shares makes it clear that listing privileges and index inclusion can be offered as a commercial package to those companies wanting to go public. Index-based investors should be very aware that they may be the fall guys in these discussions.
There’s been a vocal recent debate over self-indexing and the need (or otherwise) for a third-party index provider to calculate the benchmarks underlying tracker products. Less attention has been paid to index firms’ ownership and their own independence from entities that may have different objectives than ensuring the quality of an index-based investment portfolio. I expect this will change as tensions rise over listing rules and corporate governance standards.
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