It’s been an eventful few weeks in the world of index constituents, specifically which types of companies will be permitted in broad stock indices. Two of the largest index companies, FTSE Russell and S&P Dow Jones Indices, have issued new rules regarding voting rights and which companies may join their indices.
Companies with multiple share classes left outside major indices
FTSE Russell announced on July 26, 2017 that it would require new index constituents to have at least 5% of their voting rights in the hands of public shareholders. Current index constituents would have 5 years to comply with the new requirement. Approximately 30 current index constituents are not in compliance with the new rule. This change will mean such companies as Snap, Inc., maker of the widely popular Snapchat app, will not be eligible to join any of FTSE Russell’s many indices.
The following week S&P Dow Jones Indices went one step forward by outright banning companies with multiple share classes from joining the S&P 500, S&P MidCap 400 and S&P SmallCap 600 indices. However, existing constituents, such as Google, Berkshire Hathaway and Facebook, will be able to remain. Also, the S&P Global BMI Indices and S&P Total Market Index will continue to include companies with multiple share classes, and other S&P and Dow Jones branded indices will remain unchanged.
It’s about voting rights
These changes have less to do with the criteria determining index constituents, and more to do with a growing battle over corporate governance and shareholders’ voting rights. Both FTSE Russell and S&P Dow Jones cited pressure from market participants for their decisions on restricting companies with multiple share classes.
In an interview with Reuters in June 2017, the Chief Executive of FTSE Russell, Mark Makepeace, shared that many of his clients were worried that such multiple class shares like those of Snap, Inc. would be a bad model for the market. He said, “There were strong opinions that voting rights are in important issue.”
DIH would be surprised if we don’t see more changes to how index constituents are determined. MSCI, Inc., another leading index company, is currently reviewing its criteria on how to handle such multi-class shares. In public statements, MSCI appears to be leaning toward following its peers in adding corporate governance consideration when determining index constituents, apparently after consulting with its institutional investment clients.
All the stakeholders are in for the long haul
There are several very powerful stakeholders in the fight over voter rights…
Index companies want their indices to be used by investors to build their equity trading universes, and as benchmarks to measure the performance of other securities and portfolios. So index companies are keenly aware of institutional investors’ concerns regarding voting rights.
Founders and company insiders want to maintain their control over the direction of their companies, even after they IPO and have minority ownership stakes. However, such newly IPO’d companies also want to be added to a major stock index so their shares are bought up by passive index funds and ETF’s.
However, institutional investors (think of firms like BlackRock, Vanguard, State Street, Fidelity and big pension funds) are not comfortable investing their capital (or their clients’ capital) in companies over whom they have little to no influence. Without voting rights, shareholders feel they cannot hold boards accountable.
Add to the mix stock exchanges all over the world fighting over the next big IPO in an environment where private companies are waiting longer and longer to IPO. The list of Unicorns (private companies with a valuation over $1 billion) is pretty long, and every exchange on the planet wants to take those private companies public.
For example, Hong Kong Exchanges & Clearing Ltd. (HKEX) has claimed that Chinese companies that have multi-class shares have raised $30+ billion in the USA over the last 10 years. Given that environment, HKEX’s CEO (Charles Li) has eluded that his exchange will embrace more IPO’s by companies with multiple share classes, even though so far those same companies will be excluded from the Hang Seng Indices.
Singapore’s government has also supported multiple share classes, and even the United Kingdom has hinted it may loosen its rules regarding voting rights.
Stay tuned for more fireworks over publicly traded companies with multiple share classes. As we’ve noted, each of the stakeholders are powerful, and are not likely to backdown on the subject of voting rights.
In the meantime, DIH will continue to track index constituents and help stock traders avoid survivorship bias in their research.