Weightings changes hit FTSE
Changes to the way weightings are calculated will have a big impact on the
FTSE 100 and other FTSE indices. Under the new rules, the weightings of telecommunications company Orange and media giant BSkyB would be almost halved.
The new rules will be applied in two phases – in January 2000 and June 2001.
All FTSE indices will be affected except the Stars, Eurotop 100, FT30 and FTSE Aim indices, which have different weighting systems.
The main change will be the way restricted free-float is treated in the index. Free float means a company’s shares can be traded on the stock market with no restrictions.
Currently, under the index rules, a company only needs to have a free float of at least 25% to be listed in the FTSE indices with its full market capitalisation. However, the remaining 75% could be held by the founding family, by the state, or they could be cross-holdings or shares reserved for employees.
When a company’s ownership structure or capitalisation policy limits the amount of company stock available in this way, it can lead to short-term pricing and liquidity distortion. FTSE International says this was one of the major issues which respondents wanted to put right in its public consultation on global standards for indices.
Mark Makepeace, FTSE International’s managing director said: “It is very clear that fund managers want an investible benchmark. Over 80% of fund managers wanted to change the existing free float rules and to remove restricted free float from the indices.” The number of index-orientated investors is growing, and the switch to a free-float index takes their needs into account.
Rick Lacaille, head of structured equities at Gartmore, says the current rules can be a potential problem for passive and active fund managers alike. The number of companies which have just floated a fraction of their share capital has increased, he says.
A £2bn company, for example, could make up 0.15% of an index even though only £550m of its shares are freely traded. This can lead to a scramble for shares from index-tracking fund managers, which in turn sparks sharp movements in the price. “None of us has found it impossible to buy shares, it is just regrettable that you’re often buying them in a thin market and incurring costs, he says. “The change in the rules is sensible - it will cut out this potential gaming of the index.”
Sanjiv Talwar, co-head of qualitative research and financial engineering at Commerzbank Global Equities, acknowledges that using a free-float index would make the index as investible as possible and give companies a strong incentive to create the highest possible free float ratios. “Clearly, there are both advantages and disadvantages to using a free float index,” he says.
“On the other hand, a free float index could well be less representative of the underlying economic make-up of a stock exchange, and there are difficulties with definitions and data,” he adds.
The new rules allow companies to be included in FTSE indices with as little as 15% free float. Above that level, companies will be weighted in four bands relating to the proportion of their share capital which can trade freely. If this is between 15% and 25%, the company will have a weighting of 25%; if it is between 25% and 50%, the weighting is 50%; from 50% to 75%, the weighting is 75%, and companies with free-float of more than 75% will have a 100% weighting.
FTSE International says there was strong support from respondents to its public consultation to adjust the weightings to remove cross-holdings and restricted free-float. But many users of its indices did express concerns about the availability of accurate cross-holdings and free float data.
Talwar at Commerzbank shares these worries. He says: “We believe it would only make sense for FTSE International to go ahead if some of the differences in the reliability of free float data across different markets can be overcome.”
Different countries, he says, have different rules on share block notification, and it often takes several months to get information. Countries such as the UK and the US, which has the most comprehensive and reliable cross-shareholdings data, could risk losing weight in international indices, he warns.
Another change is that the existing subsidiary rule will be removed. At the moment, subsidiaries which are more than 50% owned by another constituent of a FTSE index cannot be included in FTSE indices.
Also, a single nationality rule was brought in in September. A company’s stocks are now classified by country of incorporation, unless its stock market listing, share trading or ownership warrants a different location. This makes the change from the previous rules, under which a company was classified according to its country of incorporation or residency for tax purposes.