Why Changes to Hong Kong’s Stock Index Are a Big Deal

(Bloomberg) -- The Hang Seng Index is undergoing a dramatic overhaul aimed at giving investors who track it greater exposure to China’s growing technological might. The heavy weighting of financial firms and state-owned enterprises will be reduced, which should go some way to rectifying the Hong Kong benchmark’s serial under-performance, and the near-doubling of the membership will add diversity. The changes aim to better reflect the city’s position as the preferred venue for mainland firms to sell shares, while keeping enough local companies on board to ensure it’s still a “Hong Kong” benchmark. Some $38 billion is invested in funds that follow the Hang Seng group of indexes.

1. What is changing?

First off, the index compiler is adding three companies -- Xinyi Solar Holdings Ltd., BYD Co. Ltd. and Country Garden Services Holdings -- boosting the number to 58 as of June 7. The benchmark should grow to 80 companies by mid-2022 and eventually 100. New stocks will need just three months of trading before they’re up for inclusion, regardless of market cap. Previously, stocks that weren’t among the 25 largest had to wait two years. Weightings for all shares will be capped at 8% as of June 7, versus the previous 10% for primary listings and 5% for secondary listings or stocks with unequal voting rights. Constituents will be selected based on their industry group, comprising financials, information technology, consumer discretionary and staples, property and construction, telecommunications and utilities, energy, materials, industrials and conglomerates and health care. And finally, the index will feature at least 20 Hong Kong companies in a new requirement.

2. Why now?

Change was long overdue for the index, which was launched in 1969, for several reasons.

• With a flood of Chinese companies selling shares in the city, either for the first time or as secondary listings, the index was becoming too limited to reflect the changing landscape. The Hang Seng Index was also at risk of becoming too similar to other Chinese indexes by losing its local component.
• The reliance on banks and insurers harked back to a different era and hobbled the gauge’s performance relative to other global benchmarks, leaving the city’s investors with lackluster returns. According to the December consultation paper, in the past 15 years, Hong Kong’s stock market capitalization increased almost 500%; the proportion of mainland companies on the bourse rose to 79% from about 42%; and IT overtook the financial sector as the biggest industry in 2019.
• The new composition should make the Hang Seng a more appealing index to benchmark against because its members will command higher valuations. The timing is also fortuitous. There’s plenty of cash in the city, the yuan is strong and Hong Kong money market rates remain near multi-year lows, which which helped fuel a rally in local shares in early 2021.

3. Will it still be a Hong Kong index?

Yes and no. The changes will ensure the new index captures the shift in Hong Kong’s stock market as Beijing positions the city to be the alternative funding center to New York. Tech firms -- many clustered just across the border in Shenzhen -- will be among the biggest capital raisers, as Chinese President Xi Jinping seeks ways to prevent the U.S. and its allies from blocking China’s rise. Hong Kong firms have reserved spots, but investors seeking heavy exposure to the local economy should look elsewhere, such as the MSCI Hong Kong Index.

4. Was there any opposition?

Some. About 60 individuals, corporates, exchanges and financial organizations replied to the consultation that Hang Seng launched Dec. 23. Four of the five proposals received 70% to 80% support or no preference. Respondents however didn’t agree with scrapping the listing history requirement entirely. New stocks tend to be more volatile and trading history helps inform investment decisions, some respondents said, which is why Hang Seng Indexes went with the three-month rule instead.

The Reference Shelf

• Details on what’s being added to the Hang Seng Index.
• Hong Kong is also raising stamp duty on stock trading, the first hike since 1993.
• Why Hong Kong’s stock market is so dependent on capital coming in from the mainland.
• Another QuickTake on the Hong Kong dollar peg, and one on why Chinese companies were delisted from the New York Stock Exchange.
• How Japan is planning to reform its own stock market.
• Bloomberg Opinion’s Elisa Martinuzzi asks if global banks are headed for extinction, and Shuli Ren looks at the city’s apartment market.

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