The Hang Seng Index (SEHK: ^HSI) is the most commonly used barometer of the Hong Kong stock market.
It consists of 52 blue-chip companies listed on the Hong Kong Stock Exchange (HKEX), covering 57.6% of the exchange’s total market capitalization.
However, the composition of the exchange has changed dramatically over the years.
Companies from Mainland China now form 79% of the HKEX, a striking increase from just 41.6% in 2005.
Meanwhile, information Technology (IT) companies also overtook the Financial sector as the largest industry in 2019.
In order to reflect the respective shifts of the market, Hang Seng Indexes Company (HSIC) recently proposed five enhancements to the HSI.
The final decision and details on the changes will be announced in February 2021.
1. Expanding Industrial Representation
The first proposed change will consolidate the current list of 12 industries into six groups.
Companies will then be selected to join the HSI based on the target coverage ratio for each industry group.
This amendment is aimed at achieving a more balanced representation of the major industries on the Hong Kong Stock Market.
A common criticism of the HSI has been the heavy weightage to financial companies, which currently form 43% of the index.
Under the proposed changes, the financial sector will see its weightage diluted to 34.9%.
In addition, industrial coverage will be boosted for certain industries who had less than 40% of market capitalization represented in the index.
The property and construction industry would have 95.2% coverage with the changes, a significant increase from the current 42.2%.
2. Increasing Number Of Constituents
The second enhancement proposed is to increase the number of constituents in the HSI to between 65 and 80.
In recent years, the HKEX has relaxed its listing regulations, encouraging more mega-cap technology companies to list on the exchange.
Listing reforms in 2018 allowed companies with weighted voting rights to list in Hong Kong for the first time.
The reforms prompted a wave of IPOs, including technology giants Xiaomi Corp (SEHK: 1810) and Alibaba Group Holdings Ltd (SEHK: 9988)
With the increased number of mega-cap companies in the market, the HSI’s market capitalization coverage of the HKEX has been dwindling.
The proposals to increase the size of the HSI would allow it to cover up to 78.2% of Hong Kong’s total market capitalization.
3. Removal of Minimum Listing History Requirement
Another proposed change is the removal of the minimum listing history requirement.
Currently, new listings on the HKEX ranked below 25th by market capitalization must wait 24 months before being considered for inclusion in the HSI.
Companies ranked above 25 also have to wait between three to 18 months before being admitted to the index.
This has caused the HSI to lag behind when it comes to achieving an accurate representation of the market.
The December 2020 listing of JD Health International Inc (SEHK: 6618) saw it become the 14th largest company on the HKEX.
However, it will have to wait six months before it can be added to the HSI.
The proposed amendments would allow the HSI to add companies like JD Health more quickly to its list of constituents.
4. Maintain a Minimum Number Of Hong Kong Companies
Among the changes is a proposal to keep a minimum of 25 Hong Kong Companies within the HSI.
This change would increase the number of Hong Kong-based firms from the current 24.
HSIC, which runs the HSI, asserts that this move is to maintain a level of geographic representation for Hong Kong companies, given that the HSI tracks the HKEX.
The HKEX is one of the largest IPO markets in the world, and more Mainland Chinese companies are expected to list in Hong Kong in 2021.
Some companies rumoured to be gearing up for listing in Hong Kong include TikTok operator ByteDance, streaming giant iQiyi (NASDAQ: IQ) and ride-hailing platform Didi Chuxing.
In the long run, these listings will push more Hong Kong companies out of the HSI, hence the move to introduce a minimum number.
5. Calibrate Weightage Cap Of Individual Companies
The final proposed change is to lower the weightage cap of individual companies from 10% to 8%.
This will reduce the index’s concentration in its top five constituents from 39.9% to 37.1%.
In addition, secondary-listed constituents will also have the current cap of 5% raised to 8%.
The lifting of the cap allows the index to better represent large companies like Alibaba and Xiaomi, who have primary listings in other exchanges.
Conclusion
The proposed changes to the Hang Seng Index will allow it to mimic the make-up of the Hong Kong Stock Exchange more rapidly and accurately.
While not exactly a complete overhaul, the changes are a refreshing update to the index, which used to face criticism for its heavy bias towards the financial sector.
With the changes, the HKEX will become even more attractive for Chinese technology giants, and this can help solidify Hong Kong’s reputation as both a financial and technology hub.
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Disclosure: Herman Ng does not own shares in any of the companies mentioned.
