The world’s biggest index companies have taken sides in one of the most controversial issues in today’s markets, setting up a clash with stock exchanges pushing to loosen rules on multiple share classes.
The decisions by FTSE Russell and S&P Dow Jones Indices to ban companies that use the structures has already had an effect, with photo-sharing app Snap. now unable to qualify for S&P’s US indexes.
But a bigger battle is likely to play out in the months ahead, as bourses from New York to Hong Kong step up efforts to woo such companies while index compilers and fund companies that track their offerings keep the stocks out of benchmarks and investor portfolios.
Firms such as Facebook and Alibaba like dual or even triple-class structures because they ensure founders and leaders keep control over their companies even with minority ownership. But investors have become increasingly vocal in questioning whether it’s in their best interests. Those concerns have led to the index companies taking a stand, one that could deter firms from issuing multiple classes in future, according to a corporate governance specialist.
“Companies do listen to their bankers, their sponsors,” said Jamie Allen, secretary general of the Asian Corporate Governance Association in Hong Kong. “So if they come down and say, ‘This is going to devalue your company, your exposure, and the marketing benefit you get from being in an index,’ then yes, that would have some effect.”
On Monday S&P blocked multi-class shares from joining US indexes including the S&P 500, though a grandfather clause spared giants such as Google parent Alphabet and Berkshire Hathaway . Last week London Stock Exchange Group unit FTSE Russell announced a list of more than 30 companies it would bar from its indexes unless they raised the percentage of voting rights accorded to public investors.
MSCI’s Henry Fernandez, told Bloomberg Television in July that exchanges relaxing their rules to allow multi-class shares “is not the right direction” and that MSCI is consulting with clients about the best way to handle such stocks.
At least one of the firms on FTSE Russell’s list -- market maker Virtu Financial -- is in talks with the index compiler to make the case it shouldn’t be blocked, according to people familiar with the matter. Virtu is working with FTSE Russell on the definitions for its thresholds, said the people, who asked not to be named.
While Virtu wouldn’t be booted from FTSE Russell’s gauges for five years even if its talks fail, Snap’s situation is more immediate: its class of zero voting right shares means it’s barred from FTSE Russell’s benchmarks and S&P’s US indexes. The firm’s shares have lost a quarter of their value since Snap’s IPO in March.
Officials at Virtu and Snap declined to comment while FTSE Russell didn’t immediately reply.
S&P’s decision affects only its US indexes and its global gauges will continue to include companies with multiple share classes and zero shareholder voting rights, said spokeswoman Soogyung Jordan.
The indexers’ decisions won’t help Snap as it tries to recover its share price, Monness Crespi Hardt & Co analyst James Cakmak said. “The broader takeaway is that up-and-coming companies need to do a serious gut-check on pursuing multi-class share structures,” he said.
Chinese companies with multi-class shares raised US$34bn in the U.S. over the past decade, Hong Kong Exchanges & Clearing said in June, as it unveiled plans to allow the structures.
“Our present listing regime isn’t agile enough to cope with the demands of this new age,” Charles Li, chief executive officer of HKEX, wrote in a related blog post Tuesday. “This global relay race is in the first leg, and we are lagging behind.”
In Singapore, the government supported a proposal to allow dual-class shares as part of a package to drive economic growth. The UK regulator suggested loosening its restrictions in a February discussion paper on the effectiveness of its markets.
“We are still evaluating the feedback received and target to update the market before the year-end,” said Tan Boon Gin, head of Singapore Exchange’s regulatory unit, said in response to a request for comment.
“The resistance of some exchanges to non-voting shares is admirable, but competition might force them to allow it. The index guys have an economic motivation to please the funds that use the indexes,” said Paul De Vierno, a strategist at UOB Kay Hian Holdings in Singapore. “Both sides are going in different directions.”
Index exclusion may be the price that founders pay to stay in charge. HKEX said that any dual-class stocks that listed in the city would be ineligible for inclusion in the benchmark Hang Seng indexes.
“It’s hard to say who’s winning or losing at this moment,” said Chow Kar Tzen, a Kuala Lumpur-based senior portfolio manager at Affin Hwang Asset Management Bhd. “It’s a balance between profits and governance.”
* Bloomberg
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Our family matters legal consultant
Name: Hassan Mohsen Elhais
Position: legal consultant with Al Rowaad Advocates and Legal Consultants.
FFP EXPLAINED
What is Financial Fair Play?
Introduced in 2011 by Uefa, European football’s governing body, it demands that clubs live within their means. Chiefly, spend within their income and not make substantial losses.
What the rules dictate?
The second phase of its implementation limits losses to €30 million (Dh136m) over three seasons. Extra expenditure is permitted for investment in sustainable areas (youth academies, stadium development, etc). Money provided by owners is not viewed as income. Revenue from “related parties” to those owners is assessed by Uefa's “financial control body” to be sure it is a fair value, or in line with market prices.
What are the penalties?
There are a number of punishments, including fines, a loss of prize money or having to reduce squad size for European competition – as happened to PSG in 2014. There is even the threat of a competition ban, which could in theory lead to PSG’s suspension from the Uefa Champions League.
Mercer, the investment consulting arm of US services company Marsh & McLennan, expects its wealth division to at least double its assets under management (AUM) in the Middle East as wealth in the region continues to grow despite economic headwinds, a company official said.
Mercer Wealth, which globally has $160 billion in AUM, plans to boost its AUM in the region to $2-$3bn in the next 2-3 years from the present $1bn, said Yasir AbuShaban, a Dubai-based principal with Mercer Wealth.
“Within the next two to three years, we are looking at reaching $2 to $3 billion as a conservative estimate and we do see an opportunity to do so,” said Mr AbuShaban.
Mercer does not directly make investments, but allocates clients’ money they have discretion to, to professional asset managers. They also provide advice to clients.
“We have buying power. We can negotiate on their (client’s) behalf with asset managers to provide them lower fees than they otherwise would have to get on their own,” he added.
Mercer Wealth’s clients include sovereign wealth funds, family offices, and insurance companies among others.
From its office in Dubai, Mercer also looks after Africa, India and Turkey, where they also see opportunity for growth.
Wealth creation in Middle East and Africa (MEA) grew 8.5 per cent to $8.1 trillion last year from $7.5tn in 2015, higher than last year’s global average of 6 per cent and the second-highest growth in a region after Asia-Pacific which grew 9.9 per cent, according to consultancy Boston Consulting Group (BCG). In the region, where wealth grew just 1.9 per cent in 2015 compared with 2014, a pickup in oil prices has helped in wealth generation.
BCG is forecasting MEA wealth will rise to $12tn by 2021, growing at an annual average of 8 per cent.
Drivers of wealth generation in the region will be split evenly between new wealth creation and growth of performance of existing assets, according to BCG.
Another general trend in the region is clients’ looking for a comprehensive approach to investing, according to Mr AbuShaban.
“Institutional investors or some of the families are seeing a slowdown in the available capital they have to invest and in that sense they are looking at optimizing the way they manage their portfolios and making sure they are not investing haphazardly and different parts of their investment are working together,” said Mr AbuShaban.
Some clients also have a higher appetite for risk, given the low interest-rate environment that does not provide enough yield for some institutional investors. These clients are keen to invest in illiquid assets, such as private equity and infrastructure.
“What we have seen is a desire for higher returns in what has been a low-return environment specifically in various fixed income or bonds,” he said.
“In this environment, we have seen a de facto increase in the risk that clients are taking in things like illiquid investments, private equity investments, infrastructure and private debt, those kind of investments were higher illiquidity results in incrementally higher returns.”
The Abu Dhabi Investment Authority, one of the largest sovereign wealth funds, said in its 2016 report that has gradually increased its exposure in direct private equity and private credit transactions, mainly in Asian markets and especially in China and India. The authority’s private equity department focused on structured equities owing to “their defensive characteristics.”
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