Ahead of HDFC-HDFC Bank merger, NSE Indices floats consultation paper on index rules

NSE Indices Ltd, a subsidiary of National Stock Exchange, is planning to change the methodology of merger and demerger of index constituents for equity indices to avoid big churnings, which happens in the current system.

This comes ahead of the proposed merger of HDFC with HDFC Bank.

The proposal, if considered, is expected to avoid sharp movement in stock prices of firms that are in the process of merger or demerger.

In its consultation paper, NSE Indices has suggested to make ex-date an important factor for replacing an index constituent.

It has sought comments from market participants on the proposed revision in the treatment of merger and demerger of index constituents for equity indices till November 2.

With regards to the treatment of a merger, NSE Indices has proposed that the transferor company will be excluded from the index on the ex-date (T Day) of the merger -- the closing of the T-1 day merged entity.

Equity shares, investible weight factor and capping factor of the merged entity would be updated based on the terms of a merger on the ex-date of the merger.

On ex-date, a replacement of company will be made based on the eligibility criteria of respective indices in place of the transferor company, which is being excluded from indices with a fixed number of constituents, as per the proposal issued late night on Tuesday.

Indices with a variable number of constituents, NSE Indices suggested that no replacement will be made in place of the transferor company which is being excluded.

The announcement of these changes would be made a minimum of three working days in advance for the change in the constituents of indices, including the indices on which Futures and Options are traded at NSE.

At present, shareholders' approval for the scheme of arrangement for a merger of a company is considered a trigger for making the index reconstitution and weight rebalancing and soon after the shareholders' approval, exclusion of the transferor company is initiated from the respective indices.

According to NSE Indices, due to the current method, the demerged company is excluded from the index much ahead of its ex-date of the demerger.

In addition, companies with large market capitalisation may get excluded and again become eligible for inclusion in subsequent reviews, thereby increasing churn in the index and consequently in funds tracking such index.

With regards treatment of demerger, it has been suggested that in case special trading of the demerged company is conducted by the stock exchanges for price discovery, such demerged entity would be retained in the index and the index divisor would be adjusted before the market opening of ex-date of demerger based on the price discovered.

Further, the demerged company, which is retained in the index, would be screened for its continued eligibility, considering data for the period starting the ex-date till the last trading day of the next calendar month.

Such demerged company would be replaced, in case a suitable replacement is available.

In case a special trading session is not conducted by the stock exchanges, after the shareholders' approval, such demerged firm should be excluded from the index on the ex-date of demerger or the next scheduled review effective date of Nifty 500 and Nifty Microcap 250 indices (after such shareholders' approval) whichever is earlier, the exchange said.

Experts believe that if these proposals are considered then HDFC Ltd will only get excluded on the ex-date-- which could be Q1 FY24.