Unless something unexpected will happen during the next month, on December 15 we will witness an unprecedented spectacle on the Tel Aviv Stock Exchange (TASE): More than 26% of the index that represents Israel's stock market performance (TA-100) will be allocated to foreign companies with minor activity in Israel if at all.
TASE's flagship index (TA-25) will become a pharmaceutical sub-index through representation of no less than 36% to global pharmaceutical companies: Teva Pharmaceutical Industries Ltd. (Nasdaq: TEVA; TASE: TEVA) and three foreign companies.
How did we reach this point? The answer is very simple - TASE’s listing rules allow US and UK companies traded on a regulated market such as NYSE, NASDAQ, and LSE to dual-list their shares on the TASE. Dual-listing offers companies more trading hours and adds new investors to their shares. As long as the dual-listing is done in order to reach these objectives, it sounds like a win-win-win for the company, the investors and off course, for the exchange.
The problem lies elsewhere - TASE’s indices rules. While the local equity indices eligible criteria include liquidity, market cap and float conditions, they don’t distinguish between Israeli and foreign companies. According to today’s market conditions, almost each publicly traded company in the US or in the UK with a minimum market cap of $100 Million and a free-float rate of 50% or above, can dual-list their shares in Israel and immediately be nominated to join the TA-100.
At this stage it’s important to clarify that the criticism made in response to the current inclusion of foreign companies in the TASE indices, resulted in an announcement published last weekend by the stock exchange that starting from November 22, a foreign company will have to have some “Israel identity” in order to be included in the local equity indices.
The problem with this definition is that almost any multinational company operating in Israel could claim to meet the requirement. For example, Intel is one of the largest employers (7,000) in Israel. Google and Facebook have R&D and marketing activities here.
There is no doubt that if these companies decide to dual-list their shares in Israel it would be great for the stock exchange trading volumes, but at the same time, using the “Israel identity” definition in order to join the TASE indices may result in an extreme situation of exclusion of representation of Israeli companies in the local indices, which originally been designed to measure their performance.
Cannot happen on S&P 500 or NIKKEI
Some may argue that there is no problem with the inclusion of foreign companies in the local indices, as the indices universe refers to all shares traded on the TASE. But, from my point of view, we need to learn from changes made in known equity indices around the world and implement the best solution for the Israeli investors.
The major indicators for the US equity market are S&P 500, Dow Jones Industrial Average, Russel 1000 and NASDAQ 100. Except for the last index that acts in a similar way to our stock exchange and does not discriminate against companies on the basis of their domicile, all other indices don’t include non-American companies.
In Europe, inclusion in the DAX index is possible only for companies with headquarters in Germany. The FTSE indices for the UK equity market have two special criteria for foreign company that wish to join them: a minimum free-float rate of 50% (UK company needs only 25%) and reporting under the laws and regulations in the UK.
In the Asia-Pacific region, two major indices are the Australian S&P/ASX 200 and Japanese NIKKEI 225. While the NIKKEI includes only domestic companies, the Australian main equity index may include companies incorporated overseas that have an exclusive listing on the ASX, or most of the trading activity occurs on the ASX.
As you can see above, most of the indices exclude foreign equities such as Mylan and Mannkind. Hence, in light of recent events, now is the time to conduct in-depth discussion on the subject and establish clear criteria for foreign companies that may be included in TASE indices.
From Home-Bias to No-Bias
So far, I have presented the problem mainly on the theoretical level. However, when looking at the relevant numbers, we understand how deep the problem is on the practical level.
Let’s take a look at the numbers of ETN’s and index tracking funds local equity indices. As of the end of October, these products had total net assets of NIS 31 Billion. These funds are held both by Israeli private and institutional investors.
In addition to the index products assets, we should add direct investments of institutional investors in equities listed in the TASE. This is because these managers use the TA-100 index as their equity reference asset. Naturally, the correlation between the domestic equity holdings of institutional investors and the local stock index constituents is strong. Let’s say it will be a very difficult task to find an Israeli investment manager who does not hold Teva, Israel Chemicals (TASE: ICL: NYSE: ICL), or one of the largest local banks.
According to data published by the Bank of Israel, Israel Securities Authority and the Ministry of Finance, about NIS 100 billon of long term investments held in domestic equities and additional NIS 10 billon by mutual fund managers. There is also approximately NIS 5 billon of domestic equities held by local portfolio managers.
In fact, those total NIS 146 billon that belong to Israeli investors and are fully or almost fully linked to the percentage of local equity indices. In other words, TASE impacts on the Israeli stock market performance significantly more than any single investment house or insurance company.
Going back to our current example, the outcome of Mylan and Mannkind's latest inclusion on TASE indices is the almost immediate reduction of approximately NIS16 billon of institutional investments for Israeli companies.
If we consider that nowadays the typical equity allocation of local institutional investors is 40% in Israel and 60% globally, then the real ratio between the regions is much higher. If this behavior continues, Israel may soon turn to No-Bias market, a stark contrast to our Home-Bias status a few years ago. Such a sudden move is expected heavy consequences for the future of the stock market in Israel.
Yaniv Kunis is founder and CEO of Index Research, an Israeli-based index provider specializes in research and development, calculation and maintenance of fixed income and equity indices.
Published by Globes [online], Israel business news - www.globes-online.com - on November 18, 2015
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