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Explained: What the NSE proposal on reconstitution of indices after mergers means for HDFC twins

Explained: What the NSE proposal on reconstitution of indices after mergers means for HDFC twins

Explained: What the NSE proposal on reconstitution of indices after mergers means for HDFC twins
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By Nigel D'Souza  Oct 19, 2022 12:58:19 PM IST (Updated)

NSE Indices Ltd has proposed a revision in the treatment of mergers and demergers of index constituents for Nifty equity indices. Therefore, it has initiated consultation and sought feedback on the manner of reconstitution of indices by November 2.

NSE Indices Ltd has proposed a revision in the treatment of mergers and demergers of index constituents for Nifty equity indices. Therefore, it has initiated consultation and sought feedback on the manner of reconstitution of indices by November 2.

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HDFC Bank and HDFC Limited are likely to be among the first stocks to undergo the new process if the proposal is approved and implemented.
Following the announcement on Tuesday evening, HDFC and HDFC Bank shares rallied 2.5 percent and 1.6 percent, respectively, on Wednesday.
What happens currently when two or more firms merge/demerge
At present, right after shareholders give a nod to the merger, the stock of the merging company is excluded from indices and replaced with new stock.
Shareholders’ approval is considered a trigger to initiate the replacement of such a stock. As a result, the exclusion of the stock is done much ahead of its ex-date of merger/demerger.
“More specifically, in case of event-based reconstitution on account of merger, index reconstitution takes place at the time of exclusion of the transferor company and subsequently weight rebalancing of the stocks in the index takes place when the shareholders of the transferor company are allotted shares of the merged entity and they are available for trading at NSE (in case the merged entity is a constituent of the same index),” according to the NSE Indices circular.
This results in the churning of stocks twice in case passive funds (ETF/Index funds) are tracking such index.
What changes
If the NSE proposal goes through, it states that the stock of the merging company (for instance, HDFC) will be removed but not after shareholders’ approval but only on ex-date. This will lead to passive holders automatically holding HDFC Bank as their name will come on record.
The investible weight factor and capping factor (if applicable) of equity shares of the merged entity shall be updated based on the terms of the merger on the ex-date of the merger.
The exchange will also announce the new company to be included in the index on ex-date.
As per the proposal, in case of indices with fixed number of constituents, a replacement of company will be made on ex-date, based on the eligibility criteria of respective indices in place of a transferor company being excluded.
In the case of indices with a variable number of constituents, no replacement will be made on the ex-date in place of the transferor company which is being excluded.
Why has NSE proposed the change
The key rationale behind the move is that it would address longer exclusion and multiple adjustments to indices, especially given the rise of exchange-traded funds (ETFs) and index funds.
Nuvama Alternative and Quantitative Research believes that it is now unlikely HDFC gets excluded from Nifty, which would have meant an estimated outflow of $1.5 billion.
“If these proposed changes are considered after the consultation is over, then HDFC Ltd will only get excluded on the ex-date (which will likely be Q1FY24). This is the standard practice followed globally,” the experts at Nuvama cited by Moneycontrol said.
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