Hong Kong's benchmark index provider is at a turning point. European regulations that take effect in January will test its ability to remain relevant.
Hang Seng Indexes Co. is already behind the curve. The company, owned by Hang Seng Bank Ltd., said last week that it would add non-state-owned Chinese companies to its gauge of so-called H shares in the city, a step that would allow the inclusion of new-economy stars such as Tencent Holdings Ltd.
The Hang Seng China Enterprises Index, which is dominated by financial and industrial companies, has risen 17 percent this year, compared with a 38 percent surge in the MSCI China Index. Two years ago, rival index compiler MSCI Inc. made the decision to include U.S.-listed Chinese technology companies, whose shares have been on fire this year.
Unfortunately, Hang Seng Indexes will soon be hit by a regulatory tsunami from Europe. Shaken by the Libor manipulation scandal, the European Union will require that the region's financial entities -- from banks to fund managers -- only use third-country benchmarks that have been cleared by the European Securities and Markets Authority. Unless the Hong Kong provider can prove that its gauges meet these strict standards, no European institutional investor will be able to benchmark against any of the Hang Seng indexes.
Hang Seng Indexes has three options to become compliant. The first, which requires that "supervision and regulation in a third country should be equivalent" to the EU standards, wouldn't work because the company isn't regulated in Hong Kong.
Second, an EU entity could "endorse benchmarks provided from a third country." Perhaps London-headquartered HSBC Holdings Plc, with a 62 percent stake in Hang Seng Bank, could be the sponsor? But that would make HSBC "fully responsible" for Hang Seng's compliance with the EU standards.
The third option would require Hang Seng Indexes going to a major market regulator, say in Paris or Frankfurt, to obtain recognition. European regulators would have to visit Hong Kong to make sure the company was in compliance.
Like the impending MiFID rules, the EU's regulation of benchmark indexes is still young and it's unclear how providers can clear the hurdles. A spokesman for Hang Seng Indexes said it was assessing the regulations and their implications and couldn't comment at this stage.
The question for Hang Seng Indexes is whether compliance will be worth the trouble. The company, which makes money by licensing its name, doesn't get much from Europe.
More than 150 funds managing more than $41 billion of assets track the Hang Seng family of indexes, of which the best known is the blue-chip Hang Seng Index. Among these, only eight funds commanding $1.4 billion of assets are from Europe, data compiled by Bloomberg show. European investors accounted for only 5.4 percent of total cash equity trading in the city last year, according to Hong Kong Exchanges & Clearing Ltd.
There's no question that MSCI will go out of its way to comply with the European demands. Of the $15.2 billion of assets that are pegged to the MSCI China and Hong Kong indexes, $2.6 billion come from Europe. However, a far bigger $227 billion of assets under management are pegged to the MSCI Emerging Markets Index, in which Hong Kong-listed Chinese stocks have a 21 percent weighting. Continental Europe accounts for almost half that amount.
The new European regulations will make the indexing world smaller, leaving a handful of global players, forcing regional compilers to become more local and perhaps even pushing some into oblivion.
Despite the limited presence of European money in Hong Kong's stock market, Hang Seng Indexes would show foresight in bending to the continent's will.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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