Introduction

The Hang Seng Index (“HSI”) is a market capitalisation-weighted index of the largest companies whose “blue-chip” stocks are listed and traded on the Hong Kong Stock Exchange. Since it was started in 1969, the HSI has been commonly regarded as a useful barometer for indicating the overall economy or market sentiment of the Hong Kong stock market. With the accelerating exchanges between the financial markets in Hong Kong and the Mainland, the compiler of HSI is exploring to launch more indices to track performance of the shares of companies in the Greater Bay Area, as well as those in the biotech and environmental sustainability-related sectors.

Background

The HSI is compiled and maintained by Hang Seng Indexes Company Limited (the “Compiler”), a wholly-owned subsidiary of Hang Seng Bank Limited. The HSI employs a freefloat-adjusted market capitalisation weighting scheme, which is currently consisted of 58 constituent stocks.  It is calculated and refreshed real-time every other two seconds during the trading hours of the Hong Kong Stock Exchange.

There are currently four main sub-indexes under the HSI, namely commerce and industry, finance, utilities and properties.

Major development of the HSI

In 2020, the Compiler proposed to increase the number of constituent stocks from 55 to 80 in order to reflect a more comprehensive market situation given the fast-growing number (i.e. over 2,500 as of this date) of listed companies in Hong Kong. Relevant changes are expected to be implemented in various phases until mid-2022.

Moreover, after the stock connect schemes are launched, foreign investors can have a wider access to making investments in the Chinese capital market through Hong Kong. As such, the Compiler believes that having new indices to track Chinese stocks performance will be helpful for foreign investors and therefore attract foreign investments and benefit market practitioners.

More indices to come

The chief executive (the “Chief Executive”) of the Compiler of Hong Kong’s benchmark stock index, indicated, during an interview with the South China Morning Post, that it would like to launch more indices to track performance of shares in the Greater Bay Area. The Greater Bay Area comprises the two Special Administrative Regions of Hong Kong and Macao, and the nine municipalities of Guangzhou, Shenzhen, Zhuhai, Foshan, Huizhou, Dongguan, Zhongshan, Jiangmen and Zhaoqing in Guangdong Province. Given the development of the Greater Bay Area and the increasing interaction between the capital market of Hong Kong and that of the Mainland China through, among others, the Stock Connect and Bond Connect schemes, it is an anticipated trajectory for the Heng Seng Indexes to include indices for tracking performances of shares in the Greater Bay Area in order to meet investors’ expectation. It is suggested that the new indices will include a broader range of companies from different industries.

Further, stocks relating to climate change and tracking performance of companies which conform to the environmental, social and governance standards will also be included as, in the Chief Executive’s words, “Many big fund managers have vowed to add investments in companies that have good ESG practices, and they need benchmark indices to help with their investment decision”. In addition, smart-beta indices will be introduced and they differ from the other existing indices as they will take into account also the value, quality, yield and volatility of the shares, such that investors can better make different investment strategies.

When it comes to biotech start-ups, which have been allowed to get listed on the Main Board of the Stock Exchange under a new listing regime as stipulated in Chapter 18A of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited, we have witnessed more and more listing applications. As such, the Chief Executive considers introducing thematic indices which will track biotech companies as benchmarks.

Index-linked financial products

With the expansion of the Hang Seng Indexes, we may expect an increase of financial products which are linked to the Hang Seng Indexes. In fact, according to Hang Seng Bank, indexes under the Hang Seng family of indexes have been widely used by investors to create index-linked products and derivatives under which the investment returns are linked to the performance of the underlying equities. This prompts us to revisit the topic of careful drafting of the terms of instruments or marketing materials for such index-linked financial products to avoid misleading practices. A few notes here may be useful:

1.         As investment returns are linked to the performance of the underlying equities, neutral wording such as “final performance” or “final result” of a formula is preferred to avoid any connotation suggesting positive results;

2.         The fact that the change in value, be it upwards or downwards, of an investment is linked to that of an index should be clearly stated; and

3.         If the formula involves the level of dividends distributed in respect of the underlying assets based on the indexes and there is a dividend waiver, investors must not be misled to believe that dividends will contribute to the final performance or result so words such as “high dividend distribution rate” should be avoided.

Conclusion

The reform of the Hang Seng Indexes will result in a more comprehensive Indexes with more constituent stocks. Not only will the expansion catch up the development of the market, it will also facilitate investors in formulating their investment strategies by tracking the companies’ performance through the Hang Seng Indexes, which have been the major indicator of the overall market performance of the companies. However, when it comes to the drafting of instruments in relation to index-linked financial products, it is always the prudent practice to consult legal advisers.