Amid reports of the merger of HDFC Bank with parent HDFC soon leading to the ouster of the former from all Nifty indices, resulting in an outflow of about $1.5 billion from passive funds, the National Stock Exchange has proposed to make ex-date as a crucial factor for replacing an index constituent.

In case of merger for indices with a fixed number of constituents such as Nifty50, Nifty Next 50, Nifty 100, Nifty 200, Nifty Midcap-50, NSE Indices, a consultation paper suggested: "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 for fixed constituent index."

However, indices with variable number of constituents — no replacement will be made in place of the transferor company.

Weight factor

Transferor company will be excluded from the index on the ex-date (T Day) of merger — closing of T-1 day and equity shares, investible weight factor and capping factor (if applicable) of merged entity would be updated based on the terms of merger on the ex-date of merger — closing of T-1 day, said the NSE.

Announcement of the changes would be made at least three working days in advance for change in the constituents of indices including for indices on which futures and options (such as Nifty 50, Nifty Bank, Nifty Financial Services and Nifty Midcap Select) are traded, the leading bourse said in the consultation paper.

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

Current challenges

According to the NSE, the current procedure poses challenges, especially to index funds.

First, funds tracking the index will be required to sell the shares of transferor company and rebalance the weights of the index constituents; and again when the shareholders of transferor company are allotted shares of merged entity, funds will be required to buy shares of merged entity (post merger).

For funds tracking the index, both the instances will result into additional buying and selling in a short span of time, it said.

Similarly, for demerger, the stock is excluded from the index much ahead of its ex-date; besides 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.

For demerger

NSE now moots a special trading session of the demerged company for price discovery that would be retained in the index and the index divisor would be adjusted before the market opening of the ex-date of demerger based on the price discovered.

The demerged company, which is retained in the index, should 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, the paper suggested.

Besides, in case a special trading session is not conducted by the stock exchanges, after the shareholders’ approval, such demerged company 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, it said.

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