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JSE invites comment on capping Naspers and Prosus together

Following concerns raised by market participants.

When Prosus listed in September, one of the benefits to local investors was that the unbundling reduced the size of Naspers on the JSE. At the end of the second quarter of 2019, Naspers was 19.4% of the FTSE/JSE All Share Index (Alsi). By the end of September, however, its weighting had dropped to 14.3%.

This lowered some of the concentration risk on the local market that comes from having a single company making up a fifth of the index. Ironically, however, it created a related problem somewhere else.

Over the past few years, capped indices have become increasingly popular, precisely because of Naspers’s outsized influence on the market. The FTSE/JSE Capped Alsi and the FTSE/JSE Capped Shareholder Weighted All Share Index (Swix) limit the weighting of a single stock to 10%.

However, the unbundling of Prosus has undone this to a certain extent, since the market now has two stocks, capped independently.

“The reason for applying capping in indices is to reduce single stock exposure,” the JSE’s Indices Department explained in a market consultation note on Wednesday. “Since Naspers and Prosus are two separate companies, the capping is applied separately and their combined index weight is thus in excess of the capping level of 10%. However, both companies draw a significant portion of their value from an underlying holding in Tencent, and some index users believe that this should be considered when capping their index weights.”

Read: What the unbundling of Naspers means for benchmarks and investors

The table below illustrates how the combined weighting of Naspers and Prosus was meaningfully above 10% from the first index review date after the Prosus listing.

Source: FTSE/JSE

“After the completion of the transaction, investors ultimately have a large exposure to Tencent and the other internet assets, through separate holdings in both Naspers and Prosus,” the JSE noted. “Many market participants would have seen the Capped Swix All Share Index launch as a means to reduce the weight of Naspers in the main market benchmark index to 10%, and would reasonably question having an increased weight, above the capping level.”

Proposal

The JSE has therefore asked for comment on a proposal that would see Naspers and Prosus considered together for the purposes of these capped indices. However, it acknowledges that this needs to be treated with some caution.

According to the JSE, there is no global precedent for this. The local market would therefore be venturing into an approach that has not been tested anywhere before.

It also needs to ensure that a decision taken to address a particular issue now doesn’t cause problems in the future by changes in the composition of the market that cannot be foreseen. It has therefore proposed a set of rules that would have to be met in order for two companies to be capped together.

The most important of these considerations is that the parent company must not just own a controlling stake in the subsidiary, but that the investment in the subsidiary must be so large that it dominates the value of the parent company itself.

“In effect, the proposal defines the scenario where more than 75% of the market valuation of a parent company can be attributed to its holding in a subsidiary JSE-listed company,” explains Mark Randall, director of information services at the JSE. “In the Naspers/Prosus example, the market value of the Naspers strategic holding in Prosus is greater than the market value of Naspers itself, and the proposal therefore would cap their combined index weight at 10% in our capped indices.”

If the JSE were to implement this approach, the impact on the two main capped indices would be as shown below.

Source: FTSE/JSE

“Note that this proposal would have no impact on any of the uncapped indices in the FTSE/JSE Africa Index Series, and in particular would not impact the way that companies are selected for index inclusion purposes,” the JSE pointed out. “The core objective of this proposal is to improve the quality of the capped indices in the series as a benchmark for local equity funds.”

The JSE has invited any index users to comment on this proposal by Friday November 22. Feedback should be sent to indices@jse.co.za.

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“The reason for applying capping in indices is to reduce single stock exposure,” says the JSE’s Indices Department.

This seems to be a misinterpretation of the objective of the rule. I believe that the “reason” stated should specify that the “single stock” is a stock listed on the JSE, not a stock that exists elsewhere.

The tactic proposed is aimed at Tencent. Tencent is not listed on the JSE.

The fundamental purpose of Naspers unbundling in the way they did, was to satisfy the JSE’s capping rule. Now this new proposed action would nullify that move by Naspers, resulting only in shareholders having now been exposed to a substantial capital gains tax, unnecessarily. Everybody back to where they were, except for SARS taking a pound of flesh.

End of comments.

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