FTSE GROUP MARKET CONSULTATION ON NATIONALITY ABI RESPONSE Introduction This paper is the response of the Association of British Insurers (ABI) to the FTSE Group consultation, published in September 2006 on nationality and eligibility to the UK s national indices. ABI Members as institutional investors have some 1,200 billion of funds under management including holdings of UK equities representing close to 20% of the value of the UK market. As large users of both the market and the indices, we have a substantial interest in the questions raised. General Comments The specification of indices needs to reflect the requirements of their users. To a material extent this will represent a commercial decision for index providers. However, in the context of a recognised national index provider, there is a wider market and public interest in ensuring that these decisions are well-informed ones that reflect the needs of companies and investors. The current consultation allows FTSE to consider responses from all relevant perspectives. We are pleased to take the opportunity to participate in this process. All investors will to some degree be influenced by index composition decisions, passive investors particularly so. It is important, though, that all investors should be able to benchmark themselves against a pool of shares that measure up to an appropriate quality threshold. For companies that are both incorporated and listed in the UK this will generally be assured through the process of scrutiny attaching to admission to listing. Clearly the situation is more complex for companies that do not fall fairly and squarely into this box. In practice, admission to the indices is an inseparable part of what is thought of as the listing process, which also includes admission to trading on the London Stock Exchange. It is therefore vital that the process up to and including admission to the national indices gives assurance that investment grade has been demonstrated. We believe that, rather than merely defining nationality as a matter of location, the indices should play an important role in defining companies listed in the UK as meeting British standards of quality. This should not be too rigidly defined but should give consideration to a wide range of criteria to determine whether a critical mass of relevant yardsticks has been met.
We emphasise that ABI Members support an open-door policy as far as possible to those companies that recognise the merits of the UK s capital markets and wish to list in the UK. However, it is important to avoid this leading to a lowest common denominator approach. A quality threshold is needed but assessment of quality inevitably includes some subjective judgment. There is also some need for coherence and congruity among companies qualifying for index inclusion. In practice it is difficult not to believe it necessary for companies seeking admission to the UK s national indices to exhibit some elements of national affiliation over and above it being the country of listing. Specific Comments Q1 Should the country of listing be the principal driver for determining nationality? We are of the opinion that country of listing and of trading is best thought of as being a necessary but not sufficient condition for inclusion in indices pertaining to the country in question. Q2 If not, what other criteria should be used and why? Please bear in mind the practicalities of dealing with different time zones and currencies. There is a long list of potentially relevant criteria to consider. Jurisdiction of incorporation is of very considerable significance as the company law framework is crucial in underpinning shareholder rights. For some index users this would be at least as important as country of listing. Other possible criteria include adherence to the jurisdiction of the country s Takeover Panel or equivalent, any other regulatory framework relevant to the territory in question, adherence to a national corporate governance code and any other aspects of recognised best practice, country of location of the corporate headquarters, country with greatest contribution to the company s production (or, perhaps, sales) by value of turnover, tax domicile, currency of denomination of the company s accounts (except in sector-specific circumstances where a common currency is usually adopted), country where shareholder general meetings are normally held, country where shareholders of the company are predominantly based, country where the company has historic connections. With regard to the last-mentioned we would see a good case for grandfathering in the event of any step change in the rules on nationality to avoid either exclusion or forced transfer unless demonstrably necessary. In circumstances where companies seek, for whatever reason, to change nationality for index purposes the case of the burden of proof should be on the applicant to demonstrate that any change of national allocation is justified, has been approved by shareholders and will be sustainable in the longer run. 2
Q3 Do you agree that investor protection should be a key factor in determining nationality? Yes, investor protection should be of particular relevance as an aspect of quality for assessing eligibility for inclusion in an index. It should, however, be seen as a useful filter for excluding unsuitable candidates whose nationality is ambiguous rather than the prime factor which determines nationality. Some qualitative features of an investor protection regime that apply to a particular company and its shares may help to confirm impressions of nationality and hence eligibility for national index inclusion. Q4 Do you think that this issue is of particular importance in developed markets? Generally speaking, levels of investor protection will be higher in developed markets and it would be inappropriate to allow inclusion in indices of companies of ambiguous nationality with demonstrably lower standards in this regard. Q5 If yes, what principles should be applied in determining the eligibility for inclusion in a particular country index? FTSE s current practice, outlined in the consultation paper, of seeking confirmation from overseas issuers listing solely in London of intention to comply with the main features of the Combined Code and with standard UK limits on pre-emption focuses on important areas. It would perhaps also be appropriate to expect such companies to seek to incorporate, so far as is practicable, provisions within their articles of association or equivalent constitutional document to enshrine relevant rights and procedures in a manner that de facto will provide parallel investor protection to that which applies in any event to UK companies. In addition to respect of pre-emption rights a particularly important marker would be the incorporation of the effect of key elements of the Takeover Code. Q6 Should there continue to be consistency between the nationality rules for the UK index series and the FTSE Global Index Series? We have concluded that breaking the rigid link is probably the best way forward to address investor concerns and create indices that meet the needs of users. Q7 If not, what distinction would you draw between the two series? Accepting that, from the perspective of a global approach, all traded companies need to be allocated to one country or another, we would see the domestic index series constructed with the inclusion of a filter to exclude those companies, presumably a minority, that do not sufficiently measure up to the accepted national template. One refinement of this approach could be to adopt a policy of excluding for an initial period a newly-listed company that 3
does not fall fairly and squarely within a definition of nationality during which time they would be required to demonstrate acceptable standards of corporate governance and investor protection. Q8 & Q9 Should a company s tax status and operational base be considered in the determination of nationality? If yes, what factors should be taken into consideration and how? Yes, as per our answer to Q2 these would seem to be relevant matters without necessarily being of primary significance. These factors will not always provide a clear lead but where they do they should be given due weight. Q10 Where different classes of share have different tax implications for investors, should this be reflected in a company s nationality, perhaps by splitting the allocation between countries? We see no objection in principle to splitting the country of allocation according to the tax status of particular classes of share. Indeed this would seem entirely sensible and could also be adopted in other cases where some defined portion of the company s share capital is traded on a market in a different jurisdiction to the main country of listing. However, we are aware that the adoption of this stance with regard to tax status of shares by FTSE would have significant implications if it were to be applied to extant cases where FTSE has already provided a 100% allocation to the UK s index series, as it did on the formation of Royal Dutch Shell. Such a change if it were not to involve grandfathering of existing index allocations would need to be handled sensitively. We favour grandfathering of existing shares but with this subject to review in the event of any significant subsequent corporate action. Q11 Should FTSE reflect the growth of trading in Depositary Receipts in both the pricing of securities and the determination of nationality? & Q12 If so, what principles should be used and how should FTSE reflect trading in Depository Receipts in measuring liquidity? Overseas trading in whatever form can provide additional depth of liquidity and hence greater confidence that the quoted or traded prices in the country of main listing provide an accurate reflection of worth and of prices close to which investors would be able to deal. We have no objection per se to the concept of allocating nationality to that where trading in practice takes place by virtue of the listing of depositary receipts. However, this should not be allowed to permit double counting to take place. In practice we recognise that it will be difficult to devise a satisfactory regime to accommodate this but it might be feasible in there were a long-term commitment to hold a designated proportion of a company s shares in depositary receipts traded in a second jurisdiction. 4
Q13 Is nationality becoming a less important factor in setting the investment strategy for funds you manage or advise? Although this is the case to some degree for ABI Members, as for other types of institutional investor, we believe nationality will continue for many to be of primary relevance in the segmentation of equity portfolios. We do not believe that a continuation of the trend to cross-border sectoral segmentation has the prospect of rendering redundant the concept of national indices in the foreseeable future and therefore we do not consider that FTSE can afford to duck the nationality question. Q14 What structural changes, if any, would you like to see in the way that FTSE indices are compiled, either now or in the future? We do not consider that any structural changes in the indices are needed at present but an improved level of disclosure on how the principles have been applied in determining nationality would be appropriate. Q15 If FTSE s nationality rules are changed whereby some constituents of FTSE indices no longer meet the criteria for inclusion, how should such legacy issues be dealt with? This is not so much a legacy question as one that will need a logical and workable on-going policy framework. We could envisage a regime in which there are parallel indices, one set including all companies allocated to a nationality by virtue of country of listing and another where a filter is applied and some companies necessarily excluded from the date of introduction of the new arrangements. An alternative might be to have a global index of transnational orphan companies not allocated to the index series of the country of their listing. A further refinement might be to divide such a transnational category between companies that pass a basic quality threshold and therefore merit inclusion in an index giving some assurance that they would have a place within a global portfolio of equities of investment grade from those companies that do not measure up to expectations 1. Q16 Are there any other factors which you would like included in the criteria for determining the nationality of specific companies? We have no particular comments to make. 6/11/06 [m:\mmck\response\ftsenationalityse05 1 If this course were adopted we think it would probably be important for companies to be allocated to an appropriate national index wherever possible and that the transnational category should be reserved for exceptional and genuine cases where allocation to a national index would be inappropriate. 5