INTRODUCTION

This paper summarises the latest review by the Hang Seng Index Services Limited (HSIS) on the Hang Seng Index (HSI).

DETAILS

Background

2. The HSI was first launched on 24 November 1969 as a measurement of the performance of the Hong Kong stock market. Like other stock indices, HSI measures the performance of the stock market by reference to the changes in value of a sample of stocks (the constituent stocks) selected according to a set of criteria. A full series of current indices issued by the HSIS is contained in Annex A.

3. HSI is a market value weighted index in which the contribution of individual stock to the index is weighted against the total market value of the stock. Currently, the HSI has 33 constituent stocks (see Annex B), or the so-called "blue chips", comprising companies of the finance sector, utilities sector, properties sector and commerce and industry sector. The HSI is compiled and managed by the HSI Services Ltd., which is a wholly-owned subsidiary of the Hang Seng Bank. To ensure the impartiality of its operations, the HSIS has appointed an independent Advisory Committee to advise on matters relating to the management of the HSI. The Committee comprises academics, legal and accounting professionals, institutional investors and investment consultants and meets on a quarterly basis (see Annex C). Also, all staff of HSIS have to comply with a stringent code of conduct which restricts them from dealing in securities that may involve sensitive information accessible to HSIS.

Selection Criteria for the HSI Constituent Stocks

4. The usefulness of an index depends on its representativeness of the market and its ability to track market performance. Since the HSI, as in the case of most other overseas stock indices, is a sample-based index, its representativeness will in turn depend largely on the composition of its sample stocks.

5. Constituent stocks of the HSI are selected by a rigorous process of detailed analysis, supported by extensive external consultation. To be eligible for selection, a company:

• must be among those that constitute top 90% of the total market value of all ordinary shares listed on the SEHK;

• must be among those that constitute the top 90% of the total turnover on the SEHK;

• should have a listing history of 24 months; and

• should not be a foreign company as defined by the SEHK.

From the many eligible candidates, final selections are based on the following factors of consideration:

• the market value and turnover rankings of the companies;

• the representation of the sub-sectors within the HSI directly reflecting that of the market; and

• the financial performance of the companies.

Representativeness of the HSI

6.The representativeness of the HSI can be measured by its coverage of the market capitalisation and turnover of the whole stock market. The HSIS has endeavoured to maintain the aggregate market value of the HSI constituent stocks at approximately 70% of the total market value in the past years. This coverage ratio compares favourably with major overseas stock indices (see Annex D). The turnover of HSI also used to cover over 60% of the total market turnover but the ratio could be much lower at times of heavy trading which tends to spread the turnover to second and third-liners with increasing retail investor participation.

7.The representativeness of the HSI can also be reflected by its resemblance with the movements of the All Ordinaries Index (AOI) compiled by the SEHK, which includes all listed stocks on the SEHK. For the whole year of 1997, the correlation coefficient between the HSI and the AOI was 0.97. Even during the recent October market turmoil, the daily change of the HSI still closely matched that of the AOI.

Review of the HSI

8.The HSI was last reviewed in the last quarter of 1997, taking into account many views expressed in the light of the financial turmoil. The review has considered the composition of the HSI and concluded that, with a market capitalisation coverage of about 70%, the HSI had been able to achieve its prime objective of reflecting the performance of the Hong Kong stock market. However, in light of the structural changes to the local stock market with more listings of H shares and China-affiliated corporations (or so-called "red chips"), the HSIS has decided that the constituent stocks will no longer be required to have a substantial business presence in Hong Kong, but they should not be a foreign company as defined by the SEHK. Moreover, the rule of 24-month listing history will be flexibly applied in order to permit companies meeting all other selection criteria to be included in the HSI. As a result of this policy, China Telecom (HK) and Shanghai Industrial Holdings Ltd. have been added to the HSI with effect from 27 January 1998, which has increased the HSI's market capitalisation coverage to above 70%.

9. In order to meet the increasingly divergent and sophisticated needs of different investors and taking into account the experience in overseas stock markets, the review has also recommended the introduction of a wider-based index called the Hang Seng 100 Index (HS100). The HS100 will select, from all listed companies, the top 100 ones in terms of both market capitalisation and turnover on the SEHK to be its constituent stocks. Accordingly, the current Hang Seng MidCap 50 Index will also be revised to cover the next 50 top stocks outside the HS100. The HS100 is expected to achieve a market capitalisation coverage of more than 80% and a turnover coverage of close to 80%. Both the HS100 and the New Hang Seng MidCap 50 Index will be launched in April 1998.

10. In response to some market comments, the review has also looked into the concern of over-weighting of the HSBC Holdings in the HSI and related allegation of possible manipulation.

11. With a market size of HK$550 billion, which is larger than even the Citicorp of the US and double the size of the second largest HSI constituent company, it is inevitable that the weighting of the HSBC Holdings in the HSI will by far be larger than the rest of its constituent stocks as it is also a reflection of the structure of the market itself. However, as the HSBC Holdings is extensively traded and commands a wide investor base, the review considered that it would be difficult to manipulate the index through the HSBC Holdings. Apart from the huge sum involved, such attempts would also involve substantial risks as they contend with a large group of investors who might hold different views on the stocks.

12. Separately, such allegations have also been considered under the review on the financial turmoil by the SFC. The findings of the review are now expected to be released by end March.

13. The HSIS review has also studied the issue of cross-ownership among HSI constituent stocks. The review acknowledged that cross-ownership may lead to double-counting of market capitalisation and reduce the number of shares actually available for public trading. However, it also recognised that it is a phenomenon which reflects the realities of the stock market. The review has examined various proposals to address the problem but considered none would be viable without drastically upsetting the continuity the HSI as a reference to the stock market performance. Nonetheless, the HSIS will continue to consider the issue and take into account a stock's corporate relationship in the selection of HSI constituent stocks.

14. The review further concludes that the HSI composition should be kept under constant review to capture new market developments but radical changes which would impair its continuity and cause market disruptions without significantly improving its accuracy in replicating the market's performance should be avoided.

CONCLUSION

15. In its nearly 30-year's history, the HSI has established itself as the benchmark of Hong Kong's stock market performance. HSI Services Ltd. aims to maintain the HSI's continuity and representativeness through constant review on its constituent stocks. The company's declared policy is to maintain and enhance wherever possible the transparency in the management of the HSI and to ensure that it responds to market needs. The company has also expressed that its prime objective is to serve the investment-related community and contribute to the development of the financial market. Hence, the HSIS is open to comments in order to continuously improve and enhance the quality of services provided.

Financial Services Bureau
26 February 1998

Annex A

Current Indices issued by the HSI Services Limited

• Hang Seng Index

• Hang Seng MidCap 50 Index

• Hang Seng China Enterprises Index

• Hang Seng China-Affiliated Corporations Index

• Hang Seng London Reference Index

• Hang Seng Asia Index

Annex D

Number of constituents and Market Capitalisation

Coverage of Other Major Indices

Note: * referring to the New York Stock Exchange