Q1: Can you brief us on the background of revising the methodology of the SSE Composite Index?
A: As the first stock index in the A-share market,the SSEComposite Index was launched in 1991 and its core methodology is still in use today. In recent years, there have been many voices among the market participants regarding revision of the methodology of the SSE Composite Index, with frequent complaintsincluding “distortion of the SSE Composite Index” and “failure to fully reflect changes in the market structure”, etc. During the Two Sessions this year, the market insiders including the deputies to the National People’s Congress (NPC) and the members of the national committee of theChinese People’s Political Consultative Conference (CPPCC) once againproposed to improve the methodology of the SSE Composite Index.
To respond to market demandsand compilethe index in a more scientific and rational manner so that the index can more accurately represent the overall performance of the SSE market, the SSE and China Securities Index Co., Ltd.(CSI) have continued to study and prudently launched the efforts in revising the methodology of the SSE Composite Index after listening to market opinions, considering the developments and changes of China's capital market and drawing on the experience in the index construction worldwide.
To compile the index in ascientific approach, elements such as the index universe, method of selecting constituents and adjustment of the constituents for the SSE Composite Index have been studied one by one, thussetting the orientation for the revision of the index methodology. On this basis, special seminars onrevisionof index methodology have been organized, and an expert consultation mechanism for index construction has recently been established to solicit opinions and suggestions from experts at fund companies, insurance and assets management institutions, index companies at home and abroad and other institutions, universities and research institutes. Finally, the scheme for the revision of the methodology of the SSE Composite Index has been established, including removing the stocks with risk warnings, extending time for new stocks to be incorporated, and absorbing securities on the SSE STAR Market into the SSE Composite Index universe.
The implementation of the revision scheme for the index methodology will further enhance the market representativeness and stability of the SSE Composite Index, enablingthe index more accurately demonstrate the overall performance of the SSE market and fully reflect the changes in the SSE market structure, and providean ideal yardstick for investors to observe market operations and conduct wealth management.
Q2: Can you brief us on the reason for adjusting the time for the new stocks to be included in the SSE Composite Index?
A: The time for new stocks to be included in the index is an important basic arrangement for the SSE Composite Index. Many market experts believe that thecurrent inclusion of new stocks on the 11th trading day afterlisting is not conducive to the SSE Composite Index’saccurate and stable representation. On the basis of fully drawing on the valuable experience of representative indexes aroundthe world and objectively analyzing the characteristics of the domestic new stock market, the inclusion of the new stocks into the SSE Composite Index has been adjusted.
The time when new stocks are included in the index ofrepresentative indexesaround the world is usually set according to the characteristics of themarkets in the home country and region. Generally speaking, only after experiencing a full pricing gamein the market can a new stock be eligible to be included in an index. For example, new stocks are eligible for inclusion in the S&P 500 index after they have been listed for 12 months, and only those thathave been listed for 3 monthsare qualified to be included into the STOXX Europe Total Market Index. At the same time, in order to maintain market representativeness of the index, some typical indexes will set up a mechanism for rapid inclusion of large-cap new stocks. For example, the Hang Seng Composite Index has established a mechanism for rapid inclusion of large-cap new stocks ranking top 10% in market capitalization into the index on the 11th trading day after listing.
At present, it is common in A-share market for new stocks to trigger the upper price limit consecutively and fluctuate significantly in the initial stage of listing. From 2014 to 2019, a total of 563 new stocks were listed on the SSE andreached the upper price limit for 9 consecutive days on average after listing, with 217 new stocks hitting the upper price limit for more than 10 day in a row. Therefore, the inclusion of new stocks into the index based on the upper limit prices is not conducive to the SSE Composite Index objectively reflecting the actual market performance. As from 2010 to 2019, the average yield volatility of new stocks within one year was about 2.9 times of that of the SSE Composite Index over the same period,making the inclusion of high-volatility new stocks against the purpose of maintaining index stability .
Therefore, the time to include new shares in the SSE Composite Index will be lengtheneduntil 1 year after listing. Considering that it generally takes shorter time for large-cap new stocks than small-cap ones to see the share price stabilize, to maintain the SSE Composite Index’srepresentativeness , large-cap new stocks ranking top 10 in terms of the average daily market capitalizationsince the initial listingon the SSE market will be included into the index in 3 months after listing.
Q3: Why are the stocks with risk warnings (marks of ST and *ST) removed from the constituents of the SSE Composite Index, and will it affect the functioning of the index?
A: The risk warning system has been established in China’s capital market. The stocks with risk warningscan hardly represent the mainstream situations of the listed companies, as theyhave higher risks and greater uncertainties in fundamentals, withtheir investment value affected. The removal of stocks with risk warnings will improve the investment function of the SSE Composite Index, and enablethe index better reflect the overall performance of SSE-listed companies.
Constituents of mostmajorcomposite indexes in the world only include vast majority of the stocks in theirmarkets. For example, the Nasdaq composite index excludes the stocks with the Nasdaq market as the second listing platform. The STOXX Europe TotalMarket Index and the Hang Seng composite index only cover the stocks accounting for 95 % of the total market value. As of the end of May, constituents of the SSE Composite Index included 85 stocks with risk warnings, with a total weight of 0.6%. Therefore, deleting stocks with risk warnings will not affect the positioning of the index.
Q4: What are the considerations for including the securities listed on the SSE STAR Market into theSSE Composite Index universe?
A: Generally speaking, securities listed ona new board usually need to be tracked and evaluated for a period of time before they are considered to be included in a representative market index. Since the first batch of securities were listed on the SSE STAR Market on July 22, 2019, which the SSE has been tracking and evaluatingfor nearly a year, the overall operation of the boardhas been stable. As of the end of May, there were 105companies listed on the SSE STAR Market, with a total market value of RMB1.6 trillion. As the boardhas become an important part of the SSE market, it is increasingly necessary to include the securities on the SSE STAR Market into the SSE Composite Index. As the STAR companies cover a large number of enterprisesoriented toward science and technology innovation, the inclusion of the board willimprove the Index’smarket representativeness , and further increase the proportion of hi-techcompanies in the composite index, so thatthe SSE Composite Index will better reflect the changes in the market structure.
Considering that the Index methodologyrevision involves adjustments to the time for new stocks to be included, the inclusion of the securities on the SSE STAR Market in the SSE Composite Index according to the revised rules is conducive to ensuringthe stability and continuity of the rules for the index.
Q5: Will the implementation of the revised methodology of the SSE Composite Index affect the continuity of the index, and will it have any impact on investors' observation of market conditions?
A: By drawing on the approaches of representative indexes in the world to the construction adjustment, the revised methodology of the SSE Composite Index will be implemented in a seamless manner, which means that the point on the effective date of the revisedindex methodology willbe seamlessly connected with the point on the previous trading day, and the real-time point on the effective date will be calculated based on the closing point of the previous trading day and the ups and downs of the constituents on that day. Therefore, the implementation of the revised methodology of the SSE Composite Index will affect neither the continuity of the index,nor the investors' observation of market conditions.