Merged HDFC Bank may not make it to MSCI, FTSE indices, say analysts

There is a risk index trackers may have to sell HDFC, which is part of global indices currently

Inclusion in global indices such as MSCI and FTSE will continue to remain a pipe dream for HDFC Bank even after the merger with parent Housing Development Finance Corp (HDFC).

According to analysts, the investment legroom for foreign investment in the merged entity will be around 10 per cent—less than the required threshold of 15 per cent and 20 per cent set by MSCI and FTSE, respectively.

As a result, the country’s third-most valuable company will remain out of widely-tracked MSCI and FTSE global indices that help channelise billions of dollars of foreign investments.

Currently, HDFC Bank, with a market cap of over Rs 9 trillion, is not part of these sought-after indices due to limited room available for overseas investments. The investment limit for foreign portfolio investors (FPIs) in HDFC Bank is 74 per cent. Of this, slightly over 70 per cent was utilised, as per the December-2021 quarter shareholding data.

Nearly 26 per cent of the FPI limit in HDFC Bank is currently utilised by parent HDFC, which is classified as a foreign entity as over 50 per cent of its shares are held by foreign entities. Further, nearly 19 per cent of the  FPI limit in HDFC Bank is taken up by its American Depository Receipts (ADR)—which are traded on the NYSE.

The market initially expected that the merged entity would pave the way for entry into global indices as a result HDFC Bank rallied as much as 14.3 per cent following the merger announcement and HDFC rose 16.5 per cent.

However, gave up some of the gains as it emerged that the deal was a non-event as far as index inclusion and passive flows were concerned

“The combined entity will have a float of 95 per cent and a foreign holding of 66.24 per cent. That means the merged entity will have foreign room of 10.5 per cent. The foreign ownership limit should remain at 74 per cent for the merged entity,” said analyst Brian Freitas, who publishes on Smartkarma in a note last week (see link: https://www.smartkarma.com/dashboard?collection=all-insights&item=67960)

Interestingly, there is a risk that funds that track MSCI and FTSE indices may have to dump their HDFC shares, which are part of these indices.

“The worst case (and the much more unlikely scenario) will be if MSCI decides that HDFC Bank is not eligible for index inclusion since the foreign room is less than 15 per cent. That will require passive trackers to sell 129 million shares ($ 4.16 billion) of HDFC prior to the implementation of the merger,” said Freitas.

He said it is likely that MSCI might decide to maintain the merged entity in the index with a lower foreign inclusion factor. This will require MSCI trackers to sell 10.75 million shares ($347 million) of HDFC Bank.

As far as FTSE indices are concerned one possibility being discussed is that “HDFC shares that are converted to HDFC Bank shares are included in the index at the time of the merger and subsequent changes to the investability weight will depend on the foreign room available at the time,” Freitas added.

To be sure, the exact treatment of HDFC shares will be known by MSCI and FTSE ahead of the merger which could be several months away.

Little legroom for FPIs
 

	Now	Post merger*
FPI	30.52	52.37
Promoters	21.01	0
ADR	18.55	13.86
MF	12.2	12.97
Individuals	9.17	10.22
LIC	2.14	3.11