SGX (SGX:S68) Declined 12% In One Day – Are MSCI Indexes That Important To SGX

SGX made an announcement on 27 May 2020 about gradually discontinuing the offering of MSCI index derivative contracts except MSCI Singapore.

The market didn’t react well after this announcement. SGX stock was sold down by almost 12% by the end of the trading day.

Is MSCI index products so important to SGX?

Is the selldown overdone?

I will provide my personal views to these questions. At the same time, I want to emphasise that my views may not be what exactly transpired between SGX and MSCI. Neither am I sure about SGX’s strategy going forward. We will never know the truth unless we are the insiders. So I can only make educated guesses.

Many Financial Products Require Indexes

Indexes are the taxonomy of the capital markets as they provide the structure for the creation of investment products.

First, we shape the indexes, then the indexes shape us. This is why sometimes investors talk in terms of Asia-Pacific ex-Japan, Emerging Markets ex-China and ESG. Indexes have profound impact on the way we think about investments than we would like to admit.

Indexes are omnipresent. They can track various asset classes such as equities, fixed income, commodities. They could also be based on themes (e.g. cybersecurity) or strategies (value, growth etc).

Financial products such as ETFs, futures and options would in turn track these indexes. For example, the STI ETF tracks the FTSE Straits Times Index. There are also derivatives (futures and options) that tracks equity indexes like MSCI Singapore.

Hence, indexes play a crucial role in finance and many financial products are dependent on them.

Indexing incurs license fees

The use of indexes isn’t free. There are license fees to be paid to the indexers.

Previously I shared that indexing is getting more powerful in the world of finance and especially with the growth of index investing.

The 3 most powerful indexers are SPGI, MSCI and FTSE, and they collectively made over US$4 billion in 2019 from licensing indexes.

SGX has developed their own iEdge Indices

FTSE is owned by London Stock Exchange (LSE) and contributed 32% of LSE’s revenue in 2019.

Probably SGX was taking a leaf out of LSE’s playbook – to create a new revenue stream by creating their own index business.

SGX Index Edge was launched in October 2015 and currently offer indices such as:

• iEdge SG Real Estate (Total Return) Index
• iEdge Factset Asia Technology Advantage EW (Total Return) Index
• iEdge Factset Global Robotics Index
• iEdge U.S. Technology Enterprises (Price Return) Index
• iEdge APAC ex Japan Dividend Leaders REIT (Total Return) Index
• iEdge Developed Asia ex Japan Quality Dividend (QD)
• iEdge SGX Iron Ore Futures Index

In SGX’s 2019 Annual Report, Loh Boon Chye, the CEO of SGX, said,

We want to drive greater growth for our data and index business. Our bespoke index calculation service had a successful start in London, following the expansion of our team
there. The majority of our new index calculations were from Europe.

We will build on this momentum and expand value-added offerings to further support our clients. With the rise of sustainability, factor and
thematic investing strategies shaping the investment landscape, particularly in Asia, we will leverage technology and data analytics to develop more sophisticated and differentiated
index-based solutions.

SGX parked the index business under the “Market Data and Connectivity” business segment. The business has been growing at a compounded annual rate of 6% for the past 5 years. However, we aren’t able to find the breakdown of the index contribution to the revenue and is currently mixed with other data and connectivity fees.

HKEX introducing MSCI derivatives

I am not sure if it was coincidental or planned, HKEX announced that they would be launching derivatives using MSCI indexes on the same day SGX announced the discontinuation.

While some market observers believe that it was MSCI ditching Singapore for Hong Kong, I believe otherwise. It makes more business sense for MSCI to have both cities adopting its indexes. There’s no exclusivity and the more the merrier.

Here’s my speculation: it could be a case where SGX started to offer their own indexes years ago. Imagine your customer becomes a potential competitor. It doesn’t feel good at all. Overtime, the trading volume may not have been inspiring for MSCI and hence, they would want to strike a deal somewhere else. HKEX has been a rival to SGX. With MSCI products being offered to HKEX, the competition in the derivative space would heat up between SGX and HKEX.

Hence, I believe it all started when SGX chose to further their own index business and probably this was the right time to do so after having success in their derivative trading business and having MSCI partnering rival HKEX.

Impact to SGX’s business

SGX presented to analysts about the impact of the discontinuation of the MSCI contract on its business.

The MSCI products (except MSCI Singapore) contributed about 12% of the derivatives’ daily average volume.

SGX also estimated that a 10% to 15% reduction to its FY2021 net profits if no mitigating actions were done. I believe they would definitely do something about it by replacing these contracts with their own index products. It is possible that these new products may not be as popular but the potential reduction should not be as high as what was presented.

Moreover, SGX ended the presentation with this line (emphasis mine),

We will continue to broaden and deepen coverage of Asia by developing more derivatives products on our own or in collaboration with partners

This adds support to the idea that SGX intends to build its index business.

Is the price drop warranted?

Based on a share price of $8.75, SGX has a trailing PE ratio of 21 and a dividend yield of 3.4%.

The average PE was about 24 in the last 10 years while PE 20 was the lowest level in which the SGX stock has traded at.

If we consider that SGX’s earnings would decline by 10-15%, the trailing PE ratio may go up to the average range of 24.

Hence, the market did discount the news quite accurately.

So I would say the price is fair, but not cheap.