Germany’s DAX® Index family will see the biggest methodology reform since inception with new rules that bolster the quality of member companies, bring selection criteria in line with international standards and expand the number of constituents.
The changes have been decided after evaluating the responses of over 600 investors, financial institutions, companies and associations during a month-long market consultation, Qontigo’s global index provider STOXX Ltd. said in a press release on Nov. 24. The updated methodology covers the DAX, MDAX®, SDAX®, TecDAX®, DAX® 50 ESG and DAX® ex Financials 30 and will come into effect at different stages.
Key quality changes include the requirement for eligible companies to the DAX to be profitable,1 and for all companies to timely publish their financial statements and have an internal independent audit committee in place. The selection criterion of trading turnover is being replaced by a minimum liquidity requirement, with market capitalization remaining the key metric as is customary internationally. The flagship DAX will be enlarged to 40 stocks from 30 currently, STOXX said.
“For the past 30 years, the DAX Selection Indices have stood for transparency, predictability and replicability,” said Stephan Flaegel, global head of indices and benchmarks at Qontigo. “With the new rules, we aim to strengthen these characteristics and make the indices fit for purpose for the future.”
Raising the quality bar
The flagship DAX aims to represent the highest accomplishments in Germany’s corporate world, and STOXX constantly works to ensure the index’s rulebook is suited for that goal. Last August, a new rule was introduced that removes insolvent companies from DAX Selection Indices within two trading days.
The latest methodology reform goes further in this direction. Starting next month, only companies that have been profitable for the two most recent years will be eligible for admission into the DAX.
Secondly, index management gains more control over the financial-reporting compliance of member companies. A requirement for all DAX constituents to be listed on the Frankfurt Stock Exchange’s Prime Standard, a premium segment with higher transparency duties than the General Standard segment, is being removed in favor of a listing on the Regulated Market of the Exchange. However, the key requirement of the Prime Standard to publish quarterly statements and audited annual financial reports is now retained as part of the indices’ own methodology.
This change decouples the index management from decisions that are a prerogative of the Exchange in terms of segment listing.
“The index management wins the autonomy to enforce the requirement to publish financial statements, meaning it can react quickly to breaches,” said Giulio Castelli, head of benchmarks, strategies and style indices at Qontigo. “This enhances the quality of the indices and the independence of STOXX as the administrator.”
From March 2021, such breaches will lead to the removal of companies from indices after only a short grace period of 30 days.2
The review also incorporates a mandate for all DAX Selection Indices member companies to appoint an independent, staffed audit committee and adhere to the relevant guidelines of the German Corporate Governance Codex within their supervisory boards.3
As of next year, the DAX’s composition will be subject to a regular review every six months rather than annually as until now, matching the frequency currently followed by the MDAX, SDAX and TecDAX.
“Overall, the index will manifest its heritage of being the blue-chip index for the German capital market,” said Flaegel. “We are introducing qualitative criteria that lean on the German Corporate Governance Codex, and profitability criteria as a proxy for proven business models, among others.”
Simplify the rules, broaden the index
In a change that will simplify the index composition process and harmonize the DAX methodology with mainstream traditional benchmarks, STOXX is dropping the turnover ranking as a basis for selection as of September 2021. This will be compensated by the introduction of liquidity requirements in terms of turnover rates or minimum trading volume.
Last but not least, STOXX is also reflecting the consensus in the market consultation by increasing the number of components in the main DAX to 40 starting in September 2021. Such a constituency should foster diversification — bringing in more types of businesses and sectors into the index, and spreading weights more widely.
“Having ten more components makes the DAX bigger, more diverse and less prone to the influence of individual index components,” said Castelli.
The MDAX will be reduced to 50 from 60 components, while the SDAX will remain unchanged at 70 members.
The ESG aspect
A proposal to exclude companies involved with controversial weapons from indices was met with varied responses and will not be implemented at this point, Qontigo said separately. Given the feedback received and the interest to cover sustainability considerations comprehensively, the company said further dialogue with stakeholders is needed with regards to the integration of environmental, social and governance principles into indices.
The undisputed benchmark for Germany
The DAX changes reflect the recommendations of stakeholders and keep pace with evolving investor needs. The new rules strengthen the methodology behind the German Selection Indices, and further underpin the attributes that have made the DAX the undisputed benchmark for German stocks and a reliable barometer for Europe’s largest economy.
Visit this blog in coming weeks as we address some of these changes in more detail and review their effect on portfolios.
Access detailed information and analysis of the DAX Selection Indices review here.
1 This requirement is only for the main DAX and not extended to the MDAX, SDAX or TecDAX. The rule starts in December 2020 and refers to a positive EBITDA in the candidates’ two most recent annual financial statements.
2 From March 2021, all companies in the DAX Selection Indices will have the obligation to publish audited annual financial reports and quarterly statements. After a 30-day warning period, an infringement of these requirements will result in the exclusion from the index within two business days.
3 Starting in March 2021, all members of a DAX Selection Index will need to comply with the recommendations of the German Corporate Governance Code with respect to the formation of an audit committee in the supervisory board. For existing index members, they must comply with this requirement from September 2022.
