SIX Swiss Exchange is opening up its Swiss Market Index (SMI) flagship available to European investors. The move is aimed at addressing the restrictions set up by the European Securities & Markets Authority (Esma) Undertakings for Collective Investment in Transferable Securities (Ucits) regulation in relation to the weight of the largest shares comprising the index and the diversification of the index components.

The Swiss equity market is a very concentrated market with a few very big global companies and the SMI book has always been tilted towards those firms with the three largest companies in the index making up 60% of the weight in the index, according to Christian Bahr, head of market data and analytics, at SIX Swiss Exchange.

"The introduction of Esma's Ucits V directive in March 2016 which was aimed at exchange-traded funds (ETFs) listed in the EU has brought in new requirements around diversification on the maximum weight of constituents and restrictions (two companies cannot have more than 20% of the index) which made the SMI not eligible to be used in ETFs and that caused problems to some of our clients," says Bahr. "From September onwards the methodology of the existing SMI will be changed to bring it in line with diversification guidelines set out by Esma, and can be used in the European Union as a reference index for the Swiss equity market."

SMI current and future composition*

* This chart shows the composition of the SMI and what will happen with the weights after the Index Review in September. Grey bars are the current weights (per 06.09.2017) and the red bars are the weights after the first review (reduced weights by 3%). You will see as well that not all components achieve the 18% with the first capping - that means in December there will be a second capping because we reduce the titles maximum 3% per review.

The new regime is also relevant to listed derivatives as national regulators have adopted the Esma rules for OTC and listed derivatives which bans the use of derivatives from indices that do not meet Esma's Ucits directive. This made the SMI no longer available to be used as an underlying for derivative-based products.

According to Bahr, a significant volume on Eurex' listed derivatives segment is tied to the SMI - CHF17m traded on SMI futures and options last year, and to keep that derivatives market open for the SMI was very important in order to ensure that investor can continue using those instruments in their portfolios.

"This has also opened up new possibilities to expand the usage of the index," says Bahr. "The majority of the index users are in Switzerland and the index has always had a domestic bias but by making it Ucits-complaint more investors in the EU will be able to use it going forward."

After a market consultation the Swiss exchange's index commission decided to apply a cap to the biggest constituents to 18% with a 2% buffer to meet the directive's 20% critical threshold. "This will be done in two or three stages because the largest company in the index has 24% weight and we can't bring it down to 18% in one stage," says Bahr. "Over the next quarterly reviews we will bring the weight down progressively so we are fully compliant by the end of the year."

The SMI is not currently in the list of investable indices under the Ucits regime and the exchange expects that once it is back on the list the number of products and assets under management linked to the SMI will grow significantly, according to Bahr.

"ETF providers and issuers of structured notes will be able to use the index in products sold in Europe," says Bahr. "There is specific demand for the SMI in Europe and we think this will help to grow its usage via structured products and ETFs. This was a 0-1 decision as doing nothing meant being out while making the appropriate changes opened up opportunities and provided upside grow potential for the index."

According to Bahr, the exchange has reached out to investors and manufacturers of financial products institutions to communicate its intentions, but is not targeting any particular European market.

"Germany is a very important market for the SMI as there is a significant number of products using the SMI as underlying but we have no preference or are targeting any particular market as we see this as an improvement for any European investor or product manufacturer seeking exposure to the Swiss market via derivatives, structured products or ETFs," says Bahr.

Although the current focus of SIX' index business is on the Swiss market the exchange has "a very comprehensive suite of equity and income indices" covering blue chips, mid cap as well as smart beta indices covering multi-factor strategies.

"There is scope for us to increase our offering with new strategies and respond to particular demand," says Bahr, adding that SIX's senior management has committed to invest and add further resources to this business which will increase the business' capacity "to develop new products and be more reactive to market demand from Switzerland and Europe".

New regulatory requirements have tightened up how indexes are developed and calculated, and index providers are capitalising on the fact that investment banks have a conflict of interest if they use their own indices, according to Bahr.

"We have taken over the UBS 100 index as a benchmark administrator and we are also calculating a former Deutsche Bank real estate index," says Bahr. "The new requirements around the governance of indices has opened up opportunities for us [and] we are well positioned to capitalise from the retreat of investment banks from the index segment."

Christian Bahr has been head market data & analytics for the Indices and the Market und Reference Data Services of SIX Swiss Exchange AG since 2016. Prior to joining the exchange, Bahr spent 14 years Stoxx Ltd. and Dow Jones Indexes, where he rolled out a global index family for Stoxx and developed further specialized indices for structured products, ETFs and benchmarking purposes. During this time he was also responsible for the indices of SIX Swiss Exchange and was a member of the equity and bond index commissions.

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