Financial Regulation: German DAX Index Expansion & Wirecard Scandal
On the 24th November 2020, Deutsche Börse, the stock exchange operator, announced that Germany’s Dax stock index will expand from 30 to 40 members. The overhaul of the Xetra DAX is the largest since its initial founding i n 1988. Crucially, following the Wirecard scandal, the stock exchange operator looks to apply stricter qualification criteria.
The Reasons
The decision to review the Xetra DAX stock index follows the Wirecard accounting scandal where regulators were unable to identify the whereabouts of €1.9bn of cash. Wirecard fell into insolvency in June becoming the first member of DAX to do so since its establishment In 1988.
Importantly, the previous rules of the DAX index stopped it from ejecting the bankrupt member right away. However, due to the pressure from investors, Deutsche Börse was able to push through a rule-change that enabled the operator to remove a company within two trading days of it filing for insolvency. Although the issue was resolved, due to this matter, the operator pledged to conduct an in-depth review of the Dax’s rules to reduce the likelihood of future problems.
Furthermore, the replacement of Wirecard in the index by Delivery Hero concerned many investors. Delivery Hero was a food delivery group that has been unable to make a profit since its founding in 2011. As a result, there was major doubt regarding the profitability of the index.
The Revamp
The collapse of the fintech giant, Wirecard, illustrated the fraudulent behaviour which was going on behind the scenes. In doing so, the flaws of the current financial regulation governing DAX was exposed; a key realisation as DAX is the index representing the corporate elite of Germany. The changes to the index rules are made to increase the quality of the DAX constituents. The overhaul would make it more difficult for risky businesses to join the index as proven profitability would be necessary.
The expansion of the number of members from 30 to 40 would move the DAX Index closer to international norms, paralleling the blue-chip indices in France and Italy.
Some of the tougher regulations for Dax membership included the requirement of members to have positive earnings prior to tax, interest, depreciation and amortisation. Importantly, members are also now required to publish quarterly statements and audited annual results. If these requirements are not met within 30 days of a warning, constituents will be excluded.
The expansion is due to take place in September 2021 whereas some regulatory changes regarding governance and profitability are set to become effective earlier.
The Future & the Implications
With currently over $17 billion invested in exchange-traded funds (ETFs) tracking the DAX, a quarter of this will need to be invested in its 10 new members. As a result, there could be major benefits for the newcomers’ stock prices, especially as investment funds tracking the index are forced to buy into the companies.
Investors have noted that the increase in the number of members should theoretically reduce the impact of a failing company on the rest of the DAX index. As a result, the majority of investors welcomed the revamp of the system as it has the potential to attract more international investors. However, some have noted that more could be done. Nevertheless, the revamp is evidently a move in the right direction.
By Bobby Zhu