Explained | What made MSCI act on Adani stocks? Premium

Which are the four companies on the list whose free float designations have been lowered by the global index provider?

The story so far: Morgan Stanley Capital International (MSCI), a global index provider for financial markets, announced on Friday that it will reduce the free float designations for four Adani Group companies in multiple indices. These companies had a combined 0.4% weighting in the MSCI Emerging Markets Index as of January 30. The decision follows MSCI’s decision to review the free float status of companies belonging to the Adani Group following investor concerns. Apart from Adani Enterprises, the MSCI will cut the free floats assigned to Adani Total Gas, Adani Transmission, and ACC. These changes will come into effect from March 1.

Free float refers to the proportion of the total outstanding shares of a publicly listed company that is readily available for trading in the market. Generally speaking, shares held by promoters and large institutional investors are normally not freely traded in the market. The free float of a company can sometimes give investors a rough idea about the likely liquidity of the company’s shares in the public market. It should be noted that the weightage given to a company’s stock in certain indices is based on the company’s market capitalisation.

A company’s market capitalisation is calculated based on the free float of the company and also the market price of the company’s stock. So, a drop in the number of freely floating shares of a company can cause a drop in its market capitalisation and reduce its weightage in indices.

The decision to reduce the free float assigned to the Adani stocks comes in the wake of a report released last month by Hindenburg Research, a U.S.-based investment research firm and short seller. Hindenburg had alleged that more than 75% of the outstanding shares of various companies of the Adani Group were owned by their promoters. Indian market regulations stipulate that non-promoter public shareholders should own at least 25% of the total outstanding shares of a company. This rule hopes to prevent manipulation of stock prices by promoters who could influence the price of the stock by trading among themselves when they hold an outsized portion of the outstanding shares. In particular, Hindenburg alleged that the Adani Group used offshore shell entities to hide holdings by members of Chairman Gautam Adani’s family. If true, this would reduce the float or the proportion of outstanding shares readily available for trade in the market.

The MSCI first stated that the “characteristics of certain investors” in the Adani Group suggested that they should not be considered part of the company’s free float. Nathan Anderson, the founder of Hindenburg Research, had in a tweet noted that MSCI’s decision to review the free float status of the Adani Group companies validated his firm’s findings against the conglomerate.

MSCI’s decision to cut the weights assigned to the Adani stocks in its indices going forward, however, may not be solely due to concerns over the free float of these stocks. Shares of the Adani Group’s companies have fallen steeply over the last few weeks, thus affecting the market cap of these companies. In fact, the Adani Group has lost about $110 billion of its market cap since the release of the Hindenburg report last month. Since many indices are constructed based on the size of the market cap of securities, the crash in the Adani stocks has also likely affected the weightage of these stocks in the MSCI index.

MSCI’s decision will adversely affect the amount of capital flowing into the Adani stocks. Many passive investors invest in the indices that are constructed by bodies such as the MSCI. So, a cut in the weightage of the four Adani stocks in the Emerging Markets Index, which stood at 0.4% as of January 30, will likely reduce the amount of money flowing into these stocks. In fact, Goldman Sachs believes that India’s weight in the MSCI’s emerging markets index itself could drop by 20-30 basis points following the resultant reduction in weight of Adani stocks.