As the industrial gas manufacturer Linde announced in October of last year that it would leave the Frankfurt Stock Exchange and thereby Germany's most important stock index, the Dax, a cry went through the financial community. "This is bitter, it hurts," admitted Deutsche Börse CEO Theodor Weimer. The market operator had failed to maintain the then 150 billion euro heavyweight. Since the end of February 2023, Linde shares have only been listed in New York.

Now, the stock exchange operator is drawing lessons from this setback. It is raising the cap limit from 10% to 15%. Otherwise, there might have been a risk of also losing the software company SAP. A financial center without the two flagship companies, Linde and SAP, would have been doubly bitter.

The cap limit prevents a company from having an excessively high weight in the stock index. Particularly, the Dax is supposed to reflect the breadth and diversity of the German economy. If the weight exceeds the limit, it is lowered to the cap during the index review every three months, and the difference is distributed among the other index members. This has serious consequences for affected companies because funds that track the index must sell shares. Linde was regularly subjected to this technically driven selling pressure, ultimately leading to its withdrawal from Frankfurt.

The new cap limit of 15% applies not only to the Dax but also to its smaller siblings MDax, SDax, and TecDax. It will take effect for the first time during the index review in March of next year. The increase aligns the Dax index family with international standards, according to Deutsche Börse. The French CAC 40 also has a cap limit of 15%. Associated companies (such as Siemens, Siemens Healthineers, and Siemens Energy) are allowed to reach a maximum of 30%. Adjustments are made between quarterly reviews if the weight of a stock climbs above 20%.

With the reform, the stock exchange follows the vote of market participants, with a majority of 62% supporting the increase. Sixty-three addresses were surveyed, mainly financial institutions but also companies, organizations, and individual investors. In the market consultation in spring 2022, a majority of respondents were against an increase. According to Deutsche Börse, the existing cap limit of 10% has led to 38 caps in the Dax in the past ten years. Four companies were affected: Bayer, Siemens, Linde, and SAP. No company reached the new limit of 15% during that period, with the peak being 11.62%.

Calculations for the past ten years show that the higher cap limit has little impact on index performance and fluctuations. The average annual Dax return with a 10% cap is 6.42%, and with a 15% cap, it is 6.34%. Since the beginning of 2023, the returns are 12.97% and 12.94%, respectively.

As the only Dax stock, SAP currently exceeds the 10% mark, while the second-place Siemens is below with 9.56%. SAP is currently at 10.67%. Unsurprisingly, the index reform is welcomed in Walldorf: "SAP welcomes the increase in the cap limit in the Dax." The SAP share has exceeded the 10% limit 20 times so far this year. The current price is at the all-time high from August 2020 of €142.26. The German Stock Institute had also spoken in favor of the increase in advance. Growth companies should not be punished on the capital market, especially when index funds would have to sell shares if the cap limit is exceeded.

However, the reform encounters reservations from active portfolio managers and the German Fund Association BVI. The BVI doubts that the increase to 15% makes the leading index more attractive. "The increase in the cap limit will generally not reflect an appropriate risk distribution on the market; it can also reduce liquidity for smaller index participants," a spokesman points out. The negative consequences can be seen in the US indices.

For example, the S&P 500 mainly reflects the performance of ten large technology companies, but it no longer represents the broad market developments of the other 490 index members. The BVI had already rejected the planned increase in advance and emphasized that all financial indices should be broadly diversified so that active asset managers can invest in as many components as possible.

Marcus Poppe, Co-Head of European Equities at DWS Germany, also regrets the decision. "Actively managed Germany funds are not allowed to have individual weights above 10% and will therefore be structurally disadvantaged compared to passive products in the future. This problem seems not to have been clear to many survey participants," he tells Börsen-Zeitung. Deutsche Börse responds to such objections by announcing the consideration of introducing a Dax version with a cap of 10%.

DWS fund manager Poppe also sees the argument that the cap limit has a sustainably negative impact on the valuation of companies critically: "The example of Linde shows that the valuation of the company has hardly changed compared to the two previous years since delisting in Germany."