Nasdaq, the tech-firm-heavy New York Stock Exchange and index provider, is consulting on what, at first, appear to be some fairly technical tweaks to its rules on index composition and inclusion.
Given the seemingly dry subject matter and the distraction of the events in the Middle East, this has not received a great deal of attention. And yet the changes proposed could end up being very significant indeed.
Nasdaq proposes three major changes, together with a host of smaller tweaks. Firstly, when considering market capitalization for the purposes of eligibility to be included in indices, Nasdaq proposes now including unlisted equity in the numbers. As they note, “As corporate and share class structures evolve, it is increasingly likely that large companies will have significant portions of their market capitalization represented by unlisted shares”.
Secondly, they propose a major change in the timing of index entry: “Currently, new constituents may only be added to the index at the time of the Annual Reconstitution, as a replacement for a deleted index member, or as the result of a spinoff event. As a result, large companies that are newly listed on an eligible exchange (either by way of an initial public offering (IPO) or by transferring from an ineligible exchange) often aren’t added to the index in a timely manner”. Under the new system, a constituent could be added to the index within weeks of listing at an IPO.
Thirdly, they have mooted a formula for calculating index weights as opposed to the current setup, which imposes a 10% free float minimum on equities included in their benchmark indices.
Taken together, these measures would mean that following an IPO in which a company chose to list only, say, 5-15% of its available equity at an IPO, those new shares could be added to several large indices within days of being initially sold to the public. And with, perhaps, quite large weightings.
Given the expected mega-IPOs of SpaceX, Anthropic, and OpenAI in the near future, this matters. In all of these cases, the sale of a relatively small percentage of the firm at an IPO could now be swiftly followed by index inclusion.
The most interesting aspect of this is what it means for passive equity investors. According to data provider Morning Star:
Total assets in US passive mutual funds and exchange-traded funds first surpassed those in active ones in 2024—and the gap has continued to widen. As of December 2025, passively managed assets grew to USD 19.4 trillion, while actively managed assets stood at USD 16.0 trillion.
The worry of some analysts is that these new rules, coupled with the huge size of passively managed money, will create a situation that artificially drives up the IPO share sales and leaves passive investors holding the inflated equity.
This week, the Clark Center’s Finance Experts Panel offered its own, rather mixed, views on the proposal. The necessary context to keep in mind here is that the Finance Panel, as with the majority of the economics profession, is generally hugely in favour of passive investing in principle.
The panel was asked two questions. On the question of whether “changing the rules for index inclusion to allow fast-track entry by extremely large IPOs (including waiving the free float requirement) is consistent with the objectives of passive index-based investing”, more than half of respondents, weighted by confidence, either agreed or strongly agreed, while around one third expressed some form of disagreement.
Although when asked whether “changing the rules for index inclusion to allow fast-track entry by extremely large IPOs (including waiving the free float requirement) will make index fund investors measurably better off”, just 3% (again weighted by confidence) strongly agreed and 16% agreed, while 36% expressed uncertainty, 40% disagreed, and 3% strongly disagreed.
In other words, the panel broadly believed the potential changes were in line with the spirit of passive investing but doubted they would make passive investors better off. Of course, there is quite a big difference between something not making an investor better off and something that actively costs them money.
As John Cochrane of the Hoover Institution at Stanford noted on the first question, while expressing uncertainty: “The move makes the index better as information. But it makes the index worse as a traceable commodity, as funds that must track the index have to buy scarce shares”.
Although, as his colleague at Hoover Paolo Sapienza said, “Free float requirements ensures that index-tracked stocks are actually tradeable at scale. If a large portion of shares is locked up (by founders, governments, strategic holders), passive funds trying to match index weights will face illiquidity”.
Haoxiang Zhou, of MIT Sloan argued that, “rules about index inclusion are primarily made by the market, for the market. As long as proposed changes to the methodology are broadcasted with a sufficient lead time and interested parties have a chance to provide feedback, it is consistent with passive investing”.
Campbell R. Harvey of Duke Fuqua spelled out the potential downside: “The forced buying by passive funds in the 15 day window in stocks with limited float may lead to a transfer from passive fund investors to the IPO issuers. That is, predictable buying can have an adverse price impact”.
That is what has led the FT to brand this a ‘bag holding exercise’.
Once the expectation of index inclusion takes hold, investors will adapt their behaviour at IPO. Fund managers already position ahead of anticipated index additions, buying stock in advance of predictable demand from trackers. Fast Entry shortens the timetable and makes the trigger clearer. Buyers at the IPO can therefore be less sensitive to valuation, knowing that index-tracking funds will be required to purchase shares shortly afterwards. Combine predictable inclusion with deliberately constrained float and the effect compounds. A small pool of tradable shares meets buyers willing to accumulate in anticipation of rule-driven demand. The valuation at IPO is boosted not so much by fundamentals as by index mechanics.
It is easy to see how this scenario is helpful for the owners considering an IPO – who raise more cash while retaining more control, for the bankers helping with the listing, and, indeed, for the stock exchange attracting the listing. It is less obviously helpful for passive investors who find themselves buying potentially overvalued IPOs mechanically.
Sometimes, seemingly technical rule changes matter a great deal.
