TOPIX 2.0: from census index to selected universe

TL;DR - For 30+ years, TOPIX was defined mechanically by 1st-Section membership — making it a near-census of large Japanese listings with ~2,200 constituents at peak. JPX's December 2019 Reiwa report identified this as the single largest distortion in Japanese equity markets: passive flows rewarded any company that secured 1st-Section status, regardless of investability. - Phase 1 (Oct 2022 – Jan 2025) reduced TOPIX from ~2,100 to ~1,700 constituents by gradually phasing out names with tradable-share market cap below JPY 10 bn across eight quarterly weight-reduction steps. - Phase 2 (Oct 2026 – Jul 2028) decouples TOPIX from segment membership entirely: the index universe spans Prime, Standard and Growth, with selection driven by two liquidity tests — annual trading-value turnover ratio ≥ 0.14 and inclusion in the top 97% by cumulative free-float market cap. Estimated final constituent count: ~1,200 by July 2028.

Why TOPIX reform is the structural counterpart to segment reform

The two largest distortions in pre-2022 Japanese equity markets — the bloated 1st Section and the index that mechanically tracked it — were two sides of one design defect. A bloated 1st Section was TOPIX. A passive investor allocating to TOPIX was, by definition, buying everything in the 1st Section in proportion to free-float market cap. That meant any company that secured 1st-Section listing — whether by direct IPO under tight criteria or by graduation from the 2nd Section under softer criteria — automatically captured passive-fund flows.

The December 2019 Reiwa report from the Financial System Council's expert study group named this problem explicitly. The 1st Section had become "more of a broad census than a selective index," and the mechanical link from segment membership to passive flows meant that any company achieving 1st-Section status enjoyed index-driven demand irrespective of its fundamental investability. With an estimated 60% of TOPIX constituents not earning their cost of capital, the index was, in effect, subsidising poor capital efficiency.

The report's policy recommendation was a clean two-part fix: redesign the segments (Theme 3.1) and redesign the index. The two are inseparable. Without the index reform, even a clean three-segment structure would still produce mechanical Prime-listing demand. Without the segment reform, the index reform would have nowhere defensible to base its eligibility universe.

Phase 1 (Oct 2022 – Jan 2025): the transitional reduction

JPX announced phased TOPIX reform alongside the segment restructuring. Phase 1 began in October 2022, six months after the segment launch, and used the segment criteria as a transitional filter.

The mechanism: any TOPIX constituent whose tradable-share market cap fell below JPY 10 bn as of the Phase 1 base date was designated a "Phase Transitional Stock." These stocks were not immediately removed from the index. Instead, their TOPIX weight was reduced over eight quarterly steps, ending in January 2025. At each quarterly step, the constituent's weight was cut by 1/8 — so by step 8 the constituent had zero weight (and was removed from the index).

The choice of "eight quarterly steps" was deliberate. JPX explicitly framed gradualism as a way to limit market-impact dislocations from large passive flows. A single-shot removal of 400+ constituents would have produced significant tracking-error pain for index funds and unwanted selling pressure on individual names; the eight-step glide path spread that adjustment over 27 months.

Phase 1's outcome:

• Starting constituent count (Oct 2022): ~2,100.
• Ending constituent count (Jan 2025): ~1,700.
• Reduction: ~400 constituents, or ~19% of the index by name count.

Phase 1 reduced TOPIX along the tradable-share-market-cap dimension — the same metric anchoring Prime continued-listing criteria. The result was an index that, by early 2025, was much more concentrated in larger, more-liquid names than its 2022 starting point.

Phase 2 (Oct 2026 – Jul 2028): the decoupling

Phase 2, announced in JPX's "Overview of Revisions of TOPIX and Other Indices" in 2024, takes the structural argument to its logical conclusion. Under Phase 2:

• The TOPIX universe is detached from segment membership. The index will draw constituents from Prime, Standard and Growth issues — segment is no longer an eligibility factor.
• Selection is driven by two liquidity tests:
• Annual trading-value turnover ratio ≥ 0.14 (annual trading value divided by free-float market cap). This is a measure of investability: how much of the available float actually trades over a year.
• Inclusion in the top 97% by cumulative free-float market cap. This is a size filter that excludes only the smallest 3% by aggregate float.
• Constituents not meeting these criteria see their TOPIX weight reduced over eight quarterly steps from October 2026 through July 2028 — the same gradualism mechanism as Phase 1.
• Estimated final constituent count: ~1,200 by July 2028 (JPX Indexes Inc., July 2024 estimate).

The decoupling is the operationally important change. A Standard-listed company with strong liquidity — high turnover ratio, in the top 97% by float — will be in TOPIX. A Prime-listed company with weak liquidity will be out of TOPIX. Segment membership and index membership are now two distinct status markers governed by different criteria.

That decoupling rebalances passive-flow incentives in a profound way. Under the old regime, a company's path to passive demand ran through the 1st Section. Under Phase 2, the path runs through liquidity — actual trading turnover. A Prime-listed company whose shares are illiquid (perhaps because of a concentrated shareholder base or low free float) is no more attractive to passive flows than a Standard-listed peer with the same liquidity profile.

The Phase 1 + Phase 2 timeline

Two analytical observations on this timeline.

First, the total reduction from peak — from ~2,200 in 2021 to ~1,200 in 2028 — is approximately 45%. The TOPIX of 2028 will be roughly half the size by name count of the TOPIX of 2021. Free-float-weighted, the change is much smaller (because the removed names were small) — but for an IR perspective focused on whether your company is in the index, the distinction matters.

Second, the Phase 1 → interim → Phase 2 sequence creates a 20-month "interim period" during which the index is in steady-state under partial reform. That interim period (Feb 2025 to Sep 2026) is operationally important: it gives Standard and Growth issuers a window in which they can build the liquidity profile needed to qualify under Phase 2 criteria. By the time Phase 2 begins, the criteria are known, the measurement window for the first selection is defined, and individual companies have visibility into whether they will be in or out.

What the Phase 2 criteria actually measure

The two Phase 2 criteria reward different behaviours:

• Annual trading-value turnover ratio ≥ 0.14. This is the circulation test. A company can have a large absolute float but fail this test if its shares simply don't trade — often a sign of a concentrated shareholder base where most of the float is held in long-term institutional or passive vehicles. For Japanese mid-cap issuers, the threshold of 0.14 (i.e., 14% of free-float market cap traded per year) is achievable but not automatic; about a third of currently-eligible TOPIX names sit close to or below it.
• Top 97% by cumulative free-float market cap. This is the size test, but framed permissively: only the smallest 3% by aggregate float are excluded. For a TOPIX universe of ~1,700 names, that translates into roughly the bottom ~50–100 names by float — a relatively small group.

The interaction matters. A small-cap Prime issuer with a tight float — say, a founder still holding 60% — can have a respectable absolute market cap but a tiny free-float market cap and a turnover ratio below 0.14. Under the old regime that company would have been in TOPIX automatically by virtue of 1st-Section membership; under Phase 2 it is likely to be out. Conversely, a Standard-listed name with widely-distributed shareholding, no founder block, and strong daily trading volume can qualify into TOPIX even though its segment label is "Standard."

The behavioural implications for issuers

The decoupling produces a new set of IR-relevant incentives:

• For Prime issuers with concentrated shareholding: the path to passive-flow demand now runs through float expansion (secondary offerings, strategic-holder dispositions, share consolidations) rather than segment status. The tradable-share-ratio rule (Theme 3.2) and the TOPIX float-and-turnover tests pull in the same direction.
• For Standard-listed names with strong liquidity: TOPIX inclusion is now achievable without segment escalation. A Standard listing with high turnover and meaningful float can capture passive flows that were previously gated by Prime membership.
• For Growth-listed names: TOPIX inclusion is theoretically possible under Phase 2, though in practice the size filter and turnover test will exclude most. The signal nonetheless matters: a Growth issuer that hits sufficient scale can graduate into TOPIX without first migrating to Standard or Prime.

Combined with the Prime tradable-share-ratio bite and the Phase 1 winnowing of small-cap names, the Phase 2 decoupling rewires the entire incentive structure of Japanese segment selection. The question for a Japanese listed company is no longer "what segment should I be in?" — it is "what liquidity profile do I need to attract the investor base I want?" Segment selection is one input to that question, but no longer the determinative input.

Why the eight-quarterly-step mechanism is itself a policy

JPX has now used the eight-quarterly-step gradualism mechanism twice — in Phase 1 and in Phase 2. The choice is deliberate and is worth understanding as a piece of policy infrastructure in its own right. The mechanism:

• Spreads selling pressure over 27 months, reducing single-event market-impact costs for passive funds.
• Provides predictability to active investors, who can model the timing of weight reductions and trade around them.
• Gives issuers time to respond to falling weights with corporate actions — buybacks, share consolidations, float expansions — that might preserve their position.
• Maintains regulatory legitimacy by visibly avoiding the "cliff" framing that drew criticism on segment reform.

That last point is important. The transitional-measures cliff (Theme 3.3) is procedurally a cliff — fail at the record date, enter the improvement period. The TOPIX reforms are explicitly not cliffs — they are glide paths. JPX has institutionalised "gradualism" as its index-transition tool and is likely to use the same template for future index reforms (including the JPX Prime 150 and other thematic indices).

What this means for IR

1. Know your TOPIX status and your Phase 2 trajectory. Calculate your annual trading-value turnover ratio and your free-float market cap quarterly. If you are in the bottom 3% by float or below 0.14 turnover, your TOPIX weight will be reduced in Phase 2 — and your messaging to investors should anticipate that.

2. Treat segment and index status as separate marketing assets. A Prime listing without TOPIX inclusion sends one message (segment quality without passive sponsorship); a Standard listing with TOPIX inclusion sends another (genuine investability without Prime obligations). Be prepared to articulate both.

3. Liquidity is a strategic objective, not a passive outcome. Free-float expansion and trading-volume cultivation are now first-order capital-markets activities. IR should be involved in float-management decisions (secondary offerings, strategic-holder dispositions, share-consolidation timing) alongside the CFO.

4. The interim period (Feb 2025 – Sep 2026) is a window of action. Phase 2 criteria are known; the measurement period for the first selection is defined. Issuers that close 2026 with strong turnover and float metrics will be safely in; those that don't will face an eight-quarter weight reduction starting October 2026.

5. Use the JPX Indexes "Revisions of TOPIX and Other Indices" PDF as the primary source. This is the controlling technical document. The eligibility criteria, weight-reduction schedule, and base dates are specified there with operational precision. IR teams should treat it the same way they treat the Continued Listing Criteria PDFs.

Sources & further reading

• JPX, "TOPIX (TPX)," https://www.jpx.co.jp/english/markets/indices/topix/
• JPX, "Overview of Revisions of TOPIX and Other Indices" (PDF, 2024), https://www.jpx.co.jp/english/markets/indices/revisions-indices/b5b4pj0000049s3x-att/RevisionsofTOPIX_e.pdf
• JPX, "Second stage of revisions," https://www.jpx.co.jp/english/markets/indices/revisions-indices/02.html
• JPX, "Revisions of TOPIX," https://www.jpx.co.jp/english/markets/indices/revisions-indices/index.html
• FSA, "Publication of report by the Expert Study Group on Capital Markets in Japan" (27 Dec 2019, the Reiwa report), https://www.fsa.go.jp/en/refer/councils/singie_kinyu/20191227.html
• Sumitomo Mitsui DS AM, "A new TOPIX: the underappreciated puzzle piece in Japan's equity market reform efforts," https://www.smd-am.co.uk/insights/a-new-topix-the-underappreciated-puzzle-piece-in-japan-s-equity-market-reform-efforts

Cross-references

• Theme 3.1 — From Four Segments to Three. The segment reform that TOPIX reform structurally complements.
• Theme 3.2 — The Tradable-Share Ratio. The float-and-shareholder-base dynamics that drive both segment and index eligibility.
• Theme 3.3 — The March 2025 Cliff. The segment-level analogue to the TOPIX Phase 1 reduction.
• Theme 4.1 — PBR < 1 Is Not a Target. The cost-of-capital logic that motivated removing low-quality names from the passive index.
• Theme 1.1 — Why 8% Was the Number That Changed Japan. The ROE-gap problem that an "everyone-in-TOPIX" passive regime had been making worse.