Key points from the latest MSCI announcement
MSCI, the world’s largest indexing firm, has announced that it will not be including China’s A shares in its widely followed emerging markets (EM) index. It also made a number of comments, which are of interest to global EM funds following Pakistan, Nigeria, Argentina and Saudi Arabia.
In summary:
1. For passive EM funds, the MSCI EM Index is the most significant globally by far, with around $1.5 tn in indexed investment. For active investors, any change in the weighting of the index (against which they are benchmarked) forces them to reassess the composition of their portfolios.
2. MSCI pointed to a number of reasons behind its decision regarding China’s A share market, the main one perhaps being capital mobility. First and foremost, the 20 percent monthly repatriation limit (the amount of total capital an investor is able to withdraw from the market during one month) is considered too low, especially should the fund be faced with redemptions. The time-consuming and opaque process of receiving approval for a quota, which allows investors to invest in Chinese stocks, is also a factor. On top of this, the need for preapproval of financial products on foreign stock exchanges that are linked to A share indices has not yet been addressed.
It is important to note that China is already the largest component of the MSCI EM Index, making up more than 25 percent of the index. This is composed of ADRs of Chinese companies listed in New York and Chinese shares quoted in Hong Kong. The domestic (A share) stock market – the largest in the world after the US – is not included in the index.
3. MSCI announced that Pakistan will be reclassified as an emerging market. Given its current account deficit and need for capital to drive steady growth, many observers agree that Pakistan is the biggest winner from yesterday’s announcement.
4. Argentina will be reviewed for a potential upgrade. In December 2015 the Central Bank of Argentina abolished foreign exchange restrictions and significantly relaxed the capital controls that have been in place for a number of years. These changes have resulted in a floating currency, the elimination of cash reserves and monthly repatriation limits on the equity market, as well as a significant reduction in the capital lock-up period for investments.
5. Nigeria may be removed from the MSCI Frontier Markets Index and reclassified as a stand-alone market due to capital mobility issues. This may come as soon as November this year. Early last year Nigeria’s central bank pegged the local currency to the US dollar, resulting in a sharp decline in liquidity on the foreign exchange market. This significantly impaired the ability of international institutional investors to repatriate capital, to the point where the investability of the Nigerian equity market is being questioned.
6. MSCI says it welcomes the recent market enhancements announced in Saudi Arabia, which opened its market to foreign investors for the first time last summer. These enhancements include changes to the rules for qualified foreign investors, a settlement cycle of listed securities, elimination of the cash-prefunding requirement and the introduction of a proper delivery versus payment procedure. Many of these are on course to be implemented by mid-2017 and will bring the Saudi equity market closer to EM standards
Michael Chojnacki is co-founder and CEO of Closir, a platform that helps companies from emerging markets connect with institutional investors. This post originally appeared on Closir’s blog
