Preview for MSCI Annual Market Classification

(from my colleagues Dr. Win Thin and Ilan Solot)

At its 2013 Annual Market Classification Review on June 11 2013, MSCI announced that it started to review China A-shares for potential inclusion in its EM index. MSCI’s 2014 Review will be released tomorrow during Asian hours and there is a lot of speculation about what could happen. Most observers do not expect such a quick inclusion for A-shares in MSCI EM, and we agree. However, it will be interesting to see if MSCI offers any sort of guidance or a roadmap for future inclusion. Any positive signals here would help validate the government’s push towards financial sector reform.

MSCI wrote last year that: “The initiation of this consultation does not, in any way, indicate that the China A‐shares have already met the standards of Emerging Markets in terms of market accessibility criteria. […] The speed and magnitude of any hypothetical inclusion will be entirely dependent on the speed and magnitude of actual progress in the opening of the market and the resulting experience of international institutional investors.”

Regarding China A-shares, MSCI noted then that the key obstacles for inclusion in the MSCI EM index remained valid. These are listed as: (1) capital mobility; (2) the lack of alignment of the size of individual QFII quota and the size and investment process of investors and, (3) the lack of clarity on taxation rules. 

Financial sector reform is moving along, but we do not think Chinese policymakers are rushing to meet any of MSCI’s concerns just to be included in the index. As always, reforms will happen at China’s pace and sequencing, not MSCI’s. 

At that review, MSCI also announced that Korea and Taiwan would remain under review for a potential reclassification from Emerging to Developed. Most observers do not expect a reclassification for either country.

On Korea, MSCI wrote last year that “there are still no concrete resolutions or meaningful progress made on issues that are highly critical to international institutional investors.” It noted that “The limited convertibility of the Korean Won in the offshore currency market would be a significant issue for international institutional investors managing Developed Market portfolios as it would prevent them from using their usual currency trading practices. Instead of having full flexibility in timing and executing their currency trades, Developed Market investors would be forced to trade the Korean Won during Korean business hours and using local counterparties.” We think these issues still remain in play now and will prevent DM reclassification for Korea. 

On Taiwan, MSCI noted then that authorities had made no new progress in resolving key issues for global investors. It listed these as: 1) the absence of an offshore currency market for the New Taiwan Dollar, 2) the lack of complete removal of prefunding practices on Taiwanese equity market and 3) the rigidity of the ID system that makes the use of in‐kind transfers and off‐exchange transactions difficult to execute in practice. Similarly, we also think these issues still remain in play now and will prevent DM reclassification for Taiwan.