MSCI Decisions Tonight

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After markets close tonight, MSCI will issue its review with regards to potential market reclassification for China A-Shares, Argentina, and Nigeria.   

WHAT’S BEING DECIDED

From MSCI:  Actual country reclassifications are infrequent, with an average of just over one per year since 2000, but they sometimes come in bunches.

During the Annual Market Classification Review, MSCI analyzes and seeks feedback on those markets it has placed under review for potential market reclassification. Every June, MSCI communicates its conclusions from the discussions with the investment community on the list of countries under review and announces the new list of countries, if any, under review for potential market reclassification in the upcoming cycle.

MSCI announced last year that it would include reclassification of China A-shares, Argentina, and Nigeria in this year’s review.  The reclassification of Pakistan last month from Frontier to Emerging status was announced at the June 2016 review.  MSCI also announced last year that Korea would not be included in the 2017 review for a reclassification to Developed Market status.  MSCI noted that it would be monitoring Saudi Arabia for possible reclassification, but did not commit to any timetable since some measures didn’t take effect until mid-2017.

WHAT FACTORS ARE CONSIDERED BY MSCI FOR EM STATUS?

From MSCI:  For Emerging Markets, the classification depends on two criteria: (1) whether the equity market meets minimum size and liquidity requirements and (2) whether it exhibits accessibility levels for international investors that are sufficient in the context of Emerging Markets. 

WHICH MARKETS COULD BE AFFECTED?

China

China is already part of MSCI Emerging Markets with a current weighting of 27.96%.  MSCI China currently consists of B-shares (listed onshore and denominated in foreign currency), H-shares (listed in Hong Kong and denominated in HKD), Red Chips (companies listed and incorporated in Hong Kong but with primary operations conducted on the mainland), P Chips (companies listed in Hong Kong but incorporated in Caymans, Bermuda, or BVI and run by private Chinese nationals), and overseas listings (such as ADRs).

A-shares are listed onshore and denominated in yuan.  In June 2016, MSCI ruled against including A-shares in MSCI China.  It noted then three obstacles that had to be addressed.  From MSCI:  1) Effective implementation of the QFII policy changes and removal of the 20% monthly repatriation limit, 2) Effective implementation of new trading suspension treatment, and 3) Resolution of pre-approval requirements by the local exchanges on launching financial products

We do not think China has fully addressed these issues.  It’s a close call, but we lean towards no A-share inclusion into MSCI EM this year.

Argentina

The nation was demoted to Frontier status in 2009.  MSCI noted that it came “as a result of the continued restrictions to in- and outflows of capital in the Argentinean equity market.”

Since President Macri was elected in 2015, policymakers have worked hard to reverse decades of economic mismanagement and bad policies.  The most important of these were resolving the default holdouts, eliminating capital controls, and floating the peso.  The removal of capital controls directly addresses MSCI’s criteria for demotion.   As such, we expect Argentina to be promoted back to Emerging Market status this year.

Nigeria

In September 2016, MSCI Nigeria was formally added to the review list for potential reclassification from Frontier Markets to Standalone market status.  MSCI noted that “This decision stemmed from a continuous deterioration of the market accessibility after the introduction of restrictions on foreign currency trading in the first half of 2015 and the resulting reduction of foreign exchange market liquidity.”

Despite official claims to the contrary, the naira is still heavily controlled and managed.  The new central bank FX window for foreign investors was introduced in April and has helped clear the backlog of foreign funds waiting to be repatriated.  However, we feel that the arbitrary and unpredictable nature of FX policymaking warrants Nigeria being moved to standalone status this year.  We acknowledge that the April measures could convince MSCI to give Nigeria more time and allow it to hang on (for now) to its Frontier status.

WHAT’S AT STAKE?

According to MSCI, the weight of China A-shares in the MSCI EM Index would be approximately 0.5% under the revised 5% inclusion proposal.  MSCI China is up 25.5% YTD vs. 14.2% YTD for MSCI Frontier and 17.5% YTD for MSCI EM.

According to MSCI, the simulated MSCI Argentina Index would have a potential weight of 0.4% in the MSCI Emerging Markets Index.  The current weight of MSCI Argentina in MSCI Frontier Markets Index is 20.27%.  MSCI Argentina is up 42.9% YTD.

For Nigeria, a move to Standalone status basically means it will be ejected from the Frontier index altogether.  The current weight of MSCI Nigeria in MSCI Frontier Markets Index is 8.86%.  MSCI Nigeria is up 34.3% YTD.

CONCLUSIONS

The MSCI annual review is a good reminder that investors must continue to be discerning with EM and Frontier.  Should funds be invested in countries with questionable track records?  Are countries undertaking significant reforms?  Can investors repatriate funds easily?  Bottom line:  China and Argentina are taking the right steps.  Nigeria?  Not so much.