In June of each year, MSCI reviews the classification of the 77 markets covered by the MSCI Global Equity Indices. The aim is to reflect international institutional investors' experience of investing in a given market and to ensure that MSCI's classification remains reflective of the evolving markets.
In June 2012, MSCI released the results of the latest MSCI Annual Market Classification Review announcing that, amongst other things, the MSCI UAE Index and MSCI Qatar Index will remain classified as Frontier Markets. But what is considered in the classification of a market?
It may appear a simple question to answer with the assumption that advanced economies equate to advanced stock exchanges. Whilst frequently used, this can be misguided, given that market developments do not always keep pace with economic developments. With a reduction in home country bias and an adoption of global indexes such as the MSCI ACWI Index, a global equity index consisting of Developed and Emerging Market countries can be developed.
The classification of markets is critical to benchmark construction. The classification of a market within a global equity index may impact the cost, tracking error and overall risk of the portfolio tracking the index. Given this, MSCI uses a market classification framework to help institutional investors differentiate markets more alike and classifying in separate categories those markets that are significantly different.
MSCI Market Classification Framework
The MSCI Market Classification Framework is based on two quantitative criteria, economic development (per capita Gross National Income), and market size and liquidity measures (breadth and depth of the markets), as well as a qualitative criterion, market accessibility.
1) Economic Development is only used in determining the classification of Developed Markets while that distinction is not relevant between Emerging and Frontier Markets given the very wide variety of development levels within each of these two universes.
2) Market Size and Liquidity are based on defined terms including the minimum investability requirements for the MSCI Global Standard (Large + Mid Cap) Indices with minimum security numbers, full market cap company size, float market cap security size and tiered Annual Traded Value Ratios for security liquidity.
3) Market Accessibility is assessed using 18 distinct measures that MSCI has identified. As market accessibility aims to reflect the international institutional investor experience, it is a critical dimension as it defines how easy and frictionless it is for those investors to invest in a particular market.
A critical part of the MSCI assessment process is to consult extensively with institutional investors. When countries announce changes in their market rules and regulations, MSCI will conduct reviews with investors regarding the announced changes to assess whether the market or their experience has, in fact, changed. MSCI will only consider markets for reclassification for which a change in classification status is viewed as irreversible.
What next?
MSCI announced in June 2012 that both the MSCI Qatar Index and MSCI UAE Index will be maintained in Frontier Markets and that both remain under review for potential reclassification to Emerging Markets as part of the 2013 MSCI Annual Market Classification Review. For Qatar, where listed companies are subject to a 25% foreign ownership limit (FOL), it is expected that these FOLs remain the only impediment to the reclassification of the MSCI Qatar Index to Emerging Markets. The MSCI Qatar Index should meet all the requirements for inclusion in the MSCI Emerging Markets Index, provided the false trade mechanism introduced in May 2012 on the Qatar Exchange is successfully tested over time.
For the UAE, all requirements are met for a reclassification of the MSCI UAE Index except for specific market accessibility issues related to custody and clearing and settlement.
MSCI has been classifying Emerging Markets and Developed Markets since the inception of the MSCI Emerging Markets Index over 25 years ago. The qualitative and quantitative process is complex and ongoing for the 77 markets that MSCI covers. The MSCI process reflects its long history of constructing global equity indexes as well as engaging the institutional investor experience. Both elements are critical to creating and maintaining high-quality indexes.
Robert Ansari is MSCIs executive director and head of the Middle East.
Zawya 2013
