Index providers are a powerful force in the global economy and markets, influencing the flow of investor funds around the world. Recent announcements from MSCI regarding the possible downgrade of both the Indonesian and Turkish markets raise questions about their evolving role. Historically, country inclusion methodologies were designed to ensure markets are investable for foreign investors. MSCI's Market Classification Framework focuses on three criteria: economic development, size and liquidity requirements, and market accessibility. Every year, MSCI reviews all global markets and classifies them as developed, emerging, frontier or standalone.
Major index providers follow similar but not identical approaches, sometimes reaching drastically different results. South Korea is a classic case: FTSE Russell classifies it as a developed market, while MSCI treats it as an emerging market. Given the amount of money that tracks indices, such designations have a real impact. Index providers now appear to be considering factors such as possible market manipulation. MSCI cited "suspected co-ordinated trading behaviour" and a need for improved company ownership data transparency as reasons for a possible downgrade of Indonesia to frontier status. S&P Dow Jones Indices is also reviewing both markets, flagging disclosure concerns and liquidity impacts in Indonesia and market accessibility and ownership transparency issues in Turkey.
Data transparency matters because index providers weight companies by free float, the shares actually available to investors, rather than total shares. This prevents a small amount of trading in a thinly held company from distorting an index. In Indonesia, the underlying concern is potential market manipulation, which the regulator OJK has acknowledged. Despite new leadership, a higher free-float requirement and new ownership disclosure rules, MSCI says market participants feel insufficient progress has been made. MSCI has launched a consultation to reclassify Indonesia as standalone, a major blow since such markets are excluded from indices used by investors. The Jakarta Composite fell more than 11 per cent on Friday in response.
Turkey received a similar warning the same day, with MSCI freezing some index changes and flagging a possible reclassification. The move follows allegations that investment funds manipulated low-float stocks to inflate returns, leading to arrests and the liquidation of 131 funds by the local regulator. The common thread is a global index provider pushing for change where local regulators have been slower to act, raising the question of how far index providers should reach beyond their traditional role.
Source: Financial Times Markets · Summarized by HeadlinesBriefing