Alibaba IPO’s Huge ETF Conundrum

September 15, 2014

Where ETF investors can find Alibaba shares is no simple matter.

Alibaba, China’s e-commerce juggernaut, is set for a historic IPO later this week, but many questions have been raised regarding how the newly public company will be placed in ETFs.

The issue with Alibaba, regarding index placement, deals with its incorporation in the Cayman Islands and its U.S. listing.

Basically, according to the methodologies of indexing giants like MSCI and FTSE, a stock like Alibaba becomes “country-less” and falls into no-man’s land.

MSCI looks at a company’s country of incorporation and primary listing for country assignment. Meanwhile, only Hong Kong-listed Chinese shares and “B shares” are eligible for inclusion into FTSE’s Global Equity Index Series. U.S.-listed China N-shares are not eligible. (For a deeper read on China share classes, see our 2014 China ETF Guide).

This makes Alibaba shares ineligible to be held in some of the largest ETFs in the world, including the $50 billion Vanguard FTSE Emerging Markets ETF (VWO | C-90) and the $44 billion iShares MSCI Emerging Markets ETF (EEM | B-98).

In a strange twist, looking beyond emerging and China-specific ETFs, Alibaba’s decision to list on the NYSE instead of Nasdaq also makes it ineligible for inclusion into the $47 billion PowerShares QQQ ETF (QQQ | A-46).

The exclusion of Alibaba from most MSCI- and FTSE-based ETFs has some big implications from the perspective of Alibaba shares and ETF investors, since the lion’s share of assets in emerging market ETFs are tied to MSCI and FTSE-based indexes.

Much has been written about how Alibaba’s variable interest entity structure (VIE) is keeping it out of these indexes. But the issue isn’t solely Alibaba’s VIE structure. It’s Alibaba’s VIE structure and that it its shares will only be listed in the U.S.

For example, Tencent Holdings, China’s largest Internet company, is also incorporated in the Cayman Islands and uses a VIE structure. But because it lists its shares in Hong Kong, it passes as a P-chip, making it eligible in MSCI’s and FTSE’s emerging markets and China indexes.

So what does all this mean?


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