Daily ETF Watch: MSCI Alters Index Eligibility

Last week MSCI announced it would change its requirements for including companies in its indexes as a result of a public consultation that it kicked off in October 2014.

Previously, MSCI’s benchmarks excluded companies that did not trade on an exchange in the country to which they were classified, even if they were listed on a foreign exchange and no matter what their market capitalization was.

That meant that behemoth companies like China’s Baidu and Alibaba—the latter of which had the largest IPO in history last year at around $25 billion—were not included in the MSCI Global Investable Market Indexes (GIMI). Baidu and Alibaba both trade as American depositary receipts listed on the NYSE Arca exchange.

MSCI noted in its press release the consultation indicated that participants favored adding foreign-listed companies to the both the broad and country-specific indexes, with a few reservations noted. MSCI said it would address those concerns by requiring that foreign-listed companies eligible for inclusion in a developed and emerging market must cumulatively represent at more than 5 percent of the single market index and more than 0.5 percent of the broad MSCI ACWI IMI in order to be included in the indexes.

In frontier markets, the cumulative weight of the foreign-listed stocks eligible for inclusion in a single market need only be more than 5 percent of that market, with no requirements for the broad ACWI.

The changes will become effective in November during the index provider’s semiannual index review and will be reflected not only in the GIMI family but in all of the indexes derived from those benchmarks.

Affected Indexes, Funds

China looks to be the most affected market. A simulation provided by MSCI indicated that investors could expect to see not only Baidu and Alibaba added to its indexes, but 15 other companies as well. Meanwhile, in the developed markets, Hong Kong would see the addition of three companies, and in the frontier markets, Bahrain, Mauritius and Ukraine would each see the addition of one company due to the rule change. Romania also could be affected by the rule change.

In another modification to its rules, MSCI announced that for companies with listings in multiple markets that are current constituents, local listings with sufficient liquidity would replace foreign listings. The local listing is required to have a 12-month annualized traded value ratio that is two times the threshold for new additions in order for it to replace the foreign listing in the index. 

MSCI said that it would not make a decision yet on whether it would apply the abovementioned rule changes regarding foreign-listed companies and local listing liquidity to Russia’s market due to investor concerns about the country’s investment environment.

While the total impact on ETFs tracking MSCI indexes is still uncertain, it looks like at least 40 exchange-traded products will be affected by the methodology modifications. The largest of those are as follows:

• iShares MSCI EAFE (EFA | A-91), $52.9 billion
• iShares MSCI Emerging Markets (EEM | B-96), $31.1 billion
• iShares MSCI ACWI (ACWI | A-96), $6.7 billion
• iShares Core MSCI Emerging Markets (IEMG | A-98), $6.1 billion
• iShares Core MSCI EAFE (IEFA | A-94), $3.4 billion
• iShares MSCI All Country Asia ex Japan (AAXJ | B-86), $3 billion
• iShares MSCI Hong Kong (EWH | B-96), $2.8 billion
• iShares MSCI Pacific ex Japan (EPP | B-97), $2.6 billion
• Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF | B-72), $2.3 billion
• iShares MSCI ACWI ex U.S. (ACWX | A-96), $2 billion