Korea and Taiwan aren’t developed enough for MSCI

Leslie Shaffer | Writer for
MSCI: Why we didn't upgrade Korea & Taiwan
MSCI: Why we didn't upgrade Korea & Taiwan

By most measures, South Korea and Taiwan look like fully developed countries, but the MSCI won't consider including them in developed market stock indexes, keeping them stuck with emerging market status.

"We always think both markets -- Korea and Taiwan - are developed countries by any means. They are fast growing economies," Chia Chin-Ping, managing director at MSCI, told CNBC on Thursday. "From our perspective, though, in the classification of MSCI countries, we do place a significant consideration on the accessibility, i.e. how friendly is the market to international investors."

With over $8 trillion globally estimated to be passively tracking MSCI's indexes and around $1.4 trillion of that tied to the emerging markets index, a country's classification can result in significant changes in fund flows.

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The main problems with Korea and Taiwan are that their currencies aren't freely convertible and they lack "all the conveniences in trading stocks," Chia said, citing technical issues with their exchanges.

MSCI took both countries off its list for potential inclusion as developed markets.

"So far, there hasn't been much progress on this issues and investor feedback has been always the same. So we decided to just take it down," Chia said. "That makes it simpler and reduces speculation in the market."

Seong Joon Cho | Bloomberg | Getty Images

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While the decision to stop considering the two for inclusion might have been unexpected, passing them over this time around wasn't really a surprise, with both Deutsche Bank and Goldman Sachs saying they didn't see it happening.

"Korea has been on the watch list for this promotion for six years, and Taiwan has been on the watch list for five years," Deutsche Bank said in a note Monday. "A developed market country in terms of economic growth doesn't necessarily mean it should be in the developed market index."

It noted that both countries' markets make large and off-exchange transactions prohibitive or difficult to execute.

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"This is a significant concern for large institutions managing thousands of funds, as well as indexers or issuers with investment products that closely replicate indices," Deutsche Bank said.

Analysts are divided on whether those two markets receive more fund flows from being classified as emerging markets rather than developed markets.

Korea, for example, has the second largest weighting in MSCI's emerging market index at 15.8 percent after China's 18.4 percent, while Taiwan is third at 11.9 percent, but in MSCI's All Country World Index, Korea has only a 1.7 percent weight and Taiwan just 1.3 percent, Deutsche Bank noted.

But some believe that rather than losing fund flows from achieving developed market status, the two would actually get a smaller slice of a far bigger pie.

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"In relative terms, it looks small in developed markets, but in absolute terms, the amount of money allocated would be larger," Mark Matthews, head of research at Julius Baer, said. "It would mean more passive money would need to be allocated to them."

But even then, he isn't sure the two markets are missing out on a clear benefit.

"Of course more passive money allocated to those markets would be nice, but what make those markets go up is cashflow," he said.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1