FTSE yesterday (Wednesday) unveiled its new framework for classifying country status (developed vs emerging) within its global equity indexes. In addition to economic wealth, the new approach will see country classifications based on the 'quality of markets', a metric that takes into account criteria such as the regulatory, custody and settlement, dealing and derivatives environment in individual countries.
"The results of our industry consultation paper show widespread support for the new approach," says Mark Makepeace, FTSE Group's CEO. "Over 100 investment organisations from 30 countries responded to the paper."
According to FTSE's provisional quality of market assessment, Korea and Taiwan do not qualify for developed market status due to their short selling and stock lending restrictions and the level of their custody and settlement facilities.
The assessment also reveals that the China A-share market does not merit inclusion into FTSE's global index series at present. "China's QFII scheme is currently still too restrictive compared to other emerging markets," Makepeace says.
However, FTSE has published a provisional watch list of potential classification changes that shows Taiwan and Korea as candidates for an upgrade to developed market status, and the China A-share market as a potential new entrant together with Cyprus, Iceland, Jordan, Saudi Arabia and Slovenia.
"The watch list gives a sense of possible future changes in the index classifications. It reflects those countries that have shown a commitment towards fulfilling the quality of market criteria. We would expect them to meet the criteria in a reasonable time frame," says Makepeace.
FTSE's watch list is to be finalised in September after further market consultation. The index provider has announced that no country status changes will take place 2004, and that future changes will be announced at least six months before they are implemented.
FTSE has also announced the introduction of new shadow indices for Asia and emerging markets that include the China A-share market as well as Korea and Taiwan reclassified as developed markets. These will be launched in March 2005.
"The shadow indexes are indicative tools to enable investors to prepare for these future changes in country status," Makepeace addds. "These indexes will increase the choice available to investors, while also ensuring that people move to the new classifications gradually minimising the market shock that sudden changes in country classifications might cause."
Makepeace says he expects the market to welcome the new changes. "We looked ahead and saw that pressure was building up for certain countries to be reclassified. We felt that a clear, transparent and consistent treatment was required. The old subjective approach is no longer acceptable."
Interestingly, 90% of the respondents to FTSE's consultation paper felt that corporate governance practises were important in determining country classifications. Makepeace says that FTSE is currently working on developing corporate governance ratings for developed and emerging markets.
"I expect the new framework and the clarity it provides to be welcomed by the market," he concludes. "We have set the lead, and I believe that other index providers will follow a similar approach."