Market structure

Vietnam: an emerging market in waiting

To qualify for emerging market status in MSCI’s suite of indices, and maybe FTSE's too, Vietnam needs to do more to attract foreign investors. A landmark new securities law comes not before time.

Vietnam, one of the most dynamic economies in Asia, hopes to advance to emerging market status from being a frontier market in the eyes of index compilers. But to stand any chance it first needs to enact a slew of reforms to satisfy foreign investors.

Morgan Stanley Capital Investment (MSCI) will announce the results of its latest annual review on June 25, but most investors and brokers consider the Southeast Asian country’s promotion unlikely for another couple of years, given how unseasoned they find some aspects of its capital markets and government-imposed limits on the foreign ownership of listed companies.

“Vietnam’s stock market needs at least another year before inclusion in the shortlist and more than one to two years to be officially upgraded to emerging markets status,” said Hinh Dinh, an analyst at local broker VNDIRECT Securities.

An easier win might be in the FTSE Russell indices, which put Vietnam on its watchlist for promotion from frontier market to a “secondary emerging” group on September 26.

To improve its chances for inclusion in both sets of indices, Vietnam is overhauling its Securities Law. The securities watchdog, the State Securities Commission, issued a draft late last year and submitted it in May to Vietnam’s highest legislative body, the National Assembly, for debate. If the bill passes a vote towards the end of the year, it will come into effect in January 2020.

In order to be classified as an emerging market, MSCI told FinanceAsia that Vietnam must be of adequate size and liquidity as well as easily accessible to investors. Vietnam already has about a dozen companies which meet MSCI’s current requirement for a minimum total capitalisation of $1.594 billion, a free float above $797 million and a 15% annualised traded value ratio. In terms of liquidity, Vietnam is more liquid than the Philippines’ stock market, which is already classified as an emerging market.

The sticking point appears to be investors' ease of access. MSCI said that market accessibility aims to reflect international institutional investors’ experience of investing which includes several qualitative measures.

Vietnamese officials have reached out to foreign investors such as Vontobel Asset Management for input into how to smooth their path into the country. Over the past few months, Vontobel Asset Management’s head of trading, Gary Thompson, has travelled to Hanoi to discuss the draft law with the State Securities Commission chairman Tran Van Dzung and representatives from the Hanoi and Ho Chi Minh City stock exchanges.

“From the outset of the meeting they were very open, very frank and willing to discuss many topics” including how to cut bureaucracy and costs for investors said Thompson, who has been trading emerging and Asian markets for around thirty years.

To attract more portfolio investors, an easy win would be to force companies to disclose market-moving news, including earnings disclosures, simultaneously in English as well as in Vietnamese. As long as many Vietnamese companies don’t, Vietnam might be missing out on smaller, more adventurous investors who can’t afford the translation costs.

Ironically, even documents pertaining to the draft Securities Law on the State Securities Commission’s website are in Vietnamese.

SIX-STEP PROGRAMME
Vietnam’s government is open to suggestion as its frontier market status severely limits the range of investors that can buy into Vietnamese firms, as many institutions have rules that prohibit exposure to equities in riskier frontier markets. Over $1.6 trillion of investors assets under management in ETFs were benchmarked to MSCI’s emerging markets index as of June 30 2017, based on data from eVestment, Morningstar and Bloomberg, a far weightier sum than the capital tied to its frontier-market benchmark.

Vontobel Asset Management says that for MSCI to reclassify the country there are six major steps that the government needs to enact: lift maximum foreign ownership levels; introduce non-voting depositary receipts (NVDRs); improve information transparency for investors; develop a derivatives and a corporate bond market; and finally, improve supervision of equity trades, pricing and information.

All are important milestones highlighting the myriad of ways outside investment that can help a country's economic development. And in frontier markets, it's about sourcing capital to help companies grow and stoke consumer demand while domestic investment institutions are still relatively small.

Even communist states such as Vietnam and China have realised that “you can’t command consumer demand,” said Sudhir Roc-Sennett, head of thought leadership and ESG at Vontobel Asset Management based in New York.

As an example, Vontobel Asset Management owns shares in the country’s largest dairy supplier, Vietnam Dairy Products, better known as Vinamilk, and the Swiss firm’s Quality Growth boutique manages $32 billion of which about $15 billion is invested in emerging markets.

“Foreigners can bring a lot of technical and branding expertise and help national powerhouses expand their domestic footprint overseas,” said Roc-Sennett.

To be sure, foreign capital has flooded into the country before, then left just as quickly, causing disruption at companies and mayhem in markets. The benchmark VN-Index hit a peak of 1,137.7 points in February 2007, before the Global Financial Crisis, but then collapsed to a low of 245.7 points by February 2009. It only clambered back up to mark a new high of 1174.5 points in March last year.

“It is a relatively young economy with a history of overheating,” said Roc-Sennett, so reformers should move slowly to create sustainable growth and not push through half-baked proposals.

LIMITS FOR FOREIGNERS
Vietnam's draft Securities Law allows companies to remove barriers to foreign ownership as long as such a move does not conflict with local laws or international treaty obligations. Under current regulations, foreign ownership is capped at 30% for banks and 49% for publicly listed companies unless they apply to the licensing authority to lift that cap. Very few have made such a move. 

It is not clear, however, whether the Securities Law applies retrospectively or only to newly listed companies.

MSCI closely watches whether countries allow foreign access to stocks. Kuwait, which was added to MSCI’s watchlist for emerging market inclusion in June 2018, slashed its foreign ownership limit for banks from 49% to zero in December 2018 to improve its chances of index inclusion.

The Securities Law’s stance on foreign ownership is likely to be a hotly contested area among Vietnam’s legislators. The $5 billion sale of control of Vietnam's biggest brewer, Saigon Alcohol Beer and Beverages Corporation, to ThaiBev in 2017 proved controversial, for example, when the buyer used a legal loophole to bypass ownership limits using a Vietnamese entity in which it had a 49% stake.

Roc-Sennett is, perhaps surprisingly, quite conservative about the issue. He said banks are an important tool for the Vietnamese government to manage the economy while it's still quite under-developed. Private ownership, especially in the hands of foreigners, could blunt that tool, he said.

“Foreign banks really have a big impact on an economy, so maintaining a 30% cap on some of the banks would be quite wise,” Roc-Sennett said.

He advises that only robust businesses already generating free cash flow raise their foreign ownership limits further as they are not dependent on sometimes fickle foreign capital for growth.

A QUICK FIX?
To smooth the way for foreign investment in companies that continue to cling to their foreign ownership ceiling, the government is revisiting the idea of Non Voting Depositary Receipts (NVDR), an instrument already in use in Thailand.

In the draft law, Vietnam envisages allowing companies and banks to set aside a further 15% of their equity as NVDRs. This would effectively raise foreign ownership to 64% in the case of companies and 45% in the case of banks.

Once foreign ownership ceilings have been touched, potential foreign buyers of a company's stock have no choice but to find a foreign seller, which can mean their holdings trade at a premium to the public market and also trade off-market.

That also happens in India where, for example, HDFC Bank, a popular stock among foreign investors, trades off-market at around a 13% premium to the listed price and has recently traded as high as about 18%, Thompson said. The cap on foreign ownership of HDFC Bank is 74%.

Vietnamese NVDRs would ideally be regarded as securities by the State Securities Commission, automatically listed by both the Hanoi and Ho Chi Minh City stock exchanges and have the same dividend rights as an ordinary share. They would, however, come without votes, which would curtail the influence of foreign investors over management.

“This would be an initial step,” said Roc-Sennett.

PRESSING ISSUES
A close community of market practitioners – including traders, lawyers, portfolio managers and custodians – are working as a tight-knit community to think through and solve some of the investment risks posed by Vietnam’s draft securities rules.

One such conundrum is the time delay between an initial public offering and the listing date, during which period investor funds are held in escrow. This, potentially, creates conflict around who bears the foreign exchange and counterparty risk on money sitting in an account.

“Instead of the regulator requiring Vietnamese dong, it could allow investors to hold dollars during the IPO process,” which would alleviate their currency risk, Thompson said. He added that this suggestion was aired during his meeting with the State Securities Commission.

Also, investors must place the full amount of Vietnamese dong in an account before they can buy the shares, without any guarantee that they will receive all the shares they subscribed to in the IPO. This is not the best use of capital.

Furthermore, the rudimentary subscription process could be significantly improved if the regulators moved to a central database where accounts could be opened and subscription data could be stored for reuse in future transactions – rather than resubmitted from scratch each time, as is the case currently, according to Vontobel Asset Management.

This issue is particularly important given the government’s ambitious plans to sell down its stakes in about 500 state-owned enterprises by 2020.

China faced a similar outcry from investors after the launch of Stock Connect in 2014, a trading link between the Hong Kong, Shanghai and Shenzhen stock exchanges. Investors were concerned about the time lag between China’s trade settlement of T+0 and funds’ settlement on T+1.

Eventually, the problem was solved by finding brokers that were willing to assume the liability for the delay, guaranteeing delivery of the funds.

“From China’s point of view, that’s exactly what they want to see and means greater inclusion into the MSCI,” said Thompson, who has also sat down with Chinese regulators to help solve the settlement cycle issue.

Vietnam’s State Securities Commission has taken these settlement concerns into consideration and the draft law eliminates the time lag on IPOs, according to a local report. However, Thompson cautioned that “revisions may not stay in place before enactment on January 1 next year”.

The State Securities Commission is run by the Ministry of Finance, which could still amend the Securities Law.

Other fixes are also sorely needed. If Vietnam was propelled into the ranks of emerging markets then Thompson envisages asset managers struggling to complete block trades off-market, because the premium to the listed price would likely spike higher due to a sudden rush of demand. Ease of trading in blocks is something Vietnam needs to address urgently prior to promotion, said Thompson.

DERIVATIVES, BONDS, BLOCKS
Vietnam has also long been working towards building its derivatives offering. A big step in this regard was the introduction of futures based on the VN30 Index of leading local shares in September 2017, with no legal restrictions placed on foreign participants.

Looking ahead, covered warrants are scheduled to make their debut towards the end of June. Other new products included in the government’s stock market plan include exchange-traded funds, real estate investment trusts and individual stock options and futures. It also plans to allow stock lending and introduce circuit breakers.

Roc-Sennett does not trade any derivatives or corporate bonds but sees them as integral to the eventual development of fully functioning capital markets in Vietnam.

Corporate bonds are in for an overhaul too. At the moment, foreign investor participation in Vietnam’s corporate bond market is tiny, at about 1% of all outstanding debt.

One point in the draft securities law states that companies will need to be rated if they want to execute a public bond deal. The draft also says what thresholds an investor has to meet to classify as a qualified or accredited investor. Investors who meet this threshold will be able to participate in private placements.

For Roc-Sennett, the development of local currency-denominated bonds could help "to defang some of this terrible volatility we have had”. A study by the Asian Development Bank (ADB) explained that the development of deep and liquid local currency-bond markets can help mitigate the risk of mismatches in currency and maturity for emerging economies. The ADB showed that Asian economies with more developed local currency-bond markets were more resilient during the Taper Tantrum of 2013. 

MSCI PROSPECTS
Even if Vietnam follows the prescriptions of investors, it won’t guarantee promotion to emerging markets status as index compilation can be as much art as science.

“It is difficult to be an index creator as there is nothing to say when a market is really ripe [for a promotion]. Politics play a huge role,” Roc-Sennett said. He sees a promotion to MSCI Emerging Markets as “unlikely this year, more probable in the next one or two years”.

A key factor will be investor appetite, he continued. The weight of demand for Vietnamese stocks is nowhere close to the hankering for Chinese equities ahead of the much bigger market elbowing its way into the MSCI Emerging Markets index.

What’s definitely within Vietnam’s power is to continue the steady development of its capital markets and further nurture its economic growth, which has been running at a 5% to 7.5% clip for the last few years. Share prices can start to rise merely on the expectation of a reclassification. The Karachi and Dubai stock exchanges soared in the year prior to the promotion of Pakistan and the United Arab Emirates to emerging market status.

In the short term, an upgrade to emerging market status looks more likely for frontier market Kuwait than Vietnam. The silver lining for Vietnam is that with Kuwait and Argentina, which was added in to MSCI's emerging markets index in May, gone, it would dominate the MSCI Frontier Market 100 Index. Vietnam’s presence would swell to 28 stocks with a 30% weighting from 21 stocks with a total weight of 17.4%. Such a rebalancing would prompt around $65 million from funds to flow into index constituents such as Vinamilk, Masan Group or Hoa Phat Group, calculates local broker SSI Securities.

Vietnam’s influence in the MSCI Frontier Market 100 index would be so overweening in such a scenario that its weighting would be three times greater than other constituents including Morocco, Kenya, Nigeria, Bangladesh, Romania or Bahrain, causing analysts at SSI Securities to dub such an index the “MSCI V-FM 100”.

The brokerage added that MSCI might be tempted to hurriedly promote Vietnam if only just to remove such a heavyweight from overshadowing other frontier markets.

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