Playing the joker

Vietnam deals uncertain hand to MSCI over EM status

Will the index provider decide to twist or stick as it gears up to announce whether it is putting Vietnam on its watchlist this June?

The collective eyes of the world’s frontier and emerging market fund managers will be re-trained on Vietnam again this June when MSCI decides whether to put the country on its watchlist for inclusion in the all-powerful MSCI-EM Index.

Last year, MSCI decided to stick. Instead, it put Kuwait on its watchlist, while upgrading Argentina and including Saudi Arabia, both effective this month.

What has changed since MSCI’s last review?

Well last September, the Vietnamese government made its intent clear after officially making MSCI-EM status a key performance indicator (KPI). In order to improve its chances, it is in the process of overhauling its Securities Law and issued a first draft in October.

The State Securities Commission (SSC) has submitted the draft to the National Assembly, which is meeting until mid-June and hopes that it will be approved at the parliament’s second session at the end of the year. Nguyen Thi Bich Nga, deputy director of the International Cooperation Department, told FinanceAsia that the commission has been maintaining the reform momentum by concurrently working on the decrees, which will be issued off the back of it.  

This means that enactment could happen towards the beginning of 2020, earlier than many market participants had been expecting.

“We really hope MSCI puts us on the watchlist this year,” she said. “We’ve been working hard to put the right legislative framework in place, introduce new products and professionalise the market.”

Earlier this May, the government also revealed its most detailed thinking to date about the potential introduction of Non-Voting Depository Receipts (NVDRs) to overcome the thorny issue of Foreign Ownership Limits (FOLs). This is the product that many local brokers and fund managers consider to be essential to unlocking an upgrade.

One aspect, on which pretty much everyone agrees, is that Vietnam looks far more like an emerging market than a fair number of its peers which already hold the distinction.

It has more companies with a market capitalisation of over $1 billion than Pakistan, for example. Average daily trading volumes are also generally higher than the Philippines.

“On a purely economic basis it looks quite strange that Pakistan is an emerging market and Vietnam is not,” said Nguyen Quoc Dung, head of institutional sales and brokerage at Viet Capital.

Since it faced a banking crisis in 2010, the Vietnamese economy has been underpinned by sustainably high growth, low inflation, a stable currency and much stronger credit controls. 

Fund managers like Kevin Snowball, chief executive of PXP Vietnam Asset Management, remain optimistic that this could help to win the day. Snowball points out that Vietnam has not only met all of the index provider’s quantitative criteria for EM status, but has the strongest case of any frontier market country from a qualitative one as well. 

“Could it happen? Should it happen? The answer to both is yes,” he remarked.

Stephen McKeever, head of institutional client brokerage at Ho Chi Minh City Securities (HSC), also believes that there is a strong chance the MSCI could move this June.

He highlights the prime minister’s recent public endorsement of a stock market reform plan. This sets out a list of changes to be executed by 2020 and a long-term vision through to 2025, which includes achieving EM status.

“We think the 2025 date is a case of wanting to under-promise and over-deliver,” McKeever stated. “Vietnam could go on the MSCI watchlist this year because the Securities Law is laying the groundwork for a market that puts foreign and local investors on a more even playing field.”

Will MSCI oblige? One thing the index provider does not want is a busted flush on its hands.

Plenty believe that two of its most recent upgrades have ended up that way. Both Argentina and Pakistan suffered crises shortly after MSCI moved them to EM status. 

If Vietnam is upgraded, it does not seem likely that it would follow a similar trajectory given the positive economic picture painted by economists. Tthe key issues which previously held MSCI back, however, have not been addressed by the draft Securities Law.


As Viet Capital’s Nguyen comments: “The big one concerns FOLs. Many emerging markets have them, but in our case they constitute a large part of the VN-Index.”

The government first tried to grapple seriously with the issue back in 2015. Under Decree 60, it allowed companies to remove their 49% FOLs voluntarily, so long as they did not operate in a restricted sector.

It did not fully elaborate what those restricted sectors are, however. Bill Stoops, CIO of Vietnamese fund manager Dragon Capital, says it is generally accepted that more than 200 sectors fall under the classification including key ones such as banking (capped at a lower 30% FOL) and real estate.

Both Stoops and PXP’s Snowball believe that the government is planning to slash the number of restricted sectors to about 20. They also hope the new Securities Law will automatically remove FOLs for all companies operating in non-restricted sectors.

Stoops further hopes that the Securities Law will enshrine its legal precedence over the country’s existing Investment Law where publicly listed companies are concerned. This would have two benefits.

First, it would mean that listed companies would no longer need to worry about being designated as foreign. This currently makes them liable for additional taxes and circumscribes certain business activities.

The listed brokerages have already tested whether the Investment Law would ensnare them by simply removing their own FOLs and waiting to see what happened. Nothing did.

But most other listed companies have simply not bothered. So far, less than 40 of 1,400 listed companies (including on UPCoM) have removed their FOLs.  

As Jeffrey Goh, regional head of brokerage at Maybank Kim Eng, explains, "I think the regulator and exchanges realise there's a fairly granular reason why there isn't more foreign participation even though they've encouraged it by theoretically removing the cap. It's because they left the decision to individual companies."

Mandatory adoption would not not only overcome this inertia, but also force companies to get over their fear of foreign ownership (FOFO) too.


Jeffrey Goh, Maybank Kim Eng
Jeffrey Goh, Maybank Kim Eng

The most notable exception is Vinamilk, which already has 60% foreign-ownership. In some respects, however, the former state-owned company is not a good example since its two strategic foreign shareholders - F&N Beverages  and Jardine Cycle & Carriage - famously do not get along, thus counterbalancing each other.

Vingroup is a better example of the confusion, which FOLs can generate. The country’s largest stock by market capitalisation recently received SSC approval to reduce its publicly traded foreign limit by 4% even though foreign investors only owned 15% of its equity at the time.

Some believe it is because it wanted to shuffle the deck before a 6.1% investment by South Korea’s SK Corp. Some local brokers say Vingroup wanted to hold back roughly 4% of its equity so that it can meet a $400 million preferred convertible issue it issued to Hanwha Group in 2018.


Whatever the reason, the confusion the move generated is unlikely to re-assure MSCI. And then there is the issue about the lack of a transparent pricing and trading mechanism for FOL-affected stocks.

This, rather than the existence of FOLs per se, is said to be the main sticking point preventing an MSCI upgrade.

Right now, there are no public quotes for stocks, which trade at a premium to the local market price when they reached their FOL. Trades between brokers and fund managers are conducted off-market instead.

Fund managers and brokers want to see Vietnam follow Thailand’s example and introduce a foreign board plus NVDRs.

A foreign board would provide fund managers with a public price for trades currently conducted off-market and enable them to mark their positions to market. NVDRs would still classify as ordinary shares, but not carry voting rights, which solves the foreign ownership conundrum.

Mike Lynch, SSI’s head of institutional brokerage, is among those who believe this is the way forward.

“Thailand had a foreign board for many years before implementing NVDRs,” he commented. “Stocks traded at premiums of up to 25% before NVDRs were introduced, but then compressed to just a couple of percentage points.”

This is because NVDRs and ordinary shares are fully fungible. Foreign investors can swap from one to the other without worrying about the FOL.

Mike Lynch SSI
Mike Lynch, SSI

Lynch believes that valuations would likely double if Vietnam adopted a similar system, since foreign investors would start to set the market price instead of the locals who currently do. Foreign investors, backed by fundamental analysis, are often far more willing to pay higher valuations.

“We’ve seen many recent examples of foreigners paying 50% premiums to encourage other foreigners to sell their holdings in FOL-limited names,” Lynch said.

“They’re not foolish,” he added. “They simply see value beyond this premium. I think there’s a general acceptance that Vietnam should trade at a big growth premium to the rest of Asia.”

Over in Thailand, brokers expect MSCI to announce, this June, that it will add NVDRs to the EM Index, boosting foreign inflows into its stock market. Back in Vietnam, local brokers and investors had begun to despair that the government would ever make a decision on the issue.


However, officials have now stated a preference for NVDRs rather than going down the route of restricted shares, which Malaysia and Japan use to maintain local ownership of key industries. They have also come up with a tentative plan to execute it.

In early May, represenatives from the Ho Chi Minh Stock Exchange (HOSE) put forward alternatives at a seminar hosted by the Vietnam Business Forum, a capital markets working group headed by Dragon Capital founder, Dominic Scriven.

The government envisages allowing companies and banks to open up a further 15% of their equity through NVDRs. This would effectively raise foreign ownership to 64% in the case of companies and 45% in the case of banks.

This threshold was settled upon because government officials want to make sure that local ownership does not slip below the 36% level which accords a right of veto under Vietnamese law. For even though NVDRs do not have voting rights, the increased foreign ownership limit would open the way for the foreign investors who do own voting shares to outnumber local ones at an Annual General Meeting (AGM).

The government has a solution for this as well. It proposes setting up a company to manage the NVDRs and vote their rights proportionally to local investors during an AGM.

This company would be a HOSE subsidiary. Nothing, however, is very straightforward in Vietnam and right now, the exchange's charter does not allow it to set up a subsidiary.

There are also other technicalities to iron out. These include the fact that FOLs are currently calculated based on a company’s charter capital rather than its ordinary shares.

Will the government’s decision to embrace NVDRs be enough to persuade MSCI? SSI’s Lynch points out that he could sell an additional 15% in many FOL-affected stocks overnight.

The key issue is not raising the cap, but providing a transparent trading mechanism. On this issue, the government has yet to formuate an answer. It has also yet to say when it might execute any of the above. 


The other change, which MSCI wants to see more of are bilingual corporate announcements so that foreign and local investors have access to the same information. Again Vinamilk is already a standout in this respect, releasing simultaneous announcements in Vietnamese and English.

Both PXP’s Snowball and Dragon Capital’s Stoops believe this issue is a fairly easy one to resolve.

“Vietnamese is the country’s official language,” Snowball explained. “But the government could make bilingual releases mandatory for companies wishing to be included in, for example, the VN30 or VN50 Index and that would hopefully be enough to satisfy MSCI.”

Snowball highlights other steps the government has taken to facilitate equal access for foreigners and locals alike.

The big one was the introduction of futures on the VN30 Index in September 2017. No legal restrictions apply to foreign participants.

It has not, however, quite worked out as planned.

Foreign custodians such as CitiDeutsche BankHSBC and Standard Chartered have so far shown no interest in becoming clearing members of the exchange, most likely because the business would not yet be profitable enough for them.

But fund managers, including PXP and Dragon, are unwilling to deal with local counterparties. As Snowball puts it, “They operate co-mingled funds and are all trading their own book. The settlement risk is just too high.”

Local brokerages and investors, on the other hand, have taken to index futures with gusto. Trading volumes are often triple or quadruple the underlying cash market’s $150 million to $200 million average daily trading volume.

“It’s turned into a bit of a Frankenstein’s monster because the settlement period is T+1 compared to T+3 for cash equities,” Stoops explained. “Local investors are arbitraging the difference.”

The government is aware of the issue and the SSC’s Nguyen told FinanceAsia that, alongside the depository, it is studying introducing T+1 in the equities market.

The regulator is also keen to introduce new products. 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 ETFs, Reits and individual stock options and futures. It also plans to allow stock lending and introduce circuit breakers. 


In the meantime, Vietnam has started to assume a dominant status in the MSCI Frontier Markets Index. At the end of March, it had a 15.56% weighting, second only to Kuwait on 22.78% and the soon-to-be-departing Argentina on 13.25%. Coming fourth, by some distance, was Morocco on 7.06%.

SSI calculates that if and when both Argentina and Kuwait become EM constituents, Vietnam would theoretically shoot up to 30% unless MSCI re-constitutes the index. Either way, their departure will place a lot of clear water between Vietnam and the remaining far smaller markets. 

This could play out either way.

It could prompt MSCI to upgrade the outsized fish. Alternatively, it might decide to keep things the way they currently are for longer so that frontier market fund managers have more investment choices.

For in recent years, there has been a progressive loss of liquid stock markets from the index. Before MSCI upgraded Argentina and Saudi Arabia last year, it lifted Pakistan (2017), plus Qatar and UAE (2014).

Many frontier fund managers have responded by adopting crossover policies that allow them to continue investing in countries once they hit EM status.

This suggests that it might be beneficial for Vietnam to gain EM status. That way, it could end up enjoying the best of both worlds - access to the $10 billion tied to frontier market funds and the far larger $1.8 trillion tied to emerging market funds.

SSI’s Lynch also flags that MSCI might be wary of repeating what happened with Qatar and the United Arab Emirates. Both were put on its watchlist in 2008, but only finally gained EM status in 2014.

The index provider may, therefore, want to see more concrete progress from Vietnam before it makes its move.

And it may not be the first to move either. FTSE Russell put Vietnam on its watchlist last September and will review it at the end of the third quarter.

And perhaps most importantly of all, the index providers and the government do not want to trigger a foreign stampede before the market is mature or robust enough to absorb the additional interest that an upgrade would bring. International investors currently account for roughly $30 billion of Vietnam’s $173 billion market capitalisation.

Lynch senses there is 10 times that amount of money waiting in the wings for the MSCI to act. Stoops think it is about $10 billion.

What no one wants to see is a repeat of 2006 and 2007 when the Vietnamese stock market blew up after foreign money surged in and then just as promptly surged out again a few years later after the market overheated. The government learned its lesson the hard way and wants to get things right this time round.

In recent years, it has had a tendency to unveil ambitious plans then weigh its options for a number of years before inching forwards. Brokers have learned to keep their optimism in check.

Going on the MSCI watchlist might prompt the government to act more decisively and there does appear to be momentum in the air. Brokers and investors, however, are also aware that Vietnam has elections coming up in early 2021, which might slow progress.

Dragon Capital’s Stoops has consequently ruled out 2019 as the MSCI watchlist year. He thinks 2020 is a possibility if MSCI sees progress on its trading system.

“After that, inclusion could happen quickly if Vietnam moves to open, compliant trading mechanisms,” he said.

VinaCapital deputy chairman Terry Mahony has also ruled out 2019 and agrees that 2020 or 2021 is more likely. The firm’s economist, Michael Kokalari agrees. “Barring a surprise, Vietnam is unlikely to join Kuwait on the watchlist,” he concluded.




This article has been updated to highlight that implementation of the Securities Law could take place in 2020.

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