MSCI announced it may launch a consultation on a reclassification proposal for Turkey from EM status, if the accessibility level of the Turkish equity market were to worsen further. We do not anticipate an imminent reclassification, but even if it were to happen, we think trading impact would be limited.
MSCI announcement on Turkey: MSCI last night announced its 2020 Market Classification Review and noted a deterioration in investability of the MSCI Turkey index. In the document, MSCI mentioned that ‘it may launch a consultation on a reclassification proposal for the MSCI Turkey Index to Frontier Markets or Standalone Markets status if the already deteriorating accessibility level of the Turkish equity market were to worsen further.’
MSCI conference call feedback
Official consultation on Turkey has not been opened: On its conference call, hosted this morning, MSCI confirmed that it has not officially opened a consultation on any potential reclassification of MSCI Turkey but flagged the negative trajectory of market accessibility seen in the past 12 months. A number of trading restrictions have been introduced recently:
in October 2019, Turkey implemented a short selling restriction on the largest local bank and in February 2020, short selling and stock lending restrictions covering the entire equity market were introduced. As also mentioned in the conference call, we note that there are other countries in EM (for example South Korea and Malaysia) which currently have short selling bans in place.
Therefore, we understand that additional restriction measures and/or further deterioration of the market accessibility in Turkey would be required for MSCI to open a formal consultation for country reclassification.
In a worst case scenario…
If Turkey were to be removed from MSCI EM, we see limited trading flow impact given the country’s low weight in the index (just c. 45bp)…
Currently, Turkey has just a 0.45% weight in MSCI EM and we estimate as of April 30th GEM fund exposure to Turkish equities was at c. 57bp. Therefore, if removed from MSCI EM, we estimate USD1.6bn of passive outflows and even if we were to conservatively assume active funds would reduce their exposure by half, it would imply an additional USD1.9bn of outflows. Considering the 1-month ADTV of the current constituents of MSCI Turkey, the combined passive and active flows represent c. 3.7 days to cover for MSCI Turkey constituents.
…While if Turkey were to be reclassified to MSCI Frontier Markets…
We estimate it would be a c. 27% weight, further reducing trading impact: Importantly, we would also need to consider the inflows related to Frontier Market funds.
Adjusting the Frontier Market composition, i.e. excluding Kuwait and conservatively assuming a reclassification of Argentina to FM status (which yesterday’s MSCI press release flags as a possibility), Turkey would have a c. 27% of weight in the Frontier Market index, which would imply USD700m in inflows on our estimates. This would bring our days to cover impact from 3.7 days to a net impact of 2.9 days, taking into account Frontier inflows. We assume AUM of USD350bn for EM passive funds, USD650bn for EM active funds and USD2.6bn of FM indexed (both passive and active) funds.
For now, we see MSCI’s comments as more of a warning flag with a potential impact on sentiment; ultimately, if the short ban were removed we would see it as a positive catalyst, in our view: We think the bigger impact of this newsflow could be on investor sentiment, though we also note that were Turkey to remove its short ban on equities, we would see this as a positive development bringing back more foreign hedge fund investors to the market at a time when fundamentals are broadly improving. We note Turkey’s high indirect exposure to the EU recovery fund catalyst via its high share of exports to Europe.
Excerpt from Morgan Stanley research report
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