[Beginner's Guide] Now in Its 15th Attempt... What Does Inclusion in the MSCI Developed Markets Index Mean?

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Recently, there was controversy over Lee Bok-hyun, the Financial Supervisory Service Governor's statement about "full resumption of short selling within the year."

The logic was that short selling regulations need to be eased to be included in the MSCI Developed Markets Index.

Let's take a look at what exactly the MSCI index is and what benefits come with inclusion in the MSCI Developed Markets Index.

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MSCI (Morgan Stanley Capital International) index is one of the global stock market benchmark indices developed by the US mega investment bank (IB) Morgan Stanley.

Along with the Financial Times Stock Exchange (FTSE) index, which is published by FTSE International Limited established jointly by the UK's Financial Times and London Stock Exchange, it is considered a representative index serving as an investment benchmark for international financial funds.

The MSCI index is classified into three types: Developed Markets Index, Emerging Markets Index, and Frontier Markets Index.

Currently, South Korea belongs to the Emerging Markets Index.

The Developed Markets include a total of 23 countries, Emerging Markets include 24 countries including South Korea, and Frontier Markets include 21 countries.

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South Korea has been striving for 15 years since 2009 to be included in the MSCI Developed Markets Index.

What advantages are there that make such efforts worthwhile to be included in the MSCI Developed Markets Index?

The MSCI index has a very significant influence on global investors' investment decisions.

Since it is an index created in the US, 95% of US-based funds use this index as their fund management benchmark.

As of the end of June 2021, the global assets tracking the MSCI index amount to $16.3 trillion,

of which $1.813 trillion track the MSCI Emerging Markets Index.

Assets tracking the Developed Markets Index amount to $3.493 trillion, about twice as much.

Depending on the research institution, it is expected that if the Korean stock market is included in the MSCI Developed Markets Index, additional inflows of at least $5 billion (about 6.595 trillion KRW) and up to $54.7 billion (about 72 trillion KRW) will occur.

According to Goldman Sachs, if Korea is included in the MSCI Developed Markets Index, an additional $44 billion will flow into the Korean market, and the KOSPI could rise by 30-35%.

The Korea Capital Market Institute expects a net inflow of $5 billion to $36 billion if Korea is included in the MSCI Developed Markets Index.

The Korea Economic Research Institute under the Federation of Korean Industries estimates that about $15.9547 billion of foreign investment funds will flow into the Korean stock market due to inclusion in the MSCI Developed Markets Index.

The KOSPI index reached the 3000 level during the COVID-19 pandemic, achieving the so-called 'Samcheonpi' (three-thousand KOSPI).

There are also forecasts that if included in the MSCI Developed Markets Index, the KOSPI could rise to the 4000 level.

[Image source=Reuters Yonhap News]

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Since the Korean capital market was first opened to foreign investors in 1992, it has belonged to the MSCI Emerging Markets Index.

As we have seen, if included in the MSCI Developed Markets Index, the boosting effect on the Korean stock market would be obvious.

To be included in MSCI's Developed Markets Index, the country must first be selected for MSCI's watchlist (countries under observation).

MSCI conducts investor surveys every April and announces the watchlist in June based on the results.

If a country is listed on the watchlist, the inclusion in the Developed Markets Index is decided after another survey the following April.

Even after the decision to include, it takes about another year for actual inclusion, so it takes about two years from being on the watchlist to inclusion.

South Korea was selected for the Developed Markets watchlist in 2008 but was removed in 2014 due to insufficient market accessibility improvements.

Subsequently, attempts were made again in 2015, 2021, and 2022 to join the Developed Markets Index but were repeatedly unsuccessful.

Morgan Stanley requires the following conditions for MSCI Developed Markets Index inclusion: ▲economic growth level ▲stock market size and liquidity ▲market accessibility for foreign investors.

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The main reason for repeated failures to join the MSCI Developed Markets Index has been criticisms regarding market accessibility.

Specific issues regarding market accessibility include ▲lack of English-language materials and information access for foreign investors ▲limited short selling on KOSPI 200 and KOSDAQ 150 companies ▲access to onshore and offshore foreign exchange markets.

In response, recently, Korean financial authorities announced plans to create a capital market that meets 'global standards' by abolishing the foreign investor registration system and expanding English disclosures.

The government also declared it will actively improve foreign exchange market accessibility.

Currently, the Korean won can only be traded during the Seoul foreign exchange market hours from 9 a.m. to 3:30 p.m.

MSCI, which values market accessibility, wants Korea to have an offshore foreign exchange market where foreigners can trade 24 hours.

The government has announced plans to open the foreign exchange market by allowing foreign financial institutions overseas to directly participate in the domestic interbank market and extend trading hours until 2 a.m. Korean time, coinciding with the London financial market closing time.

For Korea, which experienced the IMF crisis, opening an offshore market that could increase exchange rate volatility is considered a significant decision.

However, the last hurdle, 'easing short selling regulations', is still facing difficulties.

[Image source=Yonhap News]

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Currently, short selling has been partially resumed.

In March 2020, when the KOSPI fell below 2000 due to the COVID-19 pandemic, short selling was banned, but in May 2021, short selling was resumed only for 350 large-cap stocks among KOSPI 200 and KOSDAQ 150 stocks.

To be included in the MSCI Developed Markets Index, short selling regulations need to be eased, but currently, short selling in the Korean stock market is a system disadvantageous only to individual investors.

Individual investors find it difficult to borrow stocks, and there is discrimination in the repayment period (foreigners and institutions have unlimited repayment periods, while individuals are limited to 90 days).

Additionally, naked short selling exposed by the ghost stock incidents involving securities firms has also been pointed out as a problem.

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Dear Joorini investors,

The government considers inclusion in the MSCI Developed Markets Index a long-cherished goal.

With the KOSPI possibly surpassing 4000, no investor would oppose this.

However, before the Korean stock market is dominated by foreign capital, fair rules regarding short selling must be established.

Just as the Korean stock market achieved 'Samcheonpi' thanks to the Donghak Ant Movement,

if inclusion in the MSCI Developed Markets Index is achieved solely based on 'global standards' excluding individual investors,

reaching 'Sacheonpi' (four-thousand KOSPI) will remain a distant dream.

I hope a healthy capital market foundation is built where individual investors become the mainstay of the Korean stock market, and I will end my writing here.

We support the wise investments of Joorini investors today as well.

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This article is from [Joorini Guide], published weekly by Asia Economy. We explain stock-related financial news and difficult economic stories in an easy and friendly way so that stock beginners can understand. By subscribing, you can receive articles for free.

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