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MSCI, the firm responsible for developing and maintaining some of the most widely-followed indexes in the world, announced on Wednesday that Qatar and the United Arab Emirates would remain classified under frontier status until at least the middle of 2012, ending speculation over whether the two Middle East economies would be upgraded to emerging status. The decision ended weeks of speculation that had spurred increased activity as market participants sought to anticipate the ramifications of an upgrade.

MSCI cited the “stringent foreign ownership limits, including on large companies” imposed by Qatar as a remaining hurdle that must be cleared before an upgrade is possible. “Any change to the status of the MSCI Qatar Index is conditional upon a meaningful increase of foreign ownership limit levels applied to Qatari companies resulting in increased foreign room,” said MSCI in a press release.

The UAE was held back due to “significant concerns over the effectiveness of this new [DVP] framework to fully ensure the safeguarding of their assets under certain circumstances.” Regulators in the UAE have already taken the initial steps towards addressing these issues, so an upgrade at the next review is a distinct possibility.

EEM, VWO Hold Steady. PMNA To Slide?

The possibility of an upgrade was largely viewed as an extremely positive development for the stocks of those markets, since the bump up to “emerging” status would have brought with it inclusion in the MSCI Emerging Markets Index. That benchmark is the basis for EEM and VWO, which have about $75 billion in assets between them. So even a minor weight would have prompted the purchase of hundreds of millions of stock from those two ETFs alone–not to mention the other investment product linked to or benchmarked against that index.

The announcement may have come as a bit of a surprise; Middle Eastern stocks had been generally higher in recent sessions, and it was generally believed that the two markets each had a realistic chance of being upgraded. That could mean that the upward pressure that had formed in these stocks will evaporate when markets open on Thursday, potentially resulting in a mild decline. While there are no pure play Qatar or UAE ETFs, there are a couple of exchange-traded products with meaningful exposure to these markets.

  • PowerShares MENA Frontier Markets ETF (NASDAQ:PMNA): The two markets make up about 38% of this ETF.
  • Market Vectors Gulf States Index ETF (NYSEARCA:MES): Qatar and the UAE account for just over half of MES.
  • WisdomTree Middle East Dividend ETF (NASDAQ:GULF): Qatar (32%) is the largest country allocation in GULF; the UAE (18%) comes in third after Kuwait.

Taiwan and South Korea: Other Side Of The Coin?

The importance of classification decisions has increased along with the popularity of indexing as an investment strategy; with billions of dollars dedicated towards replicating benchmarks determined by firms such as MSCI, classification decisions can prompt massive sales or purchases of stock in short periods of time.

Just as the upgrade to the MSCI Emerging Markets Index would have given a boost to the UAE and Qatar, leaving that benchmark can result in big sell-offs from emerging markets-focused ETFs and mutual funds. Israeli stocks experienced that plunge last year when that market progressed to “developed” status, and there are a couple other economies that could be set to follow in Israel’s footsteps. Specifically, Taiwan and South Korea have met most of the requirements of developed market countries, yet issues such as full convertibility of currency have kept them in the “emerging” bucket (at least as far as MSCI is concerned; Dow Jones and the IMF view both Asian economies as developed).

It is very possible that one or both of those markets will be upgraded next year, which could prompt a major reshuffling of some emerging markets ETFs since the two represent about 25% of the MSCI Emerging Markets Index.

Disclosure: No positions at time of writing.

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Source: UAE, Qatar Not Upgraded To Emerging Market Status