FTSE Sizes Up the World: Israel Now 'Developed'; Taiwan, S. Korea Nearly There

FTSE announced the results of its annual review of its country classifications on Thursday. All the major index providers have different systems for classifying countries by development stages, and FTSE uses a three-tiered system, with countries falling under Developed, Advanced Emerging and Secondary Emerging designations. FTSE also updated its Watch List, which tracks countries that have a reasonable likelihood of a status change.

A committee of market participants advises FTSE as it reviews the classifications in its FTSE Global Equity Index Series [GEIS]. The major criteria used to evaluate countries in the FTSE indexes include economic size, wealth, market quality, and market depth and breadth. All together, roughly 25 factors are considered. Ultimately, the resulting assessment reflects the country's level of investability for foreign investors.

"They share this information with the relevant regulators and stock exchanges and establish a pattern of dialogue," said Steven Schoenfeld, a member of the FTSE Index Advisory Committee and chief investment officer of Northern Trust's global quantitative management ­group, at an informational meeting about the changes that was hosted by FTSE.

"This process is very helpful to move countries into a framework where it is easy to move money in and out of the market," he added.

Schoenfeld also said that, as a member of the FTSE committee that advises it on country classifications, he had been pushing for coverage of frontier markets. He said that FTSE was moving toward developing a frontier market index, possibly by next year. This would add another tier to the index provider's country classification system.

Israel Rising

In this review, perhaps the biggest news was the elevation of Israel to developed market status as of June 2008. Israel was added to the Watch List in 2006 and has continued to meet FTSE's requirements for Developed market status since its inclusion. While the news is good for Israel, with roughly 600 listings and a total market cap of about $160 billion, it will represent just a small percentage of FTSE's All-World Developed Index. Zvi Chalamish, chief fiscal officer of Israel's Ministry of Finance, also attended the FTSE session on Thursday; he noted that Israel has a strong information technology industry and more engineers as a percentage of employees than Japan and the United States combined. It is also the No. 1 country for listings on the Nasdaq after the U.S., Chalamish said.

Dow Jones Indexes and Russell Indexes classify Israel as Developed, while S&P and MSCI have given it emerging status.

Hungary and Poland

Hungary and Poland have both been upgraded to Advanced Emerging markets. FTSE says that although they meet its quality-of-markets criteria for Developed status, they cannot be promoted further until they each achieve a World Bank GNI Per Capita Rating of "High." Both currently have ratings of "Upper Middle." Poland is significantly larger than Hungary in terms of market size, with a total market capitalization of roughly $150 billion as of the end of 2006 and more than 260 listed companies. Hungary is the smallest of the emerging markets in FTSE's Europe/Middle East/Africa region at just about $42 billion, with only about 40 listings. However, The Economist recently ranked Hungary as the most stable economy out of 24 emerging markets in Europe and Asia. The other major index providers also have given Hungary and Poland emerging designations.

Pakistan Removed

Meanwhile, Pakistan is being removed from the FTSE GEIS entirely, because it no longer meets the minimum requirements with regard to the quality of its markets. However, a separate index for the country will be calculated within FTSE's Watch List index series. The other major index providers include Pakistan in their index families as an emerging market, but S&P, which includes it as part of its S&P/IFCG emerging market indexes, excludes it from the investable subset of its indexes.

Greece In Danger

Greece will remain on FTSE's Watch List and is dangerously close to being downgraded from Developed to Advanced Emerging status. Although the other major index providers include it as a developed market, current market conditions and rules make it difficult for foreign investors to invest in Greece's stock market, according to FTSE. FTSE cited as deciding factors Greece's lack of restrictions on short sales, its lack of a liquid stock lending market, its lack of omnibus account facilities for foreign investors, its failure to freely allow off-exchange transactions, and its failure to allow delivery free of payment for transferring securities between accounts. So far, no European Union member country classified as Developed has been downgraded to Emerging status: Greece would be the first.

FTSE assisted in the design of an entire family of indexes for Greece's Athens Stock Exchange that bears the FTSE brand name. It continues to assist in their maintenance and is working with the exchange as it moves toward bringing ETFs based on those indexes to market. Currently, representatives from the exchange and the Greek Capital Markets Commission are consulting with FTSE with regard to resolving the issues that have put Greece on the index provider's Watch List in hopes of avoiding a status reclassification at the next annual review.

Taiwan, South Korea On The Bubble

Taiwan and South Korea are both on FTSE's Watch List for possible promotion to Developed status from the Advanced Emerging category. Although Russell, MSCI and S&P classify both countries as emerging, Dow Jones Indexes has labeled them as developed. That South Korea wasn't promoted by FTSE was a surprise to many, but FTSE indicated that the market had a few more steps to go before it would qualify. Although the exchange has made changes that have helped foreign investors, it still does not allow the free delivery of securities between accounts and needs to resolve difficulties regarding off-exchange transactions, FTSE says. However, it does have a plan in place to address those issues. Should the plan succeed, it would then only have to remove certain restrictions on the foreign exchange market to achieve Developed status.

For Taiwan to be fully investable for international investors, it must establish a free and well-developed foreign exchange market, a liquid stock lending market and payment-free delivery of stocks between accounts. It also must ease restrictions on off-exchange transactions.

A Word On China

Oddly enough, China's A-Shares market is included on the Watch List when it is largely uninvestable for foreigners. Presumably, this is because of the rapid growth of China's stock market, its sheer size and the country's recent moves to loosen restrictions on domestic and foreign investment. FTSE lists just two changes necessary for inclusion in its FTSE GEIS: 1) substantial expansion of the Qualified Foreign Institutional Investor [QFII] program, and 2) removal of restrictions on foreign investment. However, China's A-Shares market is largely cut off from foreign investors except for its QFII program, which is fairly narrow in scope. Those two changes would represent paradigm shifts in China's approach to foreign investment, and it is highly unlikely that they will occur any time soon. Although there are signs that China is loosening its controls on investment by its own citizens and by foreigners, the pace of progress is fairly glacial.