Indonesia’s MSCI debacle

IT was at the height of the Asian Financial Crisis in 1998, when MSCI removed Malaysia from its global indices following the imposition of capital controls.

The removal triggered automatic selling by index-tracking funds. That had caused a lot of foreign outflow of capital.

Malaysia’s depressed capital markets took a long time to recover. After an easing of capital controls, MSCI reinstated Malaysia around the year 2000.

But even after that, Malaysia was viewed with some scepticism by global funds due to the ghost past of capital controls.

Fast forward to today, Malaysia is firmly entrenched as a credible emerging market, included in major global indices.

As a result, we attract a significant amount of passive investments into our markets.

Indonesia on the other hand, is going through an indice crisis.

A week ago, MSCI paused certain aspects of its regular index rebalancing for Indonesian securities, which includes a freeze on positive changes to Indonesian stocks in its indices.

All this happened due to concerns over market transparency and investability.

Key concerns cited include opaque ownership, with confusion over companies’ free float of shares.

Indonesia has one of the lowest thresholds in the region, with a minimum free float of 7.5%.

Incidentally, Malaysia has the highest mininum free float requirement among Asean stock exchanges, at 25%.

MSCI has said that if data transparency improvements remain insufficient by May, MSCI may cut Indonesia’s weighting in their global indices and reclassify Indonesia from emerging market to frontier market.

The good news for Indonesia is that it seems to be acting fast to address the issues.

Key personnel at their stock exchange and regulator have resigned and new appointments are on the way.

Indonesian authorities are promising a fast track crackdown on all the shenanigans that purportedly happened.

Tougher disclosure rules are in the works and so too is a minimum 15% free float.

Indonesia sovereign wealth fund Danantara will also be mobilised to support liquidity.

Could part of what transpired in Indonesia entail how certain stocks were “played up” in order to get into the MSCI index and then sort of dumped to the passive funds that automatically bought those stocks when they got it?

This of course is not a proven theory.

But it does seem that some stocks in Indonesia got a huge following among investors there following their initial public offering and pronouncements of their planned ascent into the MSCI index.

The basic way of getting into the index is by a measure of market capitalisation.

Some say that there was almost a “meme stock” type episode that happened.

Soon after a large company lists, it goes viral that this stock is targeting to get into the index.

So investors can see the potential upside of the stock, in terms of how much more in market capital is this stock going to grow into.

Allegations are that there was also some level of manipulation of the share price of these stocks in order to reach that size.

Once in the MSCI index, all those holders would be in a position to sell their shares to the passive funds coming into the stock.

In Malaysia, due to our more mature market and stricter regulation and enforcement, large cap stocks do not get manipulated in that way.

But sometimes, smaller companies are the subject of alleged manipulation of their share prices.

And the regulators are generally quick to investigate such transgressions here.

All of this is testament to Malaysia’s growth as a capital market.

For sure, in the early days of physical scrip trading, it was a rah-rah and almost cowboy like market, with manipulation of stock prices the norm rather than the exception.

Today, we remain a robust market for both equities and bonds and long may that be.

That said, Indonesia does have its attractions.

This is due to its vast market, a large part of which remains untapped for a variety of products and services.

Malaysia on the other hand, is a market where valuations are arguably stretched, especially considering the fact that our government linked investment funds are investing most of their money into our local markets.

This is why some reckon that in the sell down of Indonesia following the MSCI debacle, there are good picks to be had.

Some of their larger banks for example are relatively well run with adequate governance structures in place.

For the more risk averse, there are always Indonesian proxies trading on more mature markets such as Singapore and Malaysia.

These entail real estate investment trusts listed on the SGX, and Malaysia’s own banks, telecommunication companies (telcos) and plantation companies with significant Indonesia exposure.

Incidentally, aside from the planters which have been under some duress due to changing land related regulations in Indonesia, the Malaysian banks and telco’s with a presence in Indonesia have not been impacted much by the recent MSCI debacle.

Their units in Indonesia which are listed, are usually under a listing rule that specifically does not require much of a shareholding spread, something referred to as a technical listing.

Meanwhile, those following the Indonesian stock market closely reckon that for now, post the resignations and statements from the exchange and regulator there, it is now a wait and see period.

The market there seems to have found some footing.

That said, they say that other than self-disclosure, it is not going to be easy for the regulators there to enforce proper transparency of shareholdings given the significant amount of trusts and proxies that have been used in their market for a long time now.

Perhaps Indonesia today has come to a time of reckoning.

It needs to get its act together or risk its capital markets being hindered significantly.

Maybank Sekuritas Indonesia analyst Jeffrosenberg Chenlim best summed it up: “The speed at which market optimism returns will depend on the government’s ability to appoint credible leadership and to outline a clear, comprehensive reform road map for a healthier capital market”.