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As a result of the 2008 review, the following changes will be implemented within the GEIS in September 2009: South Korea will be promoted from advanced emerging to developed status while red-chip stocks will be moved from Hong Kong (which is a developed market) to China (which is a secondary emerging market). FTSE û working with an expert committee of independent market practitioners û reviews country classifications on an annual basis.
Being elevated to developed market status is expected to translate to a significant increase in fund inflows for South Korea, and this will likely occur in stages. Some of the new funds will come sooner from investors who position themselves ahead of any index classification change, while the rest will come later from passive investors who strictly track benchmarks. FTSE estimates that some $3 trillion in funds are benchmarked against its indices worldwide, mostly in developed markets.
Having developed market status leads to a more stable level of international investments. Investors that allocate based on indices tend to earmark around 30% of their portfolios to developed markets. Large pension funds worldwide tend to prefer investing in developed markets.
Emerging markets, meanwhile, tend to be the territory of active fund managers, who increase or decrease their investments in a market or a company depending on their current view and outlook. Thus, fund flows tend to be more volatile compared with developed markets.
Taiwan has made progress in implementing market reforms over the past 12 months, according to FTSE CEO Mark Makepeace. However, the market wonÆt be upgraded to developed status in 2009 and will stay on the watch list because some ôquality of marketö requirements have not been met.
Elsewhere in Asia and emerging markets, China A-shares will remain on the watch list for possible inclusion for secondary emerging status. Following the introduction of the FTSE Frontier Markets Indices earlier in 2008, Kazakhstan, Malta and Ukraine have been added to the watch list for possible inclusion. Pakistan has been removed from the watch list and is no longer under consideration for possible demotion from secondary emerging to frontier status.
In view of the size and significance of Saudi Arabia, a large Middle East market that does not currently meet the criteria for inclusion in the GEIS of the watch list, FTSE will introduce a stand-alone index for this market for those international investors wishing to add Saudi Arabia to their global portfolios.
Korea and Taiwan, both classified as emerging markets by FTSE, were placed on the watch list for possible upgrade to developed market status in 2005. Both are already considered developed countries by the World Bank, but are still classified as emerging markets by FTSE and rival index provider MSCI Barra. FTSEÆs classification is based on a countryÆs economic status and on requirements related to how easily investors can have access to and divest from its market.
The last hurdles Korea overcame to be granted developed status by FTSE involved three requirements: a free and well-developed foreign exchange market, free delivery settlement, and off-exchange transactions.
A number of regulatory obstacles have been removed in Korea since last year, meeting requirements of developed market investors, particularly in the so-called Q of M areas of settlement û free delivery and short sales:
1. Foreigners are now allowed to trade blocks at foreign ownership limits with other foreigners through K-bloc, the KRK block trading network. This allows securities companies to avoid market risk involved with market crosses and regulatory issues.
2. Scheduled amendments were done for stock lending that passed FTSE requirements.
3. For off-exchange trading, additional permissions have been granted for the free delivery of securities within individual foreign investment groups through off-exchange trading. However, investors want taxes on these transactions to be abolished and want brokers to take responsibility for regulatory reporting of these transactions. FTSE says it will continue to maintain a restricted designation for this category.
4. For foreign exchange, FTSE has acknowledged many improvements since last year including the revision of reporting procedures for won-denominated lending and borrowing transactions, and streamlining the procedures for the conversion and remittance of foreign currency into won by non-resident investors. However, FTSE maintains a restricted designation, pending improvement in market practice to extend FX trading hours and ultimately the development of an offshore FX market.
In Taiwan, some ôquality of marketö criteria remain outstanding. In some cases, new regulations have been amended and submitted but are pending approval and implementation. FTSEÆs process requires not only additional improvements but adoption by the markets in the areas of foreign exchange, stock lending, short sales, off-exchange transactions, and T+2 settlements. Specifically:
1. Rules have been revised for several categories in January 2008 allowing for the free delivery in circumstances where there is a change in beneficial owner without going through the market.
2. Changes have been implemented allowing for 24 hour/offshore currency trading. However market practice is lagging, according to FTSE, and feedback from market participants indicates spreads are much wider than trades on the domestic market.
3. On off-exchange transactions, the Taiwan Stock Exchange implemented changes to block trade regulations widening price fluctuation limits from 3.5% to 7% and reducing the minimum size for paired block trades to NT$15 million. FTSE would like the off-exchange block trading period to be extended to off-trading hours and crossing to be permitted.
4. Regarding the shift from T+1 to T+2 settlements, proposed amendments to the regulations and rules have been submitted to the Securities and Futures Bureau for approval.
5. The uptick rule for short sales has been extended to TSEC (Taiwan Stock Exchange Corporation) Midcap 100 companies and technology index companies. FTSE acknowledges that 84% of market capitalisation is now exempt from these restrictions but notes that international investors expect this to be extended to all Securities Borrowing and Lending (SBL) eligible securities.
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