How FTAs can improve Vietnam’s MSCI rating

It is estimated Vietnam could receive up to $10 billion worth of foreign capital in frontier market-focused funds, but could receive much more from emerging market-focused funds. The Vietnamese government considers MSCI’s watch list as a top priority target as it could lure a huge amount of foreign capital to the Vietnamese economy.

By Dr. Oliver Massmann - General director Duane Morris Vietnam LLC

Vietnam has been improving the legal framework, introducing new securities products, and making the market more professional.

One of those efforts is the amendment of a securities law that would make the market fairer between domestic and foreign investors. A 2015 revision eased restrictions on foreign ownership limits (FOL). However, the MSCI wants to see even further progress on relaxing those restrictions.

According to the draft version of the law, as a general rule, overseas investors are allowed to own 100 per cent of the shares of a Vietnamese company that operates in a non-critical business sector. This applies to listed firms, equitised state-owned enterprises (SOEs), and private non-listed businesses. Shareholders of each company will decide for themselves the amount of foreign-owned shares eligible.

This is different from the current Law on Securities, which automatically sets the FOL at listed companies in Vietnam at 49 per cent. Some sectors, such as banking or aviation, have a stricter limit at only 30 per cent. Experts believed that with the relaxed rules, Vietnam would likely attract at least $5 billion of new capital from abroad and receive the upgrade that it has been waiting for.

With fewer restrictions on foreign ownership, Vietnamese firms would become more attractive to major investment funds that are willing to pour millions of US dollars into Vietnamese businesses. With more foreign ownership, companies will have a broader global perspective and a level of accountability to help drive transparency and change.

Mai Le, analyst at PYN Asia Research, noted that out of all the changes in the Law on Securities, the capital market is most anxiously waiting for the FOL rule to take effect.

Kuwait was upgraded to the MSCI emerging market watch list, and not Vietnam, specifically because of “enhancements that removed foreign ownership restrictions on listed banks and simplification of requirements for investor registration.” Not coincidentally, those are the areas that Vietnam has not satisfied under MSCI’s criteria.

Under the criteria of openness to foreign ownership, Vietnam ranks as improvement needed on the FOL level, foreign room level, and equal rights to foreign investors. Many experts felt that Vietnam has met more standards of an emerging market than similar markets such as Pakistan and the Philippines (and even Kuwait), but also had the best qualitative indicators among frontier markets.

While that may be true, it is apparent that the MSCI is more concerned with long-term sustainability, which is why openness to foreign ownership is the MSCI’s top criteria for assessing upgrades.

Potential effects of FTAs

If Vietnam rectifies the discrepancies in their laws regarding investments and securities with the trade agreements of the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), the EU-Vietnam Free Trade Agreement (EVFTA), and the EU-Vietnam Investment Protection Agreement (EVIPA), they will have a greater chance at making the MSCI watch list upgrade for 2020.

Vietnam will most likely not make the list if they continue to table or endlessly debate these critical and progressive revisions. Streamlining the draft laws on investment and securities with the CPTPP, EVFTA, and EVIPA, and implementing them expeditiously will give MSCI hard data to use in their June 2020 evaluation instead of mere speculation.

Moving in that direction, one of the most significant changes in the draft law on securities is the expansion of the foreign holding cap in public companies. Accordingly, public companies would be subject to no restrictions on foreign holdings, unless otherwise prescribed by “treaties to which Vietnam has acceded or a specialised law.”

There is a minor legal distinction between “treaties” and “agreements”; however, in the spirit of the law and especially for cementing these new trading relationships, Vietnam should draw no distinction and apply them as such. Under the CPTPP and EVFTA/EVIPA, Vietnam has expressly restricted FOL in specific, listed industries that are of national significance or security. Therefore, the government should aggressively restructure their current drafts to mirror CPTPP, EVFTA, and EVIPA-specific language.

The CPTPP does have FOL set to what the current Vietnamese law is (currently 30 per cent). However, it only states that it is relative to whatever the “current” law is – so, change the law. This would mean removing the 30 per cent FOL cap in the banking industry that is currently in place, even in the draft law to revise the law on securities.

According to Long Ngo, associate director of the Research Department at Viet Capital Securities, investment trends in the banking industry will depend on when the government lifts the FOL.

As long as the government keeps the FOL at the 30 per cent level, Vietnam’s capital markets will not expand and the MSCI will not consider Vietnam for the watch list upgrade. By maintaining their current operational paradigm, Vietnam is only hampering its own development and future.

If Vietnam would internalise operating from a global perspective, there should be no distinctions between a foreign investor and a domestic one (other than protected industries of national security). FTAs create national treatment for any foreign investor, which grants (in effect) domestic status.

Article 9.1 of the CPTPP stipulates all “covered” investments (EVIPA is essentially the same list), including an enterprise; shares, stock, and other forms of equity participation; bonds, debentures, other debt instruments and loans; intellectual property rights; and licences, authorisations, permits, and similar rights conferred.

If Vietnam would stipulate in their draft laws this position already agreed to in the CPTPP, EVFTA, and EVIPA, it would virtually eliminate all three of the MSCIs concerns that it has with Vietnam currently. With the guarantee of no distinction between a foreign investor and a domestic one, entities that have been reluctant to invest millions of dollars in Vietnamese businesses will now feel much more comfortable about the investment environment; thus creating a large influx into Vietnamese capital markets.

The MSCI will notice these changes and most likely add Vietnam to the 2020 watch list for emerging markets, creating another large inlay to Vietnam’s markets.

Strong solutions

In summary, if Vietnam takes a hard look at the criteria that kept them from the upgrade, it is apparent that the solutions for most of the roadblocks cited have already been addressed in the CPTPP, EVFTA, and EVIPA. The government merely needs to incorporate the trade agreement language into their existing laws.

The tabling until May of the passage of the draft law to amend the Law on Investment through Resolution 8 from July 2019 was not a strategically beneficial move for Vietnam in order to make the 2020 MSCI watchlist.

Several key provisions in that draft (if operational) would give the MSCI concrete data to observe, rather than be speculative, and improve Vietnam’s chances of an upgrade.

Additionally, changes to the draft law on the Law on Securities to be in line with the provisions of the CPTPP and EVIPA would also be in Vietnam’s favour. The minds of investors, as well as the MSCI, would be eased if Vietnam aggressively pursues regulatory reform and potentially add another $15 billion to their capital markets.

The best indicator that reform is required to the current draft laws on amending the Law on Securities and Law on Investment came from the government itself. “Some items are unclear while others are unreasonable and no longer fit the Vietnamese market’s conditions,” the government said in a report submitted to the National Assembly’s Economic Committee.

Those issues may “befuddle investors, market members, and regulators,” adding that “policymakers must adjust the law so it matches international standards and agreements to which Vietnam is committed.”