CONSULTATION ON A MARKET RECLASSIFICATION PROPOSAL FOR THE MSCI PAKISTAN INDEX Potential Reclassification from Frontier to Emerging Markets April 2016 © 2016 MSCI Inc. All rights reserved. Please refer to the disclaimer at the end of this document. RECLASSIFICATION PROPOSAL • MSCI proposes to reclassify the MSCI Pakistan Index from Frontier Markets to Emerging Markets ─ The proposed reclassification would be reflected in all relevant global and regional composite indexes ─ The proposal is to implement the potential reclassification in one step coinciding with the May 2017 Semi‐Annual Index Review • MSCIwillconsultwithmarketparticipantsonthisreclassification proposal as part of the 2016 Annual Market Classification Review • MSCI will announce its decision in June 2016 • Please note that this proposal may or may not lead to any changes to the MSCI Indexes 2 HISTORICAL BACKGROUND • MSCI Pakistan Index was removed from MSCI Emerging Markets Index at the end of December 2008 following the deteriorated investability conditions prevailing in the Pakistani equity market. The index was classified as stand‐alone • As announced in February 2009 ─ Proposal to be included in the MSCI Frontier Markets Index • MSCI Pakistan was included in the MSCI Frontier Markets coinciding with the 2009 May Semi Annual Index Review • As announced in June 2009 ─ The Pakistani equity market will need to function without any trading disruptions for some time as a condition to being considered for reclassification in Emerging Markets. • As announced in June 2010, not added to Review List for reclassification to EM ─ Pakistani Market has returned to normal functioning since the removal of the “floor rule” in late 2008. However, the Pakistani Market was still characterized by a very limited number of sizeable securities and some holdover concerns on the institutional framework • As announced in June 2011 ─ MSCI Pakistan Index will not be added to the review list primarily due to the limited number of sizable securities 3 RATIONALE FOR PROPOSAL • The Pakistani equity market underwent a number of positive developments over the course of the past 12 to 18 months • The Pakistani equity market has grown significantly and its liquidity has greatly improved over the past years • As a result, the concerns about the potential for failing to meet size and liquidity criteria should there be a negative market event have receded 4 RECENT DEVELOPMENTS • Launch of Pakistan Unified Corporate Action Reporting System (PUCARS) at Karachi Stock Exchange (KSE) – March 2014 ─ PUCARS to provide an automated web‐based announcement interface for listed issuers for sharing price sensitive information with market participants • Restrictions on Negotiated Deal Market (NDM) transactions – April 2014 ─ NDMs between a broker’s proprietary account and a client sub‐account as well as transactions between sub‐accounts of different clients with the same broker will be blocked ─ These restrictions are aimed to prevent unauthorized movement of client securities via NDM transactions • FII’s to be taxed independently and are no longer exempted from withholding taxes (July 2014) • Approval SME Regulations for Karachi Stock Exchange – January 2015 ─ Draft regulatory framework for Private Equity is also in place • Development of an Online Complaint Management System – March 2015 5 MARKET ACCESSIBILITY Pakis tan • Foreign Exchange Market Liberalization Level: No Openness to foreign ow nership offshore currency market and minor constraints on onshore currency market (e.g., buying and selling Investor qualification requirement ++ done through a Special Convertible Rupee Account) Foreign ow nership limit (FOL) level ++ Foreign room level ++ • Investor Registration & Account Setup: Foreign Equal rights to foreign investors ++ investors are required to open a Special Convertible Ease of capital inflow s / outflow s Rupee Account (SCRA) and obtain a UIN (Unique Identification Number). The registration of UIN takes Capital flow restriction level ++ around 3‐4 days to complete Foreign exchange market liberalization level + Efficiency of the operational framew ork • Market Regulations: Regulations have frequently changed over the past few years. In particular, trading Market entry on the Pakistani equity market was practically Investor registration & account set up + suspended for five months following the Market organization implementation of a price floor rule in August 2008 Market regulations + • Clearing and Settlement: Nominee status and Competitive landscape omnibus structures are available. Overdraft facilities Information flow ++ remain prohibited Market infrastructure • Stock Lending & Short Selling: Foreign investors are Clearing and Settlement + not allowed to undertake short selling or stock Custody ++ lending and borrowing Registry / Depository ++ Trading ++ Transferability ++ • Stability of Institutional Framework: There have Stock lending -/? been instances of interventions that challenged the Short selling -/? stability of the “free‐market” economy as illustrated by frequently changing market regulations Stability of institutional framew ork -/? 6 SIMULATED CONSTITUENTS CHANGE Number of Constituents Large Cap Mid Cap Standard Small Cap IMI Frontier Markets 6 10 16 20 36 Emerging Markets 3 6 9 19 28 Data as of January 20, 2016 The simulation reflects the application of the Semi‐Annual Index Review methodology, using either the Frontier Markets or Emerging Markets requirements Free Float Adjusted Market Capitalization (USD billion) Large Cap Mid Cap Standard Small Cap IMI Frontier Markets 3.4 3.6 7.0 2.2 9.2 Emerging Markets 2.6 3.2 5.9 2.7 8.6 Data as of January 20, 2016 The simulation reflects the application of the Semi‐Annual Index Review methodology, using either the Frontier Markets or Emerging Markets requirements • The MSCI Pakistan Index would have 9 constituents under Emerging Markets, compared to 16 under Frontier Markets ─ The free float‐adjusted market capitalization would be 16% lower under Emerging Markets 7 SIMULATED INDEX CONSTITUENT LIST Company Full Mcap* FIF Mcap* FIF** Size Segment Oil & Gas Development 4.0 0.6 0.15 Large Cap Habib Bank 2.5 1.0 0.4 Large Cap MCB Bank 2.1 1.0 0.5 Large Cap United Bank 1.7 0.5 0.3 Mid Cap Lucky Cement 1.5 0.7 0.5 Mid Cap Fauji Fertilizer 1.3 0.6 0.45 Mid Cap Engro Corporation 1.3 0.6 0.45 Mid Cap Hub‐Power Co 1.1 0.4 0.35 Mid Cap Pakistan State Oil Co 0.8 0.4 0.5 Mid Cap Data as of January 20, 2016 The simulation reflects the application of the Semi‐Annual Index Review methodology, using either the Frontier Markets or Emerging Markets requirements * USD billion ** Foreign Inclusion Factor 8 SIMULATED EMERGING MARKETS WEIGHTS Pro forma Standard Index FIF Mkt Weight # Sec. Cap EM 3,016,197 100.00% 846 • The simulated MSCI Pakistan EM Asia 2,203,204 73.05% 562 Index would have a potential China 766,340 25.41% 155 Korea 486,659 16.13% 107 weight of 0.19% in Emerging Taiwan 372,102 12.34% 88 India 272,498 9.03% 74 Markets Malaysia 105,464 3.50% 44 Indonesia 84,534 2.80% 31 Thailand 66,270 2.20% 32 Philippines 43,473 1.44% 22 Pakistan 5,864 0.19% 9 EM EMEA 461,336 15.30% 166 South Africa 194,632 6.45% 55 Russia 96,382 3.20% 20 Poland 43,195 1.43% 25 Turkey 38,370 1.27% 23 Qatar 29,201 0.97% 13 United Arab Emirates 26,604 0.88% 11 Greece 12,841 0.43% 10 Hungary 8,911 0.30% 3 Egypt 5,905 0.20% 3 Czech Republic 5,293 0.18% 3 EM Latin America 351,658 11.66% 118 Brazil 157,903 5.24% 60 Mexico 133,970 4.44% 27 Chile 37,050 1.23% 19 Colombia 12,544 0.42% 9 Peru 10,192 0.34% 3 Data as of January 20, 2016 The simulation reflects the application of the Semi‐Annual Index Review methodology, using either the Frontier Markets or Emerging Markets requirements 9 KEY QUESTIONS • Is it too early to consider the MSCI Pakistan for reclassification to Emerging Markets given the market’s specific accessibility history? • Are the potential decreases in number of constituents and index market capitalization problematic? ─ If yes, should it be a show stopper? • Is the potential small weight of the MSCI Pakistan Index in Emerging Markets problematic? ─ If yes, what should be the minimum weight in global indexes that would warrant a reclassification? • Are there any other market accessibility concerns that should prevent the reclassification? 10 APPENDIX SIMULATED CONSTITUENT LIST Company Name Full Mcap FIF Mcap FIF FM EM Oil & Gas Development 4,038 606 0.15 Large Large Habib Bank 2,480 992 0.40 Large Large MCB BANK 2,056 1,028 0.50 Large Large Pakistan Petroleum 1,974 197 0.10 Large K‐Electric 1,848 92 0.05 Large United Bank 1,718 515 0.30 Large Mid Lucky Cement 1,494 747 0.50 Mid Mid • Only 1 company has a free Fauji Fertilizer Co 1,332 599 0.45 Mid Mid Engro Corporation 1,315 592 0.45 Mid Mid float adjusted market Hub‐Power Co 1,096 384 0.35 Mid Mid National Bank Pakistan 1,074 269 0.25 Mid Small capitalization of more than Pakistan State Oil Co 802 401 0.50 Mid Mid Indus Motor Company 779 156 0.20 Mid Small USD 1 billion Fatima Fertilizer 761 152 0.20 Mid Small Pakistan Telecom 729 65 0.12 Mid • Large Cap companies are in Kot Addu Power Company 654 196 0.30 Mid Small Fauji Cement Co 487 211 0.45 Small Small general exhibiting low free Dawood Hercules Corp 486 97 0.20 Small Small Packages 481 144 0.30 Small Small float Pakistan Oilfields 429 129 0.30 Small Small Fauji Fertilizer Bin Qas 428 107 0.25 Small Small • 4 Mid Cap companies Searle Pakistan 420 189 0.45 Small Small Maple Leaf Cement 414 145 0.35 Small Small would be migrating to the Bank Alfalah 410 164 0.40