The index compiler will decide by the end of January whether to tighten its definition of free float — the number of shares available for trading and a key determinant of a stock’s weighting – following industry feedback. Any approved changes would be effective in the index provider’s May review.
If MSCI finds that companies in Indonesia — which already have Asia’s smallest average free float — have even less stock available for trading than reported, passive investors would be forced to sell existing positions.
The decision would be among the most consequential for the nation’s US$971 billion equity market in years, with implications for fund flows and investor perception.
“This exercise serves as a key test of the country’s capital market reform agenda, underscoring the corporate governance improvements required to unlock greater international participation and long-term investment flows,” said Gary Tan, a portfolio manager at Allspring Global Investments.
Any withdrawals from Indonesian stocks will also pressure the rupiah, which fell to a record low on Tuesday amid heavy foreign outflows from the bond market. Investors remain concerned about the government’s commitment to keep the budget deficit within legal limits and preserving central bank independence.
In the big business of index compilations, free float is a relatively obscure but crucial metric. Benchmark providers like MSCI and FTSE Russell rely on it to measure how easily investors can buy a stock – the more shares available for trading, the higher the potential weighting in an index.
When free float is low, stocks can become what Aletheia Capital Analyst Nirgunan Tiruchelvam calls “museum pieces: you can look but not buy enough.”
Low free float has already become a flash point in Indonesia, where many of the benchmark Jakarta Composite Index’s biggest members are thinly traded stocks controlled by a handful of wealthy individuals. Investors argue these volatile stocks distort the index, which masks true market performance and heightens the risk of manipulation.
More than 200 stocks on the benchmark have a free float below 15%. Across major Asia-Pacific indexes, Indonesia’s benchmark has the lowest average free float, according to Bloomberg data.
PT Samuel Sekuritas Indonesia is among several brokerages forecasting about US$2 billion in foreign passive fund outflows if the rule is adopted.
In theory, free float math is simple: it’s the total number of shares minus those held by strategic investors like governments or founders. In practice, however, Indonesia’s opaque and web-like business relationships mean it’s difficult to identify strategic holders, a concern MSCI raised in its September consultation paper.
The Indonesia Stock Exchange currently requires companies to disclose shareholders owning more than 5% of a company.
MSCI said an additional data source, the Indonesia Central Securities Depository, can identify shareholder types for electronically traded stocks, including those holding under 5%, giving a clearer picture of true free float.