MSCI in the spotlight over controversial companies in mainstream index products

Index and ESG data firm MSCI has become embroiled in a war of words with US Senator Marco Rubio about the inclusion of controversial Chinese firms in one of its mainstream emerging markets indices in a row that highlights how ESG issues are not incorporated into ‘standard’ index offerings.

The New York-listed company has justified including Chinese companies with serious breaches of human rights in its emerging markets market capitalisation weighted index, saying that it remains lawful to do so.

In a letter authored by MSCI’s Chairman and CEO Henry Fernandez, the US firm said that “currently there is no US law or regulation that prohibits an index containing China A securities or US investors from trading in the China A market”.

The statement was made in response to a request by US Senator and former presidential candidate Marco Rubio that the index provider disclose its due diligence processes to ensure constituent companies were not complicit in “the Chinese government’s systemic and egregious human rights abuses”.

This was in reference to two constituent companies within MSCI’s flagship Emerging Markets index, Hangzhou Hikvision and Zhejiang Dahua Technology, which have been identified as suppliers of surveillance technology to state-run “re-education camps” – described by Pentagon officials as concentration camps – in which one million members of the ethnic Uighur population are being reportedly detained.

Last week, the US government added both companies to a blacklist for supporting “the implementation of China’s campaign of repression, mass arbitrary detention and high-technology surveillance”. US firms are restricted from trading with companies on the government’s Entry List although it is unclear whether this latest decision has implications for investors. RI previously reported on investor links to the camps here.

In his response, MSCI’s Fernandez said that inclusion into MSCI’s market capitalisation weighted indices is “solely on the basis of objective rules” including company size, liquidity and free float requirements. The latter refers to the minimum of shares which need to be publicly owned for a stock to be eligible.

“Asset managers are free to select any index of their choice and may elect to mirror the index or deviate from the index to attempt to outperform it or for ethical or governance or other considerations.”

Removing Chinese companies from indices, he said, would “severely limit the ability to understand and assess global markets”.Commenting on Fernandez’s letter, Rubio said: “Not only did MSCI fail to adequately address the concerns in my letter, but they also acknowledged that they do not conduct due diligence on Chinese companies … It is deeply troubling that a company like Hikvision, which is complicit in China’s human rights abuses in Xinjiang and is on the Commerce Department’s banned Entity List, can get access to the US capital markets through an MSCI index.

“I will continue to work with my colleagues in a bipartisan fashion to ensure that U.S. investors and pensioners are not at risk.”

The MSCI Emerging Market Index is a popular benchmark, providing investors with passive emerging market exposure. Based on data from justETF, a platform for exchange traded funds (ETFs), $10.3bn worth of ETF assets currently track the index. At current MSCI weights, $234m is invested of that total in the two companies.

The exchange between MSCI and Rubio takes place as the index provider prepares to increase the weighting of China companies in its Emerging Markets Index four-fold. MSCI said that the decision, announced early this year, was taken after “overwhelmingly positive feedback we received from institutional investors in the US and globally”.

While major index providers are ramping up the number of ESG-focused offerings in their product lines, there has been little attempt to re-orient mainstream products in this way.

Last month, FTSE Russell reversed a decision to label the oil and gas sector as “non-renewable energy” following pressure from its sister company, the London Stock Exchange, which is in competition for the listing of Saudi Arabia’s state-run oil company.

However, a nascent push by investors to strip controversial weapons manufacturers from all indices suggests that index providers may be forced to take a view on ESG considerations for their mainstream products sooner rather than later.

A coalition of 173 investors representing $9.1trn worth of assets, coordinated by Pictet Asset Management and Swiss Sustainable Finance, is lobbying index providers to remove makers of controversial weaponry from all mainstream indices. Investments in these companies contravene international regulations such as the Treaty on the Non-Proliferation of Nuclear Weapons and the Convention on Cluster Munitions, the group says. Investors who are interested to sign up can do so here.