Difference Between Emerging and Frontier Markets Explained
Understand the key differences between emerging and frontier markets, including classification factors, governance, liquidity, and economic depth.
Investors looking beyond developed economies often encounter the terms “emerging markets” and “frontier markets.” While both represent opportunities in fast-growing regions, they differ significantly in risk, accessibility, and economic development. Understanding these distinctions helps investors navigate regulatory stability, trading efficiency, and economic resilience.
Key Classification Factors
Market classification depends on economic scale, financial system maturity, and accessibility for foreign investors. Institutions such as MSCI, FTSE Russell, and S&P Dow Jones Indices use criteria like market size, liquidity, and ease of capital movement to differentiate markets. MSCI, for example, requires an emerging market to have at least three companies with a full market capitalization of $1.59 billion and a free-float market cap of $799 million. Frontier markets have lower thresholds, reflecting their smaller, less liquid economies.
Foreign ownership restrictions also play a role. Emerging markets typically allow higher levels of foreign investment with fewer restrictions on capital repatriation. Frontier markets often impose stricter limits. Vietnam, classified as a frontier market by MSCI, caps foreign ownership in banking at 30%, whereas Brazil, an emerging market, has fewer such constraints.
Currency convertibility is another distinction. Emerging markets generally have more liquid, freely tradable currencies, reducing transaction costs and hedging risks. Frontier markets often have illiquid or partially convertible currencies, increasing foreign exchange risks. Nigeria’s naira, for example, has faced multiple devaluations and capital controls, making it difficult for investors to repatriate funds. The Indian rupee, despite some restrictions, is more accessible.
Governance Framework Distinctions
Regulatory oversight and institutional strength vary significantly. Emerging markets generally have more established legal frameworks supporting contract enforcement, intellectual property rights, and shareholder protections. Countries like South Korea and Mexico follow International Financial Reporting Standards (IFRS) and Basel III banking regulations, ensuring consistent financial disclosures and risk management. Frontier markets often have weaker legal enforcement, making contract disputes and asset recovery more challenging. In some cases, businesses face opaque judicial processes or political interference, increasing uncertainty.
Corporate governance structures also differ. Emerging markets tend to have stronger investor protections, with stock exchanges enforcing disclosure requirements and anti-fraud measures. Brazil’s Novo Mercado, for example, requires listed companies to maintain at least a 25% free float and adhere to higher governance standards. Frontier markets frequently lack such frameworks, raising concerns over minority shareholder rights and transparency. In Bangladesh, related-party transactions and state influence over corporate decisions can weaken governance, making financial statements less reliable.
Tax policy stability is another factor. Emerging economies generally have more predictable tax regimes, with structured corporate tax rates and established transfer pricing regulations. India, for instance, has a corporate tax rate of 22% for domestic companies and a defined Goods and Services Tax (GST) system, reducing uncertainty for businesses. Frontier markets often experience abrupt tax policy shifts and inconsistent enforcement. In Kenya, frequent VAT adjustments and retrospective tax claims have complicated long-term investment planning.
Trading Infrastructure and Liquidity
The efficiency of financial markets depends on trading infrastructure and liquidity. Emerging markets generally have more advanced electronic trading systems, supporting high-frequency trading, derivatives, and structured financial products. The National Stock Exchange of India (NSE), for example, operates on a T+1 settlement cycle and processes millions of orders daily with minimal latency. Frontier markets often rely on outdated or manual trading systems, leading to slower execution times and increased risks. The Dhaka Stock Exchange in Bangladesh, for instance, still experiences periodic system outages and limited automation, delaying trade settlements.
Market accessibility through clearing and settlement mechanisms also varies. Emerging markets typically have well-integrated central securities depositories (CSDs) and real-time gross settlement (RTGS) systems that facilitate smoother transactions. South Africa’s Strate CSD ensures efficient equity and bond trade settlements, reducing counterparty exposure. Frontier markets often lack such infrastructure, leading to longer settlement cycles and higher transaction costs. In Ghana, equity trades can take several days to clear due to manual reconciliation processes, increasing inefficiencies.
Liquidity constraints further separate these markets. Emerging markets have higher average daily trading volumes and tighter bid-ask spreads, making it easier for investors to enter and exit positions. Brazil’s B3 Exchange, for example, sees daily turnover exceeding $2 billion, ensuring large trades have minimal market impact. Frontier markets, however, suffer from lower trading volumes and wider spreads, leading to price distortions and volatility. The Colombo Stock Exchange in Sri Lanka, with an average daily turnover below $10 million, often experiences sharp price swings due to low liquidity, making large trades difficult without significantly affecting stock prices.
Economic Depth Variation
The structure of an economy influences long-term investment potential and stability. Emerging markets typically have more diversified economies, with multiple industries contributing to GDP growth. Indonesia and Turkey, for example, benefit from strong manufacturing, services, and technology sectors, reducing reliance on commodity exports. Frontier markets often depend on a narrow set of industries, such as agriculture or resource extraction. Mongolia’s economy, for instance, is heavily tied to mining, making it vulnerable to global commodity price fluctuations.
Monetary policy frameworks also highlight differences in economic resilience. Emerging economies tend to have more independent central banks capable of implementing inflation-targeting policies and managing interest rates effectively. Brazil’s Central Bank, for example, follows a structured inflation-targeting regime, adjusting the Selic rate to maintain price stability. Frontier markets often experience weaker monetary policy credibility, with central banks subject to government influence or lacking tools to control inflation. In Sudan, inconsistent policy decisions and reliance on direct capital controls have led to persistent inflation, eroding investor confidence.
