The inclusion of China’s A-shares in MSCI’s benchmark global indices next year is far from certain, despite efforts by the country’s regulators to open up the markets for foreign investors, analysts said. The index provider is due to announce its decision on June 20.
A-shares – that is, shares that trade on the two main Chinese exchanges in Shanghai and Shenzhen – represent the second largest equity market by both market capitalisation and turnover, but are unrepresented on any of the major global indices. MSCI has declined to add them to its benchmark global markets index, which is tracked by around $1.5 trillion in assets under management, for the past three years in a row.
‘We think there’s a greater-than-even chance of inclusion, but this is not a done deal yet,’ Aidan Yao, senior emerging Asia economist at Axa Investment Managers, told Citywire Asia.
MSCI has previously said that capital controls – including a rule limiting redemptions to 20% of total assets under management per month – and the complexity of accessing the Shenzhen and Shanghai markets through the “Qualified Foreign Institutional Investor” programme were blocks to A-shares’ inclusion.
Chinese market rules also allow companies to suspend trading in their shares; at one point in 2015, more than half of all listed companies had done so, as the Chinese markets swung wildly. This, MSCI said, has to change.
Finally, the index provider takes issue with a requirement by the Chinese exchanges that any product based on A-shares, such as an exchange-traded fund, has to be approved by the regulators.
The capital control issues ‘have been essentially resolved’ by the creation of the China-Hong Kong Stock Connect, which allows investors to access some Chinese stocks in Hong Kong, Yao said. Trading through the Stock Connect means that investors do not have to go through the QFII certification, and are not subject to capital controls. The other concerns still remain.
In April, MSCI released proposals for what a future inclusion of A-shares might entail. Those included a dramatically slimmed-down list of shares – just the 169 Connect Stocks and a reduced weighting for China in the index.
This means that the concerns over suspension have ‘by-and-large been resolved,’ Yao said. ‘Now we’re only talking about small quotas, 169 stocks, to be considered for inclusion, and out of that 169, only two stocks are suspended. So that is a non-issue as well.’
The Chinese regulators are also pushing companies to be more transparent about why and for how long they intend to suspend their shares.
That leaves the issue of pre-approval of investment products, which remains entirely unresolved.
‘Whether there is approval this year really comes down to whether MSCI thinks this is a big deal or not,’ Yao said. ‘If there’s another rejection, that means it is a big deal for MSCI. Unfortunately we don’t know.’
MSCI did not respond to a request for comment.
Based on its proposals earlier this year, inclusion in the indices – which would not take place for 12 months after the decision – would not have much of an immediate impact. With a 5% inclusion factor, A-shares would make up a tiny percentage of the benchmark global, Asian and emerging markets indices, so the absolute amount of money flowing into the Chinese markets would be small.
Inflows would most likely be directed to a relatively small pool of higher-quality companies, according to Colin Liang, portfolio manager for emerging markets equities at NNIP.
‘For the overall market it doesn’t move the needle,’ Liang said. ‘We’re likely to see the concentration of the fund flows into very few names. For those particular names – relatively cheap, high quality, easy to understand – the impact will be very big.’
There is a symbolic aspect to the decision. The Chinese government has been moving towards a greater liberalisation of its capital markets, and is obviously keen to attract foreign investment. As well as the Stock Connect in Hong Kong, it is working on a Bond Connect that will allow overseas investors easier access to its bond markets.
‘All in all, it’s basically opening up the financial markets. Index inclusion is important, but it’s part of the broader process,’ Liang said. China’s markets are not going to reach global standards overnight, he added, ‘but it’s moving in the right direction. In general, I think the odds are much higher than previously.’
There is also the strange imbalance in the indices created by China’s absence. Global investors cannot get broad access to the world’s second largest economy through H-shares or US ADRs.
‘This is a problem they must address,’ Liang said. ‘In order to really participate in China’s growth, including A-shares in the index is quite necessary for funds. I think over the long term, it’s almost certain that [A-shares] will be in the index. It’s just a matter of timing.’