ANALYSIS

MSCI finally adds China to indices

MSCI’s long-awaited decision to include China’s A shares in its Emerging Markets and All Country World indices will affect more than $1.6 trillion in funds that track the MSCI Emerging Markets Index.

One large institutional investor, who has had a long-term commitment to onshore Chinese assets, says that although the Chinese economy faces serious issues, it has achieved a scale that makes its eventual integration into global financial markets a foregone conclusion.

“This should be a significant stepping stone to the real prize – inclusion into major global fixed income indices,” the investor says. “Foreign inflows in the onshore Chinese government bond market have the potential to counterbalance domestic capital outflows, which would improve onshore financial stability.”

MSCI is including 222 China A large-cap stocks, which will make up about 0.73 per cent of its Emerging Markets Index.

Remy Briand, MSCI managing director and chair of the MSCI index policy committee, says the expansion of the Shanghai-Hong Kong Stock Connect program has been a game changer for the accessibility of China A shares and contributed to inclusion’s approval.

Before making the decision, MSCI conducted an extensive consultation that included a large number of asset owners, asset managers, brokers and other market participants.

“International investors have embraced the positive changes in the accessibility of the China A shares market over the last few years and now all conditions are set for MSCI to proceed with the first step of the inclusion,” Briand says. “MSCI will reflect a higher representation of China A shares in the MSCI Emerging Markets Index when there is further alignment with international market accessibility standards, sustained accessibility within Stock Connect is proven, and international institutional investors gain further experience in the market. MSCI is very hopeful that the momentum of positive change witnessed in China over the past years will continue to accelerate.”

MSCI said in a statement: “This decision has broad support from international institutional investors with whom MSCI consulted, primarily as a result of the positive impact on the accessibility of the China A market of both the Stock Connect program and the loosening by the local Chinese stock exchanges of pre-approval requirements that can restrict the creation of index-linked investment vehicles globally.”

Combined, the Shanghai and Shenzhen exchanges make up the second-largest sharemarket in the world, after the US, but China represents only about 1 to 2 per cent of the world’s stock indices. The country generally is under-represented in investors’ portfolios.

In the last couple of years, the inclusion of China A shares has been delayed, due in part to investors’ concerns about the liquidity and replication risk that may result from potential renewed voluntary suspensions in trading of mainland Chinese companies on the local stock exchanges.

MSCI says international institutional investors welcome the expansion of Stock Connect and view it as a more flexible access framework than the current QFII and RQFII regimes. They also welcome the decrease in the number of suspended China A shares, but still consider the number high, compared with other markets. Investors encouraged Chinese authorities and exchanges to consider additional measures to address the issue.

During the consultation, the vast majority of institutional investors approved the proposal to include large-cap shares that are not in trading suspension. Many also recommended that MSCI include China A large-cap shares of companies that already have in the MSCI China Index equivalent shares trading in Hong Kong. Doing so meant an increase from the original 169 China A shares to 222.

Last year, when MSCI delayed China’s inclusion in the Emerging Market Index, Briand said investors had indicated they wanted further improvements in accessibility. This included the ability to move funds in and out of China and clarity on stock suspensions.

MSCI will launch its China A International Large-cap Provisional Index today, followed by additional global and regional provisional indices, including the China and Emerging Markets Provisional indices, in August 2017.