China’s booming A-share market and capital market reforms got a mixed review earlier this week as MSCI announced that the country would have to provide greater market access to foreign investors before it would include mainland-listed stocks in its benchmark MSCI Emerging Markets Index.
The indexing firm said it was working with Chinese authorities to address the market access issues and indicated that the inclusion of A shares was only a matter of time. Such a move could provide fresh fuel to a powerful rally in mainland stocks over the past year.
“Substantial progress has been made toward the opening of the Chinese equity market to institutional investors,” Remy Briand, MSCI’s Geneva-based managing director and global head of research, said on a conference call on Wednesday. “In our 2015 consultation we learned that major investors around the world are eager for further liberalization of the China A-shares market, especially with regard to the quota allocation process, capital mobility restrictions and beneficial ownership of investments.”
MSCI is forming a working group with the China Securities Regulatory Commission to examine the market access issues. Briand declined to give a timetable for the group’s efforts but said a decision to include A shares in the EM index could occur before the company’s next annual review, in June 2016.
For years the EM index has included H shares, Hong Kong–listed equities of Chinese companies, but MSCI has excluded A shares because Chinese authorities limit foreign investors’ access to the domestic market and maintain exchange controls.
The MSCI EM index is the most widely used benchmark of emerging-markets equities, and the company wants to ensure that international fund managers are not bogged down by quota applications and have ready access to yuan for trading purposes before including A shares in the index, Briand said.
Under current rules, foreign investors must apply for quotas before they can invest in mainland shares under China’s qualified foreign institutional investor program, known as QFII, or a sister program for Hong Kong–based renminbi funds, dubbed RQFII. Foreign investors can also enter the mainland market through the Shanghai–Hong Kong Stock Connect program, which allows investors in either city to trade in the other’s market, but purchases of A shares under that program are capped at a maximum of 13 billion yuan ($2.1 billion) a day. Moreover, foreign investors have to buy via designated brokerages and separate accounts, Briand said, and MSCI wants to make sure that there is clarity in the process and that the shares being traded are easily traceable to their beneficial owner.
MSCI’s announcement follows a series of major market initiatives by the Chinese government to provide global investors with wider access to China’s capital markets. Last November the authorities launched the Shanghai–Hong Kong Stock Connect program, and they are expected to launch a similar program, connecting the Shenzhen and Hong Kong markets, in the second half of this year.
In May, China announced that it will give global fund managers with operations in Hong Kong direct sales and distribution access to China’s markets. The program, called mutual recognition, also gives Chinese fund managers direct access to various global markets via Hong Kong–domiciled funds.
Currently, Chinese H shares make up 18.9 percent of MSCI’s EM index by capitalization. With the addition of A shares, Chinese equities would account for more than 40 percent of the index.
The inclusion of A shares could dramatically boost global asset allocations into Chinese equities, says Hu Yifan, Hong Kong–based chief economist and head of research with Haitong International Holdings, the offshore arm of China’s largest brokerage house. “If it happens, it will help the Hong Kong market receive a big push from international investors as many more seek access to China’s onshore markets from Hong Kong,” she adds.
The additional market opening via the mutual recognition program makes it “increasingly likely” that MSCI will include A shares in the EM index soon, which would represent an inflection point for mainland stocks, says Qi Wang, founder and chief investment officer of China Forward Capital Group, a Hong Kong–based investment manager.
Some fund managers have moved ahead of MSCI. On June 2, Vanguard Group said it planned to add A shares to its Vanguard FTSE Emerging Markets ETF, making it the first broad-based emerging-markets exchange-traded fund to offer direct exposure to mainland equities. The ETF is one of the biggest U.S.-listed exchange-traded funds, with some $50 billion in assets. Vanguard is adding the Chinese shares as part of a shift in several of the firm’s international index funds to use broader FTSE indexes as benchmarks, the company announced.
“I think what FTSE and Vanguard did has put pressure on the MSCI,” says Hao Hong, head of research at BOCOM International Holdings Co., the Hong Kong–based international brokerage arm of China’s Bank of Communications. “I don’t think the market has completely priced in all of these possibilities. As such, the impact is likely to be positive.”
China’s domestic stock markets have boomed in the past 12 months, with the CSI 300 Index of Shanghai and Shenzhen stocks up 146 percent year-over-year as of June 11, pushing the market capitalization close to $10 trillion. Many analysts believe a MSCI move to include A shares in its benchmark EM index will bolster the market’s upward trend.
“Many people bought in advance of this development, but there are still stale bears which have not participated and are waiting for a correction,” says Paul Schulte, CEO of Schulte-Research, a Hong Kong–based independent research firm. “When too many people are waiting for a correction, it never happens.”
Follow Allen Cheng on Twitter at @acheng87.
