“[A]ny international indices without A-shares are incomplete,” was the comment from the China Securities Regulatory Commission. The regulator added that the MSCI decision would not affect the opening up and reforms of China’s capital markets.
Remy Briand, MSCI global head of research, said in a conference call today that despite regulatory improvements such as granting the investment quota through the QFII scheme, investor concerns remain.
They are more on the practical and operational side, for example the redemption process, which only allows 20% of holdings to be repatriated each month under the QFII program.
“The 20% monthly repatriation quota is obviously a big constraint for mutual funds or pension funds who want to make changes to their portfolios,” Briand said.
Moreover, a trading halt raises concerns on how to withdraw the holdings or sell the shares.
"[Chinese] authorities choose the pace to develop. If they move fast, we would move fast"
During the A-share market rout, which wiped out $2trn in the market value of Chinese stocks last summer, more than half the stocks voluntarily halted trading. There are still about 10% of companies under lock-up at the moment, compared to just 0.2% for the countries already included in the MSCI EM index, Briand noted.
One way to monitor progress in this area is to see a reduction in the number of suspended stocks, he said.
Just a few weeks ago, the Shanghai and Shenzhen bourses issued guidelines on trading halts.
But Aberdeen Asset Management head of China and Hong Kong equities Nicholas Yeo earlier noted that the new rules have not been tested, and doubted if investors are confident that authorities won’t intervene when fears over falling markets resurface.
Three times rejected
Another worry is on pre-approval of all investment products using A-shares related indices. “Existing products would be potentially in breach, should we include A-shares into the MSCI indices. And we would not want to put these products at risk,” Briand said.
The launch of Shenzhen-Hong Kong Stock Connect, expected later this year, would likely have a positive impact on a future MSCI inclusion decision, he added.
The current review is the third time since 2013 that the US index provider evaluated and rejected A-share inclusion. Chinese authorities and investors had pushed for the inclusion, which some analysts said would bring at least $20bn of capital into onshore Chinese equities in the first year.
Compared to the previous review last June, issues concerning quota allocation and beneficial ownership of QFII and RQFII schemes were considered largely resolved.
MSCI’s proposal has been a 5% partial inclusion of China A-shares into the MSCI Emerging Markets Index effective in June 2017, which translates to about 1.1% weight of A-shares in the index tracked by $1.5trn of funds around the globe.
The ultimate weighting would be expected to reach 18.8%, according to the MCSI roadmap released in April.
When, not if?
The next evaluation of A-shares might not need to wait another year and could be an off-cycle announcement.
“There has been quite a lot of positive momentum to implement recent policies by the authorities. [Chinese] authorities choose the pace to develop. If they move fast, we would move fast,” Briand said.
So far Chinese companies listed in Hong Kong, also known as H-shares, as well as American Depository Receipts (ADR) such as Alibaba and Baidu, which were added since November, are already present in the key MSCI emerging market indices.
Offshore Chinese equities now account for 26.8% of the MSCI Emerging Markets Index.
Industry players viewed the eventual inclusion of A-shares as inevitable.
"Full inclusion is still a question of when, rather than if," said Danny Dolan, managing director of China Post Global, a distirbutor of ETFs. "What is certain is that when that happens, it will generate substantial capital inflows into China."
BNP Paribas Investment Partners head of APAC equities Arthur Kwong expected the move will take place within 12 months from now, following the launch of the Shenzhen-Hong Kong stock connect program.
Kwong believes that the FTSE index will then follow the MSCI decision and opt for A-share inclusion. A peer index from Vanguard, the Vanguard Emerging Markets Stock Index Fund and its ETF version (Vanguard FTSE Emerging Markets ETF) added A-shares in June last year. A-shares currently account for 5.6% of the benchmark.
Mark Valadao, head of portfolio strategists for Asia ex-Japan at State Street Global Advisors added: “When China A-shares ultimately reach full inclusion, China’s index weighting will be to emerging markets what the US is to developed.”
The MSCI Emerging Markets Index remains under-represented by China, which is the largest and most influential economy in the emerging market asset class.