China investors eye possible mainland share inclusion in MSCI annual review

The MSCI benchmark, tracked by global funds, will conduct its annual review of the emerging market index in June

PUBLISHED : Thursday, 12 May, 2016, 3:54pm
UPDATED : Thursday, 12 May, 2016, 5:01pm

Last weekend, the China Securities Regulatory Commission (CSRC) clarified its stance on the rights and interest of beneficial owner of securities held in the nominee accounts by foreign institutions.

The CSRC said that the mainland share account system supported the recognition of rights and interest of beneficial owners of securities – the clients, or investors of the qualified foreign funds.

The statement coincides with an upcoming annual review by index compiler MSCI.

Attention will be focused on whether mainland Chinese shares will be added to the MSCI Emerging Market Index, which is tracked by about US$1.5 trillion of assets worldwide.

Mainland shares traded in Shenzhen and Shanghai could be included as part of the review, with speculation that their addition would take up a 5 per cent weighting in the benchmark.

The inclusion would attract capital inflows via the existing qualified foreign institutional investor (QFII) and renminbi qualified foreign institutional investor (RQFII) schemes, as global funds allocate part of their assets to mainland-listed companies.

The beneficial ownership issue was a concern among international investors in the past years as there was a lack of clarity on ownership of securities invested through separate accounts under China’s securities trading system.

The latest CSRC statement “confirms that the legal relationship between the beneficial owner of securities and QFII/RQFII nominee holder, including the arrangements to segregate client’s assets from those of the asset manager, will be defined by legal contracts between the client and the asset manager, and be governed by the laws of the jurisdiction where they are entered into,” law firm Clifford Chance said in a research note.

Fund managers said the securities regulator was trying to smooth the way for the inclusion of mainland shares into the MSCI benchmarks after a series of reform measures stalled.

In February, the State Administration of Foreign Exchange relaxed rules governing QFIIs that allowed the qualified foreign funds to operate in a flexible manner without having to apply for the foreign-exchange quota.

Under the new rule, the quota will be distributed based on the size of the funds under management, giving the asset managers greater freedom in investing in mainland shares.

The foreign exchange regulator also allowed QFII funds to pull money from China after three months, compared to a lock-up period of one year previously.

“The A-share market is in need of stimulus,” said Zhou Ling, a fund manager at Shanghai Shiva Investment. “The MSCI annual review is likely to help shore up investor confidence.”

In 2014, the mainland and Hong Kong securities regulators launched the Shanghai-Hong Kong Stock Connect scheme, allowing individual and institutional investors in Shanghai to buy shares traded on the Hong Kong stock market and vice versa, subject to daily quota limits and a maximum trade volume of 550 billion yuan (HK$655.7 billion).

It is believed that a similar scheme linking Shenzhen and Hong Kong exchanges will debut later this year.

Normally, news about fund inflows would become a strong boost China’s domestic stock markets since retail investors look more to liquidity as a gauge for investment, rather than fundamentals.

Last year’s market crash, which saw one third of the market capitalisation of the Shanghai Stock Exchange erased within a month, has dampened enthusiasm among retail investors.

A slowing economy and worsening corporate performance has further dented buying interest.

The benchmark Shanghai Composite Index is now down nearly 50 per cent from its June 12, 2015 high, widely regarded as the high-water mark before the market crashed.

So far this year, the Shanghai Composite Index is down nearly 20 per cent.

The CSRC has scrapped a plan to launch a new board for the emerging companies and put on hold a groundbreaking move to revamp the initial public offering mechanism.

Analysts said the inclusion of mainland shares into the MSCI benchmark would help rekindle confidence in China stocks among domestic investors and act as a long term positive.

“Global funds can easily find good buys because of the cheap valuations now,” said Zhang Xiaobo, a seasoned retail investor.