China’s capital controls to hinder A-share inclusion in MSCI index
Little hope seen for A share inclusion this year, but more progress expected in mainland bond market
China’s continuation of capital controls may hamper chances for its A share market to be included in the MSCI Emerging Markets Index in 2017 – in what would be the fourth failed attempt – as foreign investors expect little improvement from regulators in terms of opening up the mainland market.
Chinese regulators restricted rules on individuals buying insurance products in Hong Kong last year, and asked financial institutions to report overseas cash transactions by clients that exceed 50,000 yuan, starting from this year. Bloomberg reported last week that regulators may ask state-owned enterprises to sell foreign currency for yuan to fight capital outflow.
Such measures won’t have a direct impact on foreign asset managers investing in the A-share market, but it does send a signal that China isn’t going to open the capital account further, said Ian Hui, global market strategist at JP Morgan Asset Management.
“I do think there is a possibility [for inclusion], but unless we are going to see some material improvement by the Chinese government, I will still lean towards a ‘no’ when MSCI does a review in June,” Hui said.
In a review released in June 2016, the compiler of the benchmark index for the third time refused to include China’s A shares into its Emerging Market Index, pointing out unsolved problems on the accessibility and liquidity of the mainland market.
MSCI said it would not rule out the possibility of an inclusion before June 2017 if Chinese regulators made significant positive developments.
However, Chinese authorities seem to be more worried about currency issues now, especially with Donald Trump set to become the next president of the United States. “They have to balance those issues, and it does appear that they worry about stability rather than being included in the major indices,” Hui said.
MSCI may not look favourably on China’s recent moves either. “I do think most people think [these moves] do not look like the steps forward to opening China’s capital account further,” Hui said.
Sherwood Zhang, who co-manages China and Asia ex Japan dividend strategies at Matthews Asia, said: “I would not bet on [the inclusion] occurring in 2017 as the Chinese regulator still has not resolved the concerns MSCI raised last year on capital mobility and anti-competitive clauses by Chinese stock exchanges.
“I expect capital controls to be a theme for the year, especially if the Trump administration starts a trade war with China. At that point the Chinese government will have no choice but to intervene if they want to defend the value of Chinese currency,” Zhang said.
Shenzhen Hong Kong Stock Connect, launched in December, enhanced the accessibility of the A-share market for foreign investors, but there is still more work to be done as far as the MSCI is concerned.
A major issue is that investors operating under the Qualified Foreign Institutional Investors quota are banned from repatriating more than 20 per cent of their prior-year net asset value from the mainland market each calendar month.
Although a 20 per cent limit would be sufficient under normal trading situations, foreign investors worry they may not be able to exit the mainland market as soon as they need to in extreme situations, Hui said.
Further, any financial products launched overseas that cover indices that include China A shares must receive approval from the Shanghai or Shenzhen bourses.
The breadth of this restriction is unique in emerging markets, MSCI said in its 2016 review, adding that it could put existing financial products based on the MSCI Emerging Markets Index at risk of trading disruption if A shares were included.
“[Chinese officials] don’t seem to want to give up their authority there,” Hui added.
However, foreign wealth managers expect to see a more relaxed attitude to China’s bond market.
“Right now you are seeing more opening up of the interbank bond market. It’s really more a question of when the inclusion in [major world] bond indices will be considered,” said Chantal Grinderslev, director of operations at Shanghai-based Z-Ben Advisors.
Although MSCI has not made the decision on Chinese equities, investors have made their own by strengthening their business presence in the credit market onshore, she said.
“2017 might be a year we’ll see more progress on bond funds,” she said.
Zhang from Matthews Asia said Chinese authorities will likely try to attract more foreign capital into their bond market, which is under some stress right now.
“If the onshore yuan bond market is included in the global bond index, foreign capital flow will be even more significant than A-share inclusion,” Zhang said.
However, attracting substantial inflows to the mainland bond market will probably take a few more years. In the near term, China may open up some business sectors such as high end manufacturing or financial services to attract more foreign direct investment, he said.