Is China ready for MSCI’s big decision on A shares?
In the year since MSCI declined to add A shares to its Emerging Markets Index, Beijing has resolved some key issues that could see it receive acceptance this time around
In June 2015 global stock-index compiler MSCI declined to include Chinese shares in its extremely influential benchmark index for emerging markets. A year on, Beijing has made great strides in addressing the issues that tripped it up last time, with analysts predicting improved odds forA-share inclusion at the upcoming MSCI review on June 14.
This time last year MSCI made an unexpected move and held off on adding China’s top yuan-denominated stocks to its Emerging Markets Index, which is tracked by roughly US$1.7 trillion in assets worldwide. In a consultation paper explaining why it put the A-shares inclusion on hold, MSCI cited three “critical” accessibility issues: quota allocation process, capital mobility restrictions, and beneficial ownership of investments.
On top of that, the index compiler issued another consultation paper in April this year and raised two new issues specific to A shares – “ voluntary suspensions” and “anti-competitive clauses” – in light of the Chinese stock market turmoil and heavy state intervention seen since June last year.
“In MSCI’s last review, they expressed key concerns over the lack of transparency on the quota system and the ability of funds managers to repatriate capital out of China. [However], these issues have been somewhat resolved,” Ken Wong, Asia equity portfolio specialist at Eastspring Investments, told the South China Morning Post.
In regard to the quota allocation, the State Administration of Foreign Exchange, China’s foreign exchange regulator, announced on February 4 that fund managers were no longer required to apply for investment quotas in the QFII system, but instead can operate a new scheme linked to the size of assets under management. The ceiling of the new quota has increased to US$5 billion, compared with US$1 billion previously.
As well as that, the new SAFE rules also eased restrictions on capital mobility, Wong said. They permit QFII funds to pull money out of China after three months, instead of the previous one-year. The repatriation frequency for QFII has also been shortened to daily.
In addition, as China has opened up its inter-bond market without the need for RQFII (RMB Qualified Foreign Institutional Investor) quota, it should also free up more QFII quota for A shares, which should further resolve the issue of limited market access to international investors, Wong added.
As for the beneficial ownership of investments, the China Securities RegulatoryCommissionissued a statement in early May clarifying its stance on beneficial ownership of securities through nominee holder, addressing investor concerns by recognising the rights and interest of beneficial owners of securities, including the clients or investors of the qualified foreign funds.
When it comes to the newly-raised concern of “voluntary suspensions”, the Chinese regulator has also taken action, analysts said.
Voluntary suspensions refers to the largest wave of trading halts in Chinese history that took place during the stock market turmoil in June. At that time, more than a half of all listed Chinese companies – over 1,400 firms – suspended their shares, severely straining market liquidity and worsening the volatility.
On May 27, the Shanghai and Shenzhen Stock Exchanges published separate detailed guidelines to regulate and curb voluntary stock suspensions, a move seen as clearing the way for the A-shares’ addition to MSCI.
“The proactive action from the Chinese regulator in addressing accessibility issues are constructive to the likelihood of A-share inclusions to be announced on 14 June,” said Irene Chow, senior China and Hong Kong equity analyst for Julius Baer. “It appears that the odds are improving.”
Sally Wong, chief executive officer of the Hong Kong Investment Funds Association (HKIFA), also said Chinese authorities appear to be trying very hard. “One can see that the mainland authorities have shown great commitment to further reform and opening up the capital markets,” she said.
Wong said the government’s efforts to increase the QFII quota, clarify beneficial ownership, and implement mutual recognition of Hong Kong funds and their Chinese peers are all testament to this commitment.
“Whilst the reform path may not be plain sailing, we are confident about the policy direction and the commitments,” she added.
However, despite the progress there is “no change to our knowledge” regarding the anti-competitive clauses, said Aidan Yao, senior Asia economist at AXA Investment Managers.
According to these clauses, Shanghai and Shenzhen exchanges require any investment products linked to A-shares listed in overseas markets, such as ETFs and derivatives, to be pre-approved by the exchanges.
Besides these clauses, analysts from Goldman Sachs raised some potential additional hurdles, including a 20 per cent monthly fund repatriation limit for QFIIs and the daily quota limits on Shanghai-Hong Kong Stock Connect.
Still, Goldman Sachs analysts have raised the estimated probability for the June inclusion to 70 per cent from 50 per cent in late April, as China has made progress in tackling the five key concerns, among which “beneficial ownership” and “voluntary suspensions” have already been “conceptually” addressed.
“We assign an equal weight (of importance) to each of the 5 concerns, and conclude that the probability for the June inclusion should rise from 50 per cent to 70 per cent,” they said.
“Additionally, we believe the conditional probability for a ‘Yes’ in June would be materially higher if Shenzhen-Hong Kong Connect were to be announced ahead of the decision on June 15,” they added.
However, even if A shares are included in June, China’s stock market still has much to do before it becomes a dream destination for international investors, said Wong from HKIFA.
“A key goal of the mainland authorities has always been to bolster the institutional investor base of the A share market. If A share inclusion materialises, it would go a long way in achieving this objective,” she said.
“From the international investors’ perspective, with the importance of China in the global economy, having allocation to the China capital markets is the way forward. We expect that mainland assets will become an asset class on their own and will become an integral part of a global portfolio,” Wong added.