What is the MSCI index, and why does it matter so much to China?

Global index compiler MSCI will add mainland Chinese stocks, or A-shares, to its benchmark Emerging Markets Index from next year, marking a financial milestone in the opening-up of the world’s second-largest economy

PUBLISHED : Wednesday, 21 June, 2017, 9:54am
UPDATED : Friday, 30 June, 2017, 2:44pm

Here is what you should know about MSCI, the inclusion, and why it’s important to China.

What is MSCI?

Morgan Stanley Capital International, better known as MSCI Inc, compiles influential indices tracked by global investment managers.

Its indices cover thousands of stocks in different geographic sub-areas and cap sizes. They are often used as benchmarks to measure portfolio performances.

One of the most popular MSCI indices is the MSCI Emerging Markets Index (MSCI EM Index), which tracks equity market performance in a number of developing countries and regions.

Currently, MSCI indices have over US$10 trillion active and passive assets benchmarked against them, with US$1.6 trillion tracking the MSCI EM Index alone, according to data from the index compiler.

The MSCI EM Index consists of indices from 23 emerging markets, including Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and the United Arab Emirates.

The index comprises about 10 per cent of global market cap and has been used as a benchmark index by many emerging market growth mutual funds.

Why MSCI inclusion matters to China?

The MSCI EM Index previously excluded China’s domestically traded, yuan-denominated stocks, or so-called A-shares. It currently only includes shares of Chinese companies listed in Hong Kong or the US.

MSCI said Wednesday it will include 222 A-share stocks, which only accounts for 0.73 per cent of the weighting of the EM Index. But the weighting could increase further over time if China implements more changes in its market reform.

The inclusion will take place in two steps, first in May 2018, and second in August 2018.

MSCI plans to add 222 Chinese A-shares to its Emerging Markets Index, with an initial weighting of 0.73 per cent. The full inclusion of domestic Chinese stocks in the widely tracked MSCI Emerging Markets Index could pull more than $400 billion of funds from asset managers, pension funds and insurers into mainland China’s equity markets over the next decade, according to analysts.

An inclusion will automatically result in capital inflows to China’s domestic equity market, as all passive index funds and ETFs that track the MSCI EM index will be forced to add those shares in their portfolios.

A greater inflow of funds into China equities is expected in the longer run from actively-managed funds. What’s more important, the inclusion is a milestone in the opening up of the mainland Chinese equity market to the world, bolstering the country’s credibility as the world’s second-largest economy and allow China to take a bigger role on the international stage.

The history of rejections by MSCI of A shares

MSCI first consulted international stock market practitioners in 2014 about whether the time has come for them to include A-shares in the MSCI EM Index. It conducted two other similar reviews in 2015 and 2016 respectively. However, the answer has been no.

Initial concerns from MSCI clients include limited market accessibility to global investors and restrictions on repatriation of capital.

The Chinese authority addressed these issues by increasing quotas on foreign ownership of A-shares and relaxing rules on fund remittance.

MSCI then raised new worries associated with the widespread, extended trading suspension of many A shares, which took place in China’s 2016 stock market rout.

China then responded by changing regulatory rules and limiting trading halts to a maximum of three months.

In March 2017, MSCI made a new proposal to only include stocks available under the Stock Connect regime, which is regarded as an attempt to improve the odds.

This reduces the number of stocks eligible to 169 from 448, but bypasses restrictions under China’s Qualified Foreign Institutional Investor (QFII) scheme and Renminbi Qualified Foreign Institutional Investor (RQFII) scheme, as these two schemes come with restrictive rules on quota, capital mobility, and licensing requirement.