MSCI’s A-share nod brings Chinese stocks into the global mainstream
Index compiler says Stock Connect has been ‘a game changer’ for the opening up of the A-share market, after MSCI’s three previous rejections
MSCI’s decision to add mainland Chinese stocks to its benchmark emerging markets index has been welcomed by officials from mainland China and Hong Kong, as well as global investment managers.
The addition is widely regarded as a landmark moment in China’s road to opening up its vast domestic financial market to the world, boosting its credibility as a global economic power, and strengthening the international status of its currency.
Ryan Stork, chairman for Asia Pacific at BlackRock, the world’s largest asset manager, said he believed its clients would benefit from the decision to bring “Chinese equities into mainstream investment”, while Thomas Fang, head of China equities at UBS, said there is already “tremendous demand” from its clients to invest in China’s domestic market.
However, serious challenges remain for China’s US$7-trillion domestic stocks before they can be considered truly global, as their valuations are high and there could also be a culture clash when Western investors enter the market, which is often viewed as more speculative than the likes of New York and London.
After three previous rejections, MSCI said it will add 222 A-share stocks to its benchmark Emerging Markets Index (EM Index), which is tracked by US$1.6 trillion worth of assets. The implementation will be take place in two steps, first in May 2018, and the second three months later.
The stocks will be available under the Stock Connect scheme, which China introduced in 2014 and expanded in 2016 to allow international investors to access more easily shares on Shanghai and Shenszhen stock exchanges.
With an initial inclusion factor of 5 per cent, the shares represent on a pro forma basis 0.7 per cent of the weighting of the MSCI EM Index. But the weighting could increase in the future if China implements more changes in its market reform, the index giant said.
“We appreciate MSCI’s decision,” said Zhang Xiaojun, a spokesman for the China Securities Regulatory Commission (CSRC), the country’s top securities regulator.
“The inclusion is both an opportunity and a challenge for China’s capital market reform.”
Hong Kong’s securities regulator – the Securities and Futures Commission (SFC) – also said it would work closedly with the CSRC to ensure “smooth implementation” of the inclusion.
Ashley Alder, SFC’s chief executive, said the move not only signifies the growing importance of the A-share market to global investors, but will also strengthen Hong Kong’s role as the gateway to access mainland Chinese market under the existing Stock Connect scheme, a sentiment echoed by Charles Li Xiaojia, chief executive for the Hong Kong Exchanges & Clearing (HKEX).
“We are pleased to see that Stock Connect has become the most convenient and effective mutual market access models in the opening up of China’s financial markets,” Li said.
MSCI said in its statement that the Stock Connect share trading link between Hong Kong and the mainland markets was “a game changer” for the opening up of the A-share market. The index compiler had previously rejected inclusion of A-shares due to investor concerns on limited market accessibility and repatriation of capital.
Nonetheless, in March this year, MSCI made a new proposal to only include stocks available under the Stock Connect regime.
That’s seen as an attempt to bypass restrictions under China’s Qualified Foreign Institutional Investor (QFII) scheme and Renminbi Qualified Foreign Institutional Investor (RQFII) scheme, two schemes which come with restrictive rules on quota, capital mobility, and licensing requirement.
Global investment managers and analysts expected the short-term effect of the inclusion to be muted given limited initial capital inflows, while the long-term impact is more profound.
MSCI estimates initial inflows could reach US$17-18 billion following the partial inclusion. The amount could increase to US$340 billion if more A-shares are to be included in future.
The inclusion will automatically lead to passive fund inflows to China, as funds tracking the MSCI EM Index will have to add A-shares in their portfolios when the change is implemented and actively-managed funds opt to increase their China stock holdings.
Robeco, a Rotterdam-based equity mutual fund with US$324 billion assets under management believes the addition will boost China’s credibility as a global economic power.
“As world’s second largest market, China A-shares market are finally stepping onto the global stage and being given the spotlight,” said Victoria Mio, co-head for Asia Pacific equities at Robecco and chief investment officer for China.
She said it will also help strengthen the yuan and enhance its status as an international currency and improve the A-share market’s investor structure.
The full inclusion of A-shares may take 5 to 10 years depending on China’s market reform progress, but Mio said this initial step will stimulate China’s market reform and liberation and improve its regulation.
“We think the demand [from investors] for this market will increase.”
Credit Suisse expects the most active funds to favour specific sectors, such as consumer, information technology, and health care after the MSCI inclusion.
However, some analysts cautioned it could take some time for Western investors to adapt to China’s unique investment culture.
Kevin Anderson, senior managing director of State Street Global Advisors and head of investments in Asia Pacific, said the main issues include the timely execution of trades and settlement and segregated accounts model that remains “out of line with international standards”.
“The A-share market is often hard to understand for international investors,” said Hao Hong, managing director and head for research for Bank of Communications International.
The Chinese investment style has already affected the Hong Kong market since the Stock Connect scheme was launched, worth some shares have witnessing “wild swings”, said Hao.
“This is something international investors will have to get used to.”
Additional reporting by Enoch Yiu and Karen Yeung