A smart move by MSCI to spur greater reform in Chinese markets
Influential index compiler has finally included A-shares in its benchmark for emerging markets, a boon for reform-minded policymakers in Beijing
After three previous rebuffs by the world’s most influential indexer of emerging market stocks, China’s domestic A-shares will be included in the MSCI benchmark, starting in 12 months. The inclusion is a landmark in China’s financial reform and liberalisation, and reflects the growing importance of the country’s capital markets in the world economy. Still, the inclusion is limited, and future increases in the index’s representation will depend on further market opening. It is, in other words, a work in progress, though still a big leap in the right direction. In response to the latest news, mainland stocks hit an 18-month high. Coming just one year after the global share index compiler rejected such an inclusion, it spells a profound change of heart among its main clients and stakeholders – global fund managers and institutional investors.
At the time, one main objection cited by MSCI was restrictions placed on foreign access to mainland equities. But that argument has been addressed with the so-called Stock Connect scheme, which links the equity market in Hong Kong with those in Shenzhen and Shanghai so foreign investors don’t have to face the same restrictions accessing yuan-denominated stocks on the mainland. It also helps that mainland regulators have allowed the exchanges to ease conditions on approving index-linked investment products.
The inclusion, in short, is a win-win for both sides. It is simply a recognition of the importance of the Chinese stock markets, which are now the second largest in the world, after only the United States. Mainland reformers, working to liberalise the Chinese financial system, are happy to “encourage” pressure from foreign institutions to help advance their programme. Be that as it may, the limited inclusion means MSCI will start at just 5 per cent of the A-shares’ market capitalisation weighting, which translates to less than 1 per cent of its flagship index for emerging markets.
So, in a sense, the decision is more symbolic than substantial, an inducement to China’s policymakers to commit to further reform. The conditions spelled out last year when MSCI rejected inclusion still apply – improved corporate governance, greater transparency in Chinese stock markets, and easing capital controls. The last condition especially reflects the concern of foreign investors, many of whom were burned in the 2015 market crash when Beijing suspended more than half of all mainland stocks from trading.
MSCI and its stakeholders have played their hand well. They have made a friendly gesture to Beijing and given it face without compromising on their previous conditions on further inclusion. And mainland policymakers will surely use these as incentives to spur greater reform.