After much ado, this year could well see Chinese domestic A shares included in the broadly followed MSCI Emerging Market Index – but don’t expect the financial equivalent of a victory parade.
Instead, after a formal announcement expected in June, both Chinese authorities and the MSCI will likely want to move on quickly from the saga – once marketed as a sign of China’s economic rise and now widely thought to be a lesson in the very real limitations of financial reforms in China.
MSCI, which is used by 97 out of 100 of the world’s largest money managers, has worked with authorities for years to include Chinese A shares. What concerns MSCI about Beijing is its true commitment to free trade, how easily it allows money to move in and out of the country, and the veto it has over any product using A shares as a reference price – an effort to control how much offshore products can affect its domestic market.
Whether A shares rise or fall isn’t the issue; index followers need to know that they can rebalance their baskets, that they have the capacity to invest more funds into China and, when they have redemptions, they need to be able to get their money out.
Almost all other Asian markets have satisfied these concerns, but 14 years after introducing the first institutional access to A shares via the Qualified Foreign Institutional Investors (QFII) facility, China still has not been able to meet the criteria. Last year, the China Securities Regulatory Commission (CSRC) introduced rules to handle suspended stocks, but not much has changed – there appears to be little will to either get those stocks trading again or delist them.
The irony is that the QFII facility was introduced specifically to bring in the very type of money managers which follow the MSCI.
This year, MSCI seems to have concluded that Beijing is unable to meet the standards of other markets, and has scaled back their requirements for inclusion by limiting qualifying shares to those accessible through Shenzhen- and Shanghai-HK Connect channels. It plans to also actively exclude those that have been suspended for 50 days or more in the past year.
This will effectively reduce the number of eligible stocks to a third of the original goal, and be a poor substitute for proper inclusion, as envisioned for many years.
MSCI has been very disciplined in its approach to A shares; it will include them only if their users are able to safely invest. They witnessed the International Monetary Fund (IMF) include the Chinese yuan in its Special Drawing Rights basket last year only to have the Chinese ramp up capital controls and restrictions after inclusion. In a Chinese version of carrot and stick, Beijing seems to have taken the IMF carrot only to the turn around beat the IMF with it as if it were a stick.
MSCI’s revised approach could allow inclusion, but should hardly be considered a victory for the Chinese authorities. They come out looking badly, unable to operate and embrace basic international access standards.
Beijing’s approach is made all the more perplexing when weighed against its moves in the much larger bond market. The People’s Bank of China (PBOC) fully opened up to foreign institutions about a year ago when the currency market was in turmoil. Nevertheless, nearly 250 foreign institutions can now freely access the China Interbank Bond Market with no capital controls, and even hedge out related foreign-exchange risks in the onshore market. Not surprisingly, a number of companies have now included Chinese domestic bonds in their global bond indices.
That the PBOC can open the bond market while the equity markets remain so restricted reflects a forever-present concern for the retail investor in China. They play little to no part in the bond market, and although their role is greatly exaggerated in the stock market, they are perceived as a huge concern for regulators. The prospects of investors outside the CSRC, angered because of some market crash or fraud, is a scene the government never wants.
It is not clear what Beijing sees as so potentially destabilising about meeting the MSCI criteria, other than a vague sense of “losing control”, but if market crashes in 2007 and 2015 prove anything, they prove the government isn’t in control, anyway.
China is trying to seize the mantle as champion of free trade and globalisation, yet its actions tell something else. China A shares should have been in the MSCI and other indices many years ago because China should have opened up its markets many years ago. If Beijing can’t commit to the same standards as everyone else, what sort of globalisation champion can it be?
MSCI’s neutered proposal may just be enough to get China A-share inclusion, but even then such an announcement would really be one of failure and not success.
Fraser Howie is co-author of Red Capitalism, The Fragile Financial Foundations of China’s Extraordinary Ris e