While China is still some way from meeting the requirements for inclusion in MSCI’s emerging-market indices, the index provider's chairman and chief executive says mainland A-shares could make sufficient progress by the next review, to be announced in June 2017.
Speaking to AsianInvestor at his office in New York, Henry Fernandez said: “We are very optimistic that the reforms that are taking place are going to help us continue to look at this favourably.” But he made it clear that the onus was on Beijing to make the necessary reforms, not on MSCI to lower its standards.
The launch of the Shenzhen-Hong Kong Stock Connect and further liberalisation of the Shanghai Connect together represented a big step, he noted. “Leaving the daily limit [the same] but changing the lifetime caps [on trading volumes under the equity trading links] is going to help create more certainty for investors.”
Earlier this year, mainland authorities made several enhancements to the accessibility of A-shares by foreign investors. These measures included China’s relaxation of the qualified foreign institutional investor (QFII) quota system, and a more recent liberalisation of the RQFII quota limits, and they were conducted at least in part to help China's A-shares become included in MSCI's indices. Yet despite the progress the index provider declined to include the onshore shares in June, questioning the effectiveness of the policy changes.
Foreign investors are still hindered by continuing limits on capital repatriation. QFII investors can only repatriate, on a monthly basis, up to 20% of the net asset value of their onshore investments as of the previous year-end.
This would mean foreign mutual and pension fund managers may not able to withdraw sufficient capital from China to be able to manage products properly. Hence the limit must be substantially increased or, ideally, removed, noted MSCI in this June’s review.
The index provider said the monthly capital-repatriation limit remained a large hurdle. It is hoped that the new changes will address such concerns amid further harmonisation of the two schemes, as RQFII investors (open-ended funds) enjoy daily liquidity without the monthly repatriation limit.
A further issue is that Chinese bourses require pre-approval for launching financial products, which is seen as an unnecessary control mechanism.
Fernandez said it was too early to tell if the issues around QFII and RQFII quota had been resolved. MSCI is now closely monitoring the implementation of the Connect links to see whether they relax the 20% withdrawal restriction.
The index provider is also monitoring the frequency with which trading of stocks is suspended, with a view to see the markets come more in line with global practices. The new rules imposed by the exchanges seem to have reduced the number of suspensions, said Fernandez.
“They are still abnormally high compared to any other market in the world, but at least they are going in the right direction.”
Another area where he wants to see more progress is around data. In respect of Chinese exchanges’ licensing of data for investment products such as exchange-traded funds (ETFs) and futures, MSCI wants to see a rules-based, transparent process that provides a level playing field for all participants. But there hasn’t been a great deal of progress on the data issue, said Fernandez.
The index provider has said China must resolve the issue of product ‘pre-approval’ requirements imposed by the Shanghai and Shenzhen bourses. These restrict foreign financial institutions from launching new products linked to indices containing A-shares, such as index fund derivatives. Such products could risk suffering trading disruptions if an exchange were to withhold approval for using MSCI’s emerging markets index.
Beijing would like MSCI to help accelerate the pace of index inclusion, noted Fernandez, “but we can’t do that because we have a responsibility to our institutional investor clients to ensure that this inclusion happens only when the conditions are right”.
“Importantly, it needs to happen not just on paper and in theory, so there has to be plenty of time to really see all of this happening in practice.”
On that basis, some feel it is optimistic to expect thevarious issues to be ironed out by the next review.
But Fernandez disagrees. “I wouldn’t say that, no. These things can happen surprisingly quickly. Some steps are being taken now.” He pointed to steps being taken to bypass the 20% repatriation restrictions. The measures include expanding the Connect links, via the introduction of bond and ETF Connect systems. Fernandez believes these steps should create more efficiency and flexibility for investors.
It is still possible that inclusion could be granted before the official review deadline, said Fernandez, since an “off-cycle consultation or decision is possible if these minimum set of requirements are met”.
The problem for China is that regulatory power is centralised in some cases and spread across different authorities in others, which makes the pace of change inconsistent. “So opening up other areas will be more complicated.”
For example capital controls, which would affect the withdrawal of money from China, fall under the remit of both the central bank and the foreign exchange regulator – not only the securities watchdog.
“Any process going forward will be very slow,” agreed a senior executive at a Shanghai-based private fund firm at the time of the June announcement.
After A-shares had failed to make the cut for the past two years, mainland fund groups and even the official Xinhua news agency had lobbied heavily in support of China’s inclusion. They argued that Beijing had done enough to address MSCI’s market-access concerns.
"The onus is on China"
Fernandez said MSCI was not expecting the Chinese markets to be perfect, “but the requirements are for a minimum set of market standards that would allow investors to invest safely”.
He said the onus was on China, not MSCI. “A lot of people in China say we’re the ultimate decision-maker – we’re not. The ultimate decision-maker is the Chinese authorities wanting to open up and create the necessary reforms.
“It is also down to our institutional investors, who tell us whether the minimum set of requirements has been met or not, which ultimately influences whether a market is ready.”