MSCI is consulting the investment community about increasing China's representation in its indices after receiving “overwhelming positive” feedback from institutional investors following the initial inclusion of A-shares.
If implemented, China's local share market could become institutionalised and internationalised more quickly, prompting global asset owners to rethink how they approach this market.
Critically, the experiences to date of institutional investors have been strongly positive. The Stock Connect schemes linking Hong Kong to Shanghai and Shenzhen have proved very robust. As a result, institutional investors have been able to put through and execute trades smoothly without breaching the daily limits after the May increase in daily trading quotas.
There are also no concerns related to offshore renminbi liquidity levels, Chia Chin-ping, Hong Kong-based head of research for Asia Pacific at MSCI, told AsianInvestor.
“What it really tells us is that we might have been a lot more conservative at the beginning just to put 5% through,” he said, referring to the factor percentage used to determine how much of China's adjusted market cap is incorporated into MSCI's flagship emerging market and world indices.*
That initial "partial inclusion factor", introduced in two stages this summer, has been comfortably assimilated by investors in part thanks to the Connect schemes and increasing it is a natural next step, Cindy Chen, managing director and head of securities services for Hong Kong at Citi, told AsianInvestor.
The Connect schemes have delivered the necessary scale and ease of access for foreign investors, she said.
In the 15 months since the MSCI inclusion of Chinese shares was announced in June 2017, the number of institutional accounts in the Connect schemes has grown from 1,700 to 6,300, which has led to $46 billion of inflows into the A-share market, Chia said.
“What it tells us is that even for the 5% inclusion, a broad number of institutional investors has actually participated. Once you’ve set up the account, moving money is much easier,” he said.
However, Chia said he does not expect the account opening to grow at a faster rate than last year, even assuming the new proposals are implemented.
“Most institutional investors who wanted to come in [have] already set up the Connect accounts,” he said.
But others see plenty of pent-up demand still out there.
Alexander Treves, emerging markets and Asia-Pacific investment specialist at JP Morgan, said substantially more capital inflows into China A-Shares will come from offshore in the next few years.
For him MSCI inclusion is just part of the reason. The bigger factor may be rising interest from European and, increasingly, US institutional investors seeking to better understand and participate in China A-share investment opportunities, he told AsianInvestor.
There are now 235 companies in the MSCI China Indexes and related composite indices, including the MSCI Emerging Markets Index. These constituent companies are all large-cap ones listed on the main boards in Shanghai and Shenzhen, excluding the Shenzhen ChiNext board and Shenzhen SME (small and medium enterprise) board.
MSCI is consulting the public on three proposals: to raise the inclusion factor in the emerging market index to 20% from 5% in two phases -- two 7.5 percentage increases in May 2019 and August 2019; to include an indicative 31 stocks listed on the ChiNext board in May 2019; and to add 168 China A mid-cap securities with a 20% inclusion factor in May 2020. (see chart)
The pro forma index weight of China A shares in the MSCI Emerging Market Index will increase from 0.71% to 3.36% in August 2020 if all the proposals are put into place.
ChiNext, on which most Chinese technology companies debut their shares, is not a segment currently represented in the MSCI China Index, but it is becoming more important and is about 20% of the representation of all the A-share stocks in Shanghai and Shenzhen, Chia said.
“It has grown in size, significance and representation. We feel that it’s a right time to bring the questions in,” he said.
Regarding the inclusion of mid-cap stocks, Chia said it is standard for MSCI indices to include both large- and mid-cap securities. That China did not the first time around was exceptional and largely because there were already 235 stocks for investors to study.
“But that created a methodology inconsistency. We now think is the time to bring it back to norm and make it consistent with ... other markets,” he said.
The incorporation of mid-cap stocks will happen a year later after the inclusion factor is increased, as investors may not be ready to cover the additional 168 stocks, he said.
The consultation will run until February 15, 2019 and MSCI plans to announce its decision on or before February 28, 2019.
* MSCI adjusts country market caps according to the free float of shares applicable to foreign investors. For more information on the partial inclusion formula used for China, click here.