MSCI will not include China A shares in its emerging market indices right now, the firm announced today.
However, the global indices provider said it is working with China's securities regulator to resolve the remaining investment accessibility issues. Once these are resolved, A share inclusion looks likely before the next review in June 2016.
In an announcement today shortly after 5am Hong Kong time, MSCI announced the results of its annual review of market inclusion into its indices, which this year saw admittance of A shares as its key decision.
In announcing the postponement of A shares inclusion in the MSCI Emerging Markets Index, the firm said it would form a working group with the China Securities Regulatory Commission to resolve the remaining hurdles to inclusion.
“Substantial progress has been made toward the opening of the Chinese equity market to institutional investors,” said Remy Briand, MSCI managing director and global head of research. “Major investors around the world are eager for further liberalisation of the China A‐shares market, especially with regard to the quota allocation process, capital mobility restrictions and beneficial ownership of investments."
MSCI said that a decision to admit A shares into the EM indices could come as soon as the remaining hurdles are overcome, and this could happen at any time before the next annual June review.
The firm said that despite the substantial raft of reforms over the past year which have opened up China's markets, there were still three key accessibility hurdles to overcome: the quota allocation process; capital mobility restrictions; and beneficial ownership.
On quotas, which have been imposed on cross-border schemes including Shanghai-Hong Kong Shanghai Stock Connect, MSCI said that "most international investors have indicated a preference for a more streamlined, transparent and predictable quota allocation process".
MSCI said large investors believed they should be given access to quota commensurate with the size of their assets under management. This would be especially important for passive investors, whose investment processes replicate benchmarks. All investors MSCI spoke to said that they needed sufficient flexibility and assurance to secure additional quota should the need arise.
On capital mobility, investors said their need for access to daily liquidity meant that access should apply to all investment vehicles, including open‐ended funds, ETFs and separate accounts.
The firm added that some investors had continued to express concerns about restrictions on capital lock‐up and the limit on the amount of repatriation. They also wanted the removal of the daily northbound quota imposed on Stock Connect traders because it was a "great source of trading uncertainty" for passive investors.
On beneficial ownership, MSCI welcomed the recent clarification of the issue, but said that more needed to be done: "A large number of asset owners invest through separate accounts. Because they typically delegate investment and operational decisions to their fund managers, recognising clear title to ownership for the ultimate beneficial owners is a crucial concern."
Passive investment specialist BlackRock said it welcomed MSCI's decision: "We support MSCI’s deliberate process on the inclusion of China A-Shares into its global indexes, recognising the practical obstacles that remain for their addition. We believe that the Chinese authorities understand these issues and intend to resolve them quickly. We will continue to work closely with the Chinese government as it takes further steps to implement their policies.”
In a separate media briefing this morning, Remy Briand explained that the working group formed with CSRC, while “not an extremely formal group”, is an extension of the work already being done to bring China’s capital markets into line with international expectations, and “to accelerate the process”.
The pace of the consultative process and the decisions to come out of the working group will be driven by the regulator, said Briand. “We are there to advise them and provide feedback, which needs to take into account a variety of factors. We are talking about an extremely broad set of investors who are using these indexes.”
The composition of the MSCI EM Index would be radically altered by the inclusion of A shares, which would make up almost 40% of the EM Index and more than 40% of the MSCI Asia ex-Japan. As such, investors would need to assess whether they were suitably diversified in emerging markets, and whether an EM-ex China index would need to be considered.
“Investment processes will have to adapt," said Briand. "China has many companies that are not well understood by investors. Inclusion of A shares will trigger a large amount of new investment, particularly by institutions such as pension funds, which will have to increase their A share exposure if they are following an index.”
Substantial progress has already been made, he added, and although no formal date has been set for conclusion of the discussions, Briand made it clear the current pace of regulatory change, and the Chinese regulator’s “eagerness” to conclude the process, suggested investors will not have to wait until June 2016.
Expectations are high on all sides, but MSCI emphasised that with the size and diversity of the investor base, it is crucial for China to resolve the outstanding issues before an affirmative decision can be made. “That is why the process is a little less rapid than people might expect.”