For many years, China's authorities had sought out the inclusion of its domestic shares into global indices, and in particular the MSCI Emerging Market Indices. But for three years in a row it was rebuffed by the US index provider due to concerns over the ease with which capital invested in China could be repatriated and the local regulator's proclivity to tinker with the functioning of the market.
We decided to ask market participants and observers whether 2017 would be the year MSCI finally opened the door to Chinese A-share inclusion.
Will China’s A-share equities be included into MSCI’s global emerging market indices?
Our conclusion, following conversations with fund managers, economists and investors, was that China's market still wasn't ready.
True, the country had made progress in direct market access, most particularly through the launch of the Shanghai-Hong Kong Stock Connect in November 2014, and then the Shenzhen-Hong Kong Connect in December 2016. And qualified foreign institutional investor programme quotas continued to increase as well.
But as we noted last year, MSCI said it delayed the inclusion of A-shares in 2016 because investors needed time to assess the effectiveness of China's policy changes on quota allocations and capital mobility. That decision had confounded some observers, including Wang Qi, chief executive of private equity firm Megatrust Investment (HK) and the former head of China equity research for MSCI.
The China Securities Regulatory Commission's vice chairman, Fang Xinghai, said in Davos on January 19, 2017 that the country’s authorities were in no hurry to push for A-share inclusion. So inclusion that year appeared unlikely.
After beating back China's A-share applications for three years in a row, on June 20, 2017 the index provider announced that it would include a weighting of local stocks into its widely tracked emerging markets index.
In doing so, observers said the index provider modified its own admission criteria covering trading and capital repatration restrictions and ownership rights. The decision also took into account the fact that China seemed willing to loosen its rules; shortly afterwards it increased the renminbi QFII quota from Rmb270 billion ($43 billion) to Rmb500 billion. The CSRC was reported to be also thinking about raising the dual Stock Connect's $3.8 billion daily cap on foreign investments into A-shares.
Despite this, MSCI didn't throw open the doors to China A-shares. It said it would only include 222 large-cap companies and that these would possess a 0.73% weighting in the index, instead of the 34% weighting that fully including A-shares would merit.
In that way, the US index provider was trying to walk a tightrope (or, less charitably, have its cake and eat it too). It wanted to include more A-shares into the global index because of the sheer size of China's stock market and the growing desire among international investors to have more exposure to it.
Yet it is undeniable that the Chinese authorities have historically tended to intervene in its market to a degree that goes against MSCI's preferences. By offering a small weighting with the promise to raise it over time, MSCI recognised the demand to add these shares, but left the door open to freezing further increases if Beijing continued to interfere in a manner that damaged international investor interests.
The 0.73% inclusion will take effect in a two-step process in May and then August this year, although MSCI has also stated that it "reserves the right to revise the planned implementation to a single phase should the daily limit on Stock Connect be abolished or significantly expanded before the scheduled inclusion dates".
At the current level, passive funds tracking the index will need to inject about $12 billion into A-share allocations, according to Credit Suisse's investment bank. But a great deal more than this is likely to end up pouring in. Many active emerging market funds are likely to seek selective overweight positions in A-shares at a time the market is performing well and the renminbi is strengthening relative to the US dollar.
The next question will be whether MSCI raises the weighting in its next round of index recalibrating, which is scheduled to be announced this June. In its statement in June 2017 the index provider said that doing so would depend on "a greater alignment of the China A-shares market with international market accessibility standards, the resilience of Stock Connect, the relaxation of daily trading limits, continued progress on trading suspensions, and [the] further loosening of restrictions on the creation of index-linked investment vehicles".
Don't be surprised to see it increase the weighting this June, at least by a further marginal degree.
Previous year of the Rooster outlook reviews: