SHANGHAI -- The first mainland Chinese shares will join the popular MSCI Emerging Markets Index on Friday, marking a major victory for a country eager to internationalize its financial markets and providing incentives for further reform.
The U.S. index provider will welcome 234 A-shares -- yuan-denominated mainland stocks -- into the index, initially weighting them at 2.5% of actual market capitalization and increasing the weighting to 5% in September. The additions include such heavyweights as Industrial and Commercial Bank of China and Ping An Insurance (Group) Co. of China.
China has long lobbied for mainland shares to be included in the index as part of its drive for financial internationalization. The International Monetary Fund handed the country a win in 2016, adding the yuan to the currency basket underpinning its Special Drawing Rights reserve asset. But few victories for internationalization have since been forthcoming.
When the index is adjusted, mainland listings will see an influx of capital as investors and funds rebalance their holdings. Worldwide, around $2 trillion is invested in funds tracking the Emerging Markets Index, which provides diversified exposure to these economies in an easy-to-access package. Some Chinese companies are already part of the index through their Hong Kong-listed H-shares.
But the symbolism of MSCI's move looms larger for China than the prospect of actual capital inflows. Even when the phase-in is complete, A-shares will make up just 0.78% of the index, receiving only around $20 billion from their inclusion. This will be a drop in the bucket compared with China's overall market cap north of $8 trillion.
MSCI evidently has lingering concerns about the Chinese stock market, leading it to underweight A-shares for now. It considered them for inclusion in the Emerging Markets Index each year since 2014 but decided against it for three years running.
China limits foreign investment in mainland markets as well as cross-border transfers of funds, and companies have significant discretion to halt trading as they please. When mainland stock prices crashed in 2015, high-volume margin traders were arrested. Mainland authorities have also shown little reluctance to intervene in the market in other ways. Trust in Chinese capital markets has crumbled as a result, and equities have yet to regain the level they reached before the 2015 plunge.
To draw in foreign traders, China has launched stock connect mechanisms providing access to Shanghai and Shenzhen shares through the Hong Kong market, and tighter restrictions have been imposed on businesses wishing to halt trading of their stock. MSCI rewarded these steps in 2017, agreeing to include A-shares on a partial basis.
But a fuller embrace of Chinese shares by international investors will require more robust steps. Few attempts have been made at corporate reform on the environmental, social and governance fronts. "Governance reform is difficult, because the government is a major shareholder in many companies," according to Naoto Saito at the Daiwa Institute of Research.
Still, adding A-shares to the mix will increase foreigners' holdings as a proportion of the Chinese market, according to Gao Ting, head of China strategy at UBS. Citigroup and Morgan Stanley are each expected to bulk up their presence in the country as international interest builds.