China makes MSCI breakthrough with Stock Connect boost
Index provider forecasts an initial inflow of $17 to 18 billion
JOYCE HO, Nikkei staff writer
HONG KONG -- China's onshore equity market finally won its way into MSCI's major indices after being rejected for three years.
The New York-based index provider said the inclusion, which had "broad support from international institutional investors," was largely the result of greater accessibility to the China A-shares market via the Stock Connect program and the loosening of pre-approval requirements by local stock exchanges that can restrict the creation of index-linked investment vehicles.
Using Hong Kong as a linchpin, the Stock Connect scheme allows investors to trade approximately 1,480 yuan-denominated stocks onshore without needing to apply for a license and quota or being subject to capital mobility restrictions.
The scheme began with Shanghai in November 2014 and later extended to Shenzhen last December. Remy Briand, chairman of the MSCI Index Policy Committee, called the expansion of Stock Connect "a game changer for the market opening of China A shares."
To start with, approximately $17 billion to $18 billion will flow into the A-share market due to funds tracking the benchmark Emerging Market index based on a 5% inclusion factor, according to Chin-Ping Chia, MSCI's head of research during a Wednesday teleconference. Chia expects inflows to be 20 times larger if the whole market were eventually included.
The 5% partial inclusion factor means A shares will make up 0.73% of the Emerging Markets Index, and roughly 0.1% of the All Country World Index. They will be counted as part of the Chinese equities universe, now largely made up of offshore shares listed in Hong Kong and the U.S., accounting for 27.7% of the MSCI Emerging Market Index as of May 31.
Only large-cap companies accessible through the equity-link programs will be eligible for inclusion into the indexes, while securities suspended for more than 50 days in the past 12 months would be banned.
As a result, the investment universe for yuan-denominated stocks referenced by the MSCI China Index would shrink to 222 stocks from 448 proposed last year; and the total number of constituents in the index will be increased to 418 from the current 150.
The inclusion process will be implemented in two phases, unless the daily limit on Stock Connect is abolished or significantly expanded, according to Sebastien Lieblich, MSCI's global head of index management research. The consultation in May also proposed to calculate the index with the offshore exchange rate as opposed to the one for its onshore currency.
Ken Wong, client portfolio manager at Eastspring Investments, said that the 5% inclusion would mean little in terms of fund flows into A shares, but positive for market sentiment and A-shares' standing.
"Hopefully the A-shares market will be fully reflected on the index in five years," said Wong, noting that it is the world's second largest equity market behind the U.S. with a market capitalization totaling $7.2 trillion and an average daily turnover of $67 billion of May 31.
"But it is contingent on the degree of the liberalization of China's onshore market, the convertibility of the yuan, and the opening up of its capital account," said Wong, adding that there is a need to boost foreign ownership, which only represented 1.4% of the market at the moment, versus 56% of domestic retail investors and 38% of restricted shares.
Last year, the New York-based compiler of capital market benchmarks rejected A shares due to concerns over extensive trading suspension, gains repatriation limits under the Qualified Foreign Institutional Investor program, and preapproval requirements by the Shanghai and Shenzhen exchanges on launching financial products.
Most of such issues remained unresolved to date. "The number of trading suspensions in the China A-shares market remains by far the highest in the world," MSCI highlighted in its May consultation, noting the sum of cases exceed 100, or 5.3% of the MSCI China A International index.
While China's domestic stock market has been performing steadily this year, with the CSI300 index returning 7.14% year-to-date, some stocks available through the trade links has been outperforming the benchmark in anticipation of MSCI's nod.
"Market interest will definitely concentrate on stock-connect related names," Raymond Chan, chief investment officer for Asia Pacific equities at Allianz Global Investors, told reporters in Hong Kong on Tuesday, noting more upside among stocks in the consumer, technology and industrial sectors, but correction and volatility in the short-term due to profit-taking activities.
Although he said MSCI's inclusion had no an immediate impact on his investment strategy, he is planning to add more exposure to A shares due to their "underrepresentation" in the benchmark.
Meanwhile, MSCI said it would consider adding the Argentina and Saudi Arabia indexes into its emerging markets index in its market classification review next year. Argentina stocks were rejected this round on uncertainties over the sustainability the recent improvements in market accessibility, such as removal of capital controls and foreign exchange restrictions.
Lieblich said the inclusion into MSCI indexes was purely a quantitative decision, factoring in market size and stock liquidity, whereas corporate governance issues were not under consideration.