Managers getting in step
Beneficiary ownership is the third key obstacle. MSCI noted that as many asset owners tend to invest through separate accounts by delegating investment and operational decisions to fund managers, recognizing clear title to ownership for the ultimate beneficial owners is a crucial concern for global investors.
The FTSE also shared the concerns of MSCI, citing the issues of capital mobility, clearing and settlement, as well as taxation, when it refused eligibility for A shares to be included in its indexes in September last year.
And STOXX’S Lou noted: “Foreign investors should be able to freely buy and sell the local currency and there should be no capital restriction as international investors have to be able to move funds freely in and out of the country, which is essential for us to consider for our STOXX standard universe.”
“As the renminbi is not fully convertible, the central government is worried that complete freedom of capital flow may make the domestic share market more volatile, so it has installed the QFII or RQFII quota system for global investors to participate the A-share market,” Patrick Shum Hing-hung, investment manager at Tenguard Fund Management, told China Daily.
“As the quota is limited, foreign investors are worried that inclusion in global indexes at this juncture may pressurize fund managers to scramble for the expensive A-shares.”
In March of last year, MSCI initiated a consultation on a proposed roadmap for A-share inclusion. MSCI proposed that 5 percent of the float market capitalization of A shares be included as the first step, translating into a 1.3 percent weighting of the MSCI EM Index. As there are $1.7 trillion in funds tracking the MSCI EM Index, A-share inclusion is tipped to trigger capital inflows of $22.1 billion into the A-share market. Contact the writer at firstname.lastname@example.org
Even though A shares have as of now been refused entry to global indexes, the exclusion — and even the FTSE’s twin transitional indexes — would likely exert only a neutral impact on the mainland A-share and Hong Kong equity market.
“The effectiveness of FTSE’s launch of two transitional A-share indexes depends on whether there are any mutual investment funds tracking these two new indexes. If there is no such investment fund, these two new transitional indexes would not make any big difference to the financial market,” said Patrick Shum Hinghung, investment manager at Tenguard Fund Management.
Some index fund managers proactively responded to new market changes by switching their tracking indexes to include A shares.
US index fund manager Vanguard Group declared in early June, just a few days after the FTSE announcement, that the tracking index of its Emerging Markets ETF (exchange-traded fund) will switch from FTSE Emerging to FTSE Emerging Markets China A Inclusion Index, with A shares representing 5.6 percent of index weight.
The inclusion of A shares in the MSCI EM Index would spark greater foreign investor participation in the A-share market, and provide diversification benefits in global equity portfolio to overseas investors because of the low correlation between the A-share market and other equity markets, a Bank of America Merrill Lynch (BAML) report said.
The Chinese A- share market is the second-largest equity market globally and its market capitalization of $5.2 trillion is 8 percent of global equity capitalization. Though still a fraction of the $24 trillion market cap in the US, daily turnover of the A-share market in January this year reached $85 billion, exceeding the $68 billion posted by the US stock market, according to BAML.
Bankers expect the continued exclusion of A shares over openness concerns to have only a neutral impact on the mainland and Hong Kong stock markets.