A-shares come in from the cold
Until now excluded from international benchmarks, China’s US$7.9trn onshore equity markets have moved a step closer to inclusion in MSCI’s indexes. For the last few years MSCI’s assessment of China’s mainland-listed A-share markets has been “closer, but still no cigar”. Although welcoming China’s progress towards international standards, each year the index compiler has refused to include A-shares in its emerging markets benchmark, citing a list of obstacles standing in the way.
Last Thursday, however, MSCI struck a different tone. In a “consultation” document, it outlined a pragmatic route around these obstacles, based on improvements in market access offered by the “Connect” schemes which link the mainland’s markets to Hong Kong. As a result, the chances that China’s A-shares could be included in MSCI’s indexes following this year’s June review are looking up.
When it last rejected China’s inclusion in June 2016, MSCI highlighted three remaining objections:
1) The 20% of net asset value monthly repatriation limit on qualified foreign institutional investors, or QFIIs.
2) The high number of protracted trading suspensions in A-share markets.
3) The insistence of Chinese regulators that overseas institutions should gain pre-approval from mainland exchanges for any new—or existing—financial products linked to A-shares.
In last Thursday’s note, the first of these objections was waved aside with a question that carried more than a hint of rhetoric: “Does the Connect scheme alone provide sufficient accessibility?”
On launch, neither the Shanghai nor Shenzhen Connect schemes received the rapturous welcome from international investors some had expected. After an initial flurry, most days have seen only a fraction of the daily northbound quota used, particularly in the aftermath of the mainland’s 2015 market crash. Yet as onshore equities have rallied, the cumulative northbound position has continued to grow, reaching RMB189bn (see chart). This figure is far smaller than the RMB2.5trn associated with the QFII and (renminbidenominated) RQFII programmes. But the Connect scheme is far more flexible, not least due to the absence of a monthly repatriation limit.
In recognition of this progress, MSCI is proposing a new lite version of its previous inclusion plan. To avoid duplication, MSCI is no longer proposing to include the Ashares of Chinese companies which also have Hong Kong Hshare listings. As a result, the number of A-shares entering the MSCI China and MSCI EM indexes would fall from 448 to 169, which would reduce the initial pro forma weighting of A-shares in MSCI EM from 1% to 0.5%.
The other important element in the new plan is a rule rendering ineligible securities that have been suspended for more than 50 days over the last 12 months. This is a practical solution to last year’s second objection. Although MSCI notes that suspensions have come down a lot from the crisis levels of 2015, they remain high by international standards.
The third obstacle is the stickiest. Institutional investors will balk at A-share inclusion if they are suddenly required to seek Chinese approval for existing products, such as ETFs, based on the MSCI China or MSCI EM indexes. MSCI says discussions on this continue.
They have at least one factor in their favour. The head of the China Securities Regulatory Commission, Liu Shiyu, is rumored to be angling for the job of governor of the People’s Bank of China when the incumbent, 69-year-old Zhou Xiaochuan, steps down. Securing MSCI inclusion would burnish Liu’s claim to have normalized onshore equity markets, compared with the chaotic state he inherited last February (remember the circuit-breaker fiasco of January 2016).
If MSCI and the CSRC can strike a deal on this third point, and if mainland markets continue their no-drama gradual rise through the rest of the first half (which appears probable) then the way will be cleared for MSCI to announce the inclusion of Chinese A-shares in its indexes in June.