Boom time ahead for global investors as China opens A-share market

THE opening up of China’s $3-trillion mainland share market, one of the world’s last big investment frontiers, is setting the stage for a huge shake-up of equity indices and global fund flows.

The giant stock markets of Shanghai and Shenzen, or Ashares, have long been no-go areas for international investors, who have been largely confined to the offshore, Hong Konglisted H-shares that represent China in global equity indices.

These have taken most of the $50bn or so that EPFR Global estimates has flowed to China equity funds since 1995. That is about to change. Beijing is expanding its QFII and RQFII quotas, schemes that allow foreigners to buy local assets.

More than 220 foreign money managers now hold total quotas worth more than $80bn.

Regulators signalled last month that a 10-fold quota increase is on the cards.

Expanding quotas that much would give foreigners access to 15% of the free float, up from 1.3%, and the news triggered a 4% jump in the market.

Longer term, it will allow the shares to blast into equity indices run by major providers such as MSCI and FTSE. They do not meet entry criteria for these indices because of restrictions on foreign ownership and on cash movement in and out of China.

“China A-shares is something we are taking very seriously,” said Deborah Yang, head of index business in Europe for MSCI, which has $7-trillion benchmarked to its indices.

“It is one of the changes we are seeing which could be monumental for global equity markets.”

To give an idea of the potential effect, Ms Yang says that in a scenario where A-shares become fully accessible, China’s weighting in MSCI’s emerging stock index, tracked by $1.4-trillion, would jump to 30% from 18%.

China’s share of MSCI’s allcountry index would meanwhile double to more than 4%, Ms Yang said, though she stressed that inclusion in indices depends on how fast the market is opened.

Donald Keith, deputy CEO of FTSE Indices, which has $3.5trillion benchmarked, forecasts Chinese A-shares will be in global indices within five years. He declined to predict possible weightings but said full inclusion could see China jump to fourth place in the FTSE world index from 11th, leapfrogging Japan. In the emerging index, China’s weight would be close to 40%.

“Index providers have to reflect available opportunities. It also means investors will have to take fairly substantial action on their portfolios,” he said.

Investors are undoubtedly keen. The proof lies in the explosion of exchange traded funds (ETFs) replicating the mainland market in recent years. The market’s plus is that it contains 2,300 firms compared to the 170 or so that trade in Hong Kong. They are also more likely to be consumer and retail firms, while big energy, telecom and financial firms dominate offshore listings.

“The A-share market is effectively a frontier market in the world’s second-biggest economy,” said Karine Hirn, Shanghai-based partner in Swedish investment firm East Capital, which got a QFII licence this year. “In terms of diversity and investment themes the A-share market is great, you get direct exposure to the Chinese consumer story.”

Opening the market makes sense for Beijing, which is fed up with volatility in A-shares, fed by rumours and besmirched by insider trading scandals. Many of the problems are attributed to its 75% ownership by retail investors. Offering greater equity access is also part of Beijing’s plan to make Shanghai a global financial centre and to make the yuan used more broadly, analysts say.

“It’s all part of China exporting itself to the world,” said chief information officer Bill Maldonado, at Asia-Pacific HSBC Global Asset Management.

But Mr Maldonado also voices investors’ fears on the effect of the index. “Not everyone will want to be benchmarked to an index that has so much weighting to one market. It raises the question of why should market cap drive benchmark weight, and how much attention should you pay them?” So what will be the fallout if China swells share indices?

At stake is a huge amount of money. China, at almost half the emerging index, will mean a proportionate drop in other countries’ weighting and potentially, investment inflows.

Russia’s Sberbank, for instance, wrote that a 1% fall in Russia’s 6% weight in the MSCI index in favour of China implies a $10bn outflow from indextracking funds.

Sberbank acknowledged that A-share inclusion will not happen in one fell swoop. But it warned that the very possibility “creates an air of uncertainty across the EM index structures and, generally, means that investor preference for China funds is likely to remain in place.”

Many will argue, however, that China is actually under-represented in benchmarks, given its size and economic strength.

Second, index officials stress inclusion will be gradual and over several years, proceeding after consultations with clients.

Ms Yang compares the process in China with Taiwan, which also had a quota system for foreigners and joined the emerging markets index between 1996 and 2005. South Korea also took six years to get up to full weight, she says.

Similarly, Malaysia accounted for a third of the MSCI emerging index in 1988. The US makes up almost half the all-share index.

“There have been major changes in the EM index since inception in 1988. This kind of evolution will continue,” Ms Yang said. “Including China A-shares could significantly add to the global opportunity set available to investors.” Reuters