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Business
Joining the Elite Club
MSCI's inclusion of China's A-shares demonstrates recognition of the country's reform efforts
By Zhou Xiaoyan | NO. 27 JULY 6, 2017
Investors look at stock information on an electronic board at a brokerage house in Shanghai on December 30, 2016 (XINHUA)
Lin Hong, a 30-year-old stock investor living in Beijing, was thrilled upon hearing that Morgan Stanley Capital International (MSCI) decided to include China's A-shares in its indexes. He expected the long-awaited move by the leading provider of global equity indexes would be a boon for his stock assets.

Lin invested roughly half a million yuan (about $75,000) in the then bullish stock market in the first half of 2015. The stock market, however, plunged just months later and has been in the doldrums ever since. Despite prolonged government efforts to lift the market, the benchmark Shanghai Composite Index has almost halved from a peak of over 6,000 points to the current status of around 3,100 points.

"Although it may have little impact in the short run, the MSCI inclusion is definitely good news for the Chinese stock market in the long run," Lin told Beijing Review, adding that he's confident he will recover his hefty investment losses, though he's not sure when.

MSCI announced on June 21 that from the start of June 2018, it will include China A-shares in the MSCI Emerging Markets (EM) Index and the MSCI All Country World Index. A two-step inclusion process will be used, with the first step coinciding with the May 2018 Semi-Annual Index Review and followed by the second step, which will take place as part of the August 2018 Quarterly Index Review, according to a statement from MSCI.

MSCI plans to add 222 China A large-cap stocks, approximately 0.73 percent of the weight of the MSCI Emerging Markets Index at a 5 percent partial inclusion factor, read the statement.

Sentiment boost

The decision has broad support from international institutional investors with whom MSCI consulted, primarily as a result of the positive impact on the accessibility of the China A-shares market in terms of the Stock Connect program. It would also loosen the re-approval requirements for local Chinese stock exchanges that can restrict the creation of index-linked investment vehicles globally, according to the statement.

"International investors have embraced the positive changes in the accessibility of the China A-shares market over the last few years and now all conditions are set for MSCI to proceed with the first step of the inclusion," said Remy Briand, MSCI Managing Director and Chairman of the MSCI Index Policy Committee, in a news release.

MSCI also announced that further inclusion will be subject to greater alignment of the China A-shares market with international market accessibility standards, the resilience of the Stock Connect program, the relaxation of daily trading limits, continued progress on trading suspensions, and further loosening of restrictions on the creation of index-linked investment vehicles.

Xu Hongcai, deputy chief economist with the China Center for International Economic Exchanges, a Beijing-based think tank, hailed the MSCI inclusion, calling it a milestone for China's capital market.

"The successful inclusion of A-shares into the MSCI indexes will significantly boost the Chinese stock market. The symbolic event marks further alignment of China's capital market with the global market," Xu told Beijing Review.

MSCI launched its first global equity indexes in 1969. The New York-based independent provider of research-driven insights and tools for institutional investors currently serves 97 out of the top 100 asset managers in the world, according to its official website.

As a matter of fact, the recent MSCI decision happened after the index provider delayed the inclusion of A-shares for three years in a row—in 2014, 2015 and 2016—citing China's restrictions on market access and on capital flows in and out of the country.

The MSCI inclusion recognizes the rapid progress China has made in making its stock market more accessible to foreign investors.

Over the past few years, arbitrary trading suspensions have been better regulated and restrictions on qualified foreign institutional investors (QFII) and renminbi qualified foreign institutional investors (RQFII) have been further relaxed. In addition, the Shanghai-Hong Kong and Shenzhen-Hong Kong stock connect schemes were launched in November 2014 and December 2016, respectively, to broaden channels for foreign investment in the A-shares market.

"The expansion of the Stock Connect [program] has been a game changer for the market opening of China A-shares," said Briand. "MSCI is very hopeful that the momentum of positive change witnessed in China over the past years will continue to accelerate."

Zhao Xiaojun, a spokesperson for the China Securities Regulatory Commission (CSRC), China's stock market regulator, said China lauded MSCI for its decision.

"Including China's A-shares into the MSCI indexes is an inevitable move to meet the demand of international investors, who have confidence in China's economic prospects and the stability of its financial market. China's capital market will welcome overseas investors in a more open manner," Zhang said at a press briefing in Beijing on June 21.

The inclusion is both an opportunity and a challenge for China's capital market. The CSRC will continue to reform the market toward being more market-oriented, law-based and international, noted Zhang.

According to a research note from the China International Capital Corp. Ltd., the MSCI inclusion will have a positive impact on China's A-shares, although the initial capital inflows following the decision may not produce material influence given the limited number of stocks included. Nonetheless, having China's stocks added to the global investor giant's portfolio will help lift market sentiment.

According to MSCI estimates, initial capital inflow following the inclusion will be around $17 to $18 billion, a negligible amount compared with the nearly 53-trillion-yuan ($7.79 trillion) market capitalization of A-shares and the daily trading volume in the market. MSCI expects the capital inflow to reach around $340 billion if all A-shares are included in the MSCI EM index in the future.

A research note from Bank of America Merrill Lynch predicts that the weight of A-shares in the MSCI EM index is likely to reach 20 percent if all A-shares are included, which might take around 10 years, depending on several factors including market size, degree of opening up and restrictions on capital flows.

A stock investor in Huaibei City, Anhui Province, uses a smartphone app to track market changes on December 12, 2016 (XINHUA)

Long-term challenges

Liao Zimei, Chief China Investment Director with Robeco, an international asset management firm, told the 21st Century Business Herald, a leading business newspaper in China, that the MSCI inclusion will have far-reaching significance on the internationalization of the renminbi.

"In the future, A-shares will attract more overseas investors, creating a larger demand for the renminbi," Liao explained.

Liao also said the inclusion will increase the presence of institutional investors in the A-shares market, helping rein in speculative activities.

"Following the inclusion, international institutions will devote more research resources to A-shares and invest more in the market. The investor structure of China's stock market will be improved due to an increase in the number of institutional investors and the prevalence of long-term and fundamentals-based investment strategies."

For global buyers, investment opportunities exist in some blue-chip stocks that have very reasonable valuations, such as companies in the consumption, hi-tech and hi-end manufacturing sectors, Liao suggested.

Xu told Beijing Review that the MSCI inclusion has both a positive impact in the short run and far-reaching influence in the long term.

"Although the 222 chosen stocks only account for a limited proportion of the entire market, it will have an exemplary effect on the market. Internationally accepted strategies that emphasize value investing are expected to subtly influence China's volatile stock market where speculative activities were rampant," Xu said.

It's a sign of a more rational and mature A-shares market, further fortifying the foundation of China's capital market, Xu pointed out.

Fang Xinghai, Vice Chairman of the CSRC, said more institutional reforms will be rolled out in China's capital market following the MSCI inclusion.

"The daily trading quotas of the Shanghai-Hong Kong and Shenzhen-Hong Kong stock connect schemes will be further relaxed; the QFII scheme will be improved; and other measures will be taken to tackle the massive inflow and outflow of foreign capital," Fang told state broadcaster China Central Television in an interview on June 21.

"China's stock exchanges should also improve their supervision capability and communication with global investors, so as to encourage more outstanding Chinese companies to get listed in the domestic stock market and lure global companies to sell shares in China when the time is ripe," Fang said.

Fang noted that the massive inflow and outflow of overseas capital may bring about some uncertainties to China's foreign exchange market, which requires a better-designed management scheme.

"For Chinese authorities, the biggest challenge lies in how to achieve effective cross-border supervision, especially in coordinating with local supervisory authorities when overseas markets produce some derivatives of China's A-shares," Fang said.

Copyedited by Bryan Michael Galvan

Comments to zhouxiaoyan@bjreview.com

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