Traders at work at the New York Stock Exchange on May 13 (XINHUA)
Overseas investors are enthusiastic about the Chinese stock market as the equities are attractively priced and investors can expect profitable returns in the long run.
This is the verdict of Mark Makepeace, head of FTSE Russell, the second largest index provider in the world, whose organization will include Chinese shares in its major benchmarks.
On May 25, the London-based index provider announced details, saying 1,097 Chinese stocks, traded on the Shanghai and Shenzhen stock exchanges and colloquially known as A-shares, will be added to the FTSE Global Equity Index Series (GEIS) starting on June 24. The inclusion is projected to draw $10 billion from passive investors.
FTSE promoted Chinese shares to secondary emerging market status following a classification review last September, which made them eligible for the inclusion.
Three days later, Morgan Stanley Capital International (MSCI), the top global index provider, announced it would increase the weight of Chinese A-shares in its indexes—which signifies their greater attractiveness for investors—by expanding the inclusion factor to 10 percent from 5 percent. According to China Securities Journal, this will lead to around $20 billion of capital inflows.
MSCI announced in June 2017 that it would include A-shares in the MSCI Emerging Markets Index and the MSCI All Country World Index, and the decision took effect in June 2018.
The New York-based S&P Dow Jones Indices followed suit, announcing in December 2018 that it too would include A-shares. The inclusion is expected to take effect in September.
Global stock index firms are extending their ambit to the A-share market in recent years.
"The moves indicate the internationalization of the Chinese capital market is accelerating," Xu Hongcai, Deputy Director of the Economic Policy Commission, China Association of Policy Science, told Beijing Review. The underlying reason, he said, is the world's recognition of the pivotal importance of China's economy.
An internationalized market
Xu said the inclusion is based on China's opening up, especially of its financial system, which has become more stable and wider.
FTSE first announced in May 2015 that it would begin a transition plan to get A-shares on the GEIS and made a special index for the stocks. It re-assessed their possible entry in the GEIS in September 2017, but refused access as the stocks did not meet the capital mobility and liquidation requirements.
In August 2018, the China Securities Regulatory Commission (CSRC) proposed several measures to deepen reform and opening up for the stable and healthy development of the capital market. The reforms led to the A-shares' inclusion on the GEIS.
"The inclusion was a milestone for the internationalization of China's capital market," Fang Xinghai, Vice Chairman of the CSRC, said in a statement in 2018. Fang called it an important step in the development of China's capital market, reflecting the long-term reforms implemented over the past years.
The inclusions come against a backdrop of China increasing the number and extent of its cross-border equity trading programs with other countries and regions. The Shanghai-Hong Kong Stock Connect scheme was launched in 2014, followed by the Shenzhen-Hong Kong Stock Connect scheme in 2016. The Shanghai-London Stock Connect scheme is in the pipeline.
According to CSRC regulations, foreigners based on the Chinese mainland and overseas employees of domestically listed companies can open A-share accounts. Foreign investors can hold a maximum of 51-percent share in the securities, fund and futures companies.
The relaxations have led to the establishment of several private equity companies with foreign investors, such as UBS Securities, where the United Bank of Switzerland holds a 51-percent stake.
Xu said with China being the second largest economy and given the size of its A-share market, the global asset management industry cannot ignore it if it wants to diversify its portfolio pragmatically. Otherwise, it may lose an opportunity to share the benefits of China's economic growth.
"It is a rational decision they have made to grab a piece from the development of China's capital market," he said, adding that finance has a role to play in the capital market to serve the real economy.
As financial development becomes a priority in China, firms such as Morgan Stanley and FTSE are adding A-shares on their indexes to serve their investors so that the latter can seize the opportunity.
Xu emphasized that the rules and regulations guiding the capital market must be of international standard. He said the Chinese stock market is gaining the international community's recognition due to its steadily rising performance.
China plans to launch a science and technology innovation board at the Shanghai Stock Exchange this year that will focus on hi-tech and strategically emerging sectors such as new materials and biomedicine. It will take this opportunity to align its rules and regulations with international ones in the innovative science and technology field.
A boon for the market
The A-share inclusion on global benchmarks will benefit both overseas investors and the domestic market.
According to China's securities group Huatai Securities, the inclusion will help the capital market in three ways. In the short run, it is likely to boost market confidence and encourage investors to have a high appetite for risks. It will also bring in capital inflows. Finally, it is a critical link in the internationalization of the A-share market and will help the domestic capital market align with international ones to attract more overseas investors, especially institutional ones. This will improve the domestic stock market's investor structure and investment climate.
"China is a country with high savings," Fang said at a press conference in Shanghai in September 2018. "But it lacks long-term investments whose profit and loss won't be calculated at the end of each year."
With the CSRC trying to bring in more long-term investors, Fang said the FTSE inclusion takes it one step closer to that goal.
To allay foreign investors' concerns, he said the CSRC is streamlining cross-border trading mechanisms and adopting a series of management measures to help overseas investors make transactions. It will optimize the stock suspension and resumption system to meet the needs of the international market. It will also change the structure of mainland portfolios and gear them toward more long-term investments.
Makepeace said most Chinese investors are individual dealers who look for quick returns. But as the market opens wider, more foreign investors are coming in. They are likely to make targeted adjustments that would further rationalize market behaviors. Domestic investors must learn to adapt to the foreign investment model.
Shi Bin, lead portfolio manager of UBS Asset Management, said as A-shares are added to global benchmarks, the number of long-term institutional investors will increase. They will introduce different strategies that will be driven by long-term investment in good performing companies instead of speculative trading. The internationalization of the A-share market will also optimize corporate governance.
Xu noted that in the past, the opening up of the capital market was characterized by the free flow of production factors. This time, the highlight is inclusive rules and regulations. "The inclusion brings opportunities for domestic reform and innovation as there is great room for the Chinese capital market to improve its systems and mechanisms," Xu said.
Copyedited by Sudeshna Sarkar
Comments to email@example.com