MSCI A-Share Inclusion
This week, after many years of negotiations between Chinese officials and the MSCI, domestic A-shares will begin their multi-year inclusion process into the MSCI benchmark global indices.
By design, and primarily because of problems still seen with the domestic market structure, MSCI will take an extremely gradual approach adding 5% this year into two separate tranches; the first on June 1st and the second on September 3th. The inclusion covers 234 eligible stocks that were pre-approved according to market capitalization, liquidity and past trading behavior; i.e. not being frequently suspended.
This year’s additional weighting, which will include inflows from index-trackers and speculators, is estimated to attract between $18-$40bn, depending on the analyst and how they measure passive managers and the appetite of active funds.
After this year, A shares will have about a 0.8% weighting in the MSCI Emerging Market Index and around 0.1 per cent of the MSCI World index. Ultimately, in a period that could take between 6-10 years, the Mainland stocks will comprise about 17% of MSCI EM. If you include, other globally listed Chinese shares, the total would be 40%. As of the end of 2017, the index is followed by more than $1.9 trillion in assets.
More short-term oriented accounts have been positioning for this move all year, with the volume of the HK-China Stock Connects spiking over the last few weeks. However, the initial inflows are expected to be minor compared with the daily turnover of the Mainland markets which is about $75bn. The real opportunities for China asset investors are longer-term.
Firstly, for international investors, the companies on the Mainland exchanges are a better representation of the Chinese economy and will give investors greater access to high growth firms that are involved in consumption, technology and healthcare.
Secondly, it will give overseas fund managers the opportunity to construct portfolios that are a more accurate representation of the global economy with China now the world’s second largest economy in the world, but only a fraction of global benchmarks.
For domestic investors, there should also be advantages. Currently, the turnover of the Chinese Mainland markets is about 85% retail-driven. Foreign institutional inflows could help dampen volatility and encourage better corporate transparency and more share-holder friendly management.
MSCI is also betting that the increase in overseas investor activity will encourage regulators from making changes that they have been urging for years. These include better currency convertibility, improved market infrastructure and less reliance on share suspension. They have said that further inclusions are dependent on investors being able to "invest without restriction and friction".
The inclusion will also have consequences for Hong Kong regulators in that the inclusion may drain liquidity from their local market as investors shift to A-Shares. This may increase short-term borrowing rates as traders’ scramble to settle shares. The HKMA has taken several steps that can be used as a backstop, including setting up a yuan liquidity facility and a 400 billion yuan (US$63 billion) currency-swap arrangement with the PBoC. They have also told Hong Kong’s main banks that are responsible for providing liquidity in the offshore yuan market to keep their credit lines with the HKMA clear on June 1.
This week’s inclusion will provide a lot of positive headlines and perhaps opportunities for short-term traders. However, ultimately this is a long-term story that all participants are hoping with bring Chinese domestic equity markets in-line with major developed exchanges and encourage corporate management to align standards with international norms.