What will MSCI's decision bring to A-shares market?

By Cao Zhongming
0 Comment(s)Print E-mail China.org.cn, July 10, 2017
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Morgan Stanley [File photo]

As the old saying goes, those who work hard will be rewarded. After suffering setbacks for three years in a row, China has finally fought its way through various barriers towards the plateau of success.

Global equity index provider Morgan Stanley Capital International (MSCI) announced on June 21 (Beijing Time) that, beginning in June 2018, it will include China A-shares in its MSCI Emerging Markets (EM) Index and the MSCI All Country World (ACWI) Index.

MSCI's decision was made amid a complicated international situation, during which China's securities regulatory authorities worked very hard to enable MSCI to carefully consider its decision and finally agree to press ahead. The whole process is a little bit dramatic, but the inclusion of China A-shares in the MSCI is a great "milestone" in the development history of the A-shares stock market.

A-shares are those issued exclusively by Chinese mainland-based companies in RMB; originally, only mainland citizens could buy them, but this restriction was later eased to allow select foreign institutions to gain access through a program called the Qualified Foreign Institutional Investor (QFII) system.

From 2014 to 2016, there were three failed attempts to seek inclusion in the MSCI. Obviously, China’s A-shares market had its own problems, which could meet neither MSCI’s requirements nor the needs of international institutional investors.

Last year, MSCI identified three major obstacles existing in China A-shares market that need to be addressed: effective implementation of the QFII policy changes and removal of the 20 percent monthly repatriation limit; effective implementation of new trading suspension treatment; and resolution of pre-approval requirements by the local exchanges on launching financial products.

So far, the third obstacle has not been completely cleared yet. However, with the expansion of mutual connectivity through the Shanghai and Hong Kong Stock Connect and the Shenzhen and Hong Kong Connect, and the regulation of arbitrary trading suspensions by the Shanghai and Shenzhen exchanges, more international investors “have embraced the positive changes in the accessibility of the China A-shares market over the last few years.” These approaches have helped to clear the last obstacle for the inclusion of China A-shares in the MSCI indexes.

It must also be noted that the MSCI inclusion is not from the original proposal, but from a slightly improved one based on MSCI’s new proposal last March.

According to the original proposal, the number of A-shares in the pro-forma MSCI China Index would be 448, representing approximately 1 percent of the weight of the MSCI Emerging Markets Index. However the last March proposal cut the list of A-share companies to 169 and only gave Chinese A-shares a 0.5 percent weighting in the index. Encouragingly in the final result, the MSCI decided to include 222 China A-shares, representing an approximate weighting of 0.73 percent.

However, there are still pending problems in China's stock market. Take the trading halts as an example. Although the government authorities have promulgated a series of rules and regulations for market standardization, the number of listed companies which halt stock trading on each trading day still surpasses 200, a high figure in the global capital market.

Trading suspension or delayed resumption of trading can deprive investors of their right to trade, and also result in the shortage of stock liquidity of listed companies, thus enlarging the investment risks.

The MSCI Emerging Market Index is the benchmark index that measures stock performance and is tracked by the largest number of investors. MSCI customers involve 98 percent of the world's top funds. Statistics show more than 6,000 index funds in the world track the MSCI index that involves about US$1.7 trillion of assets.

Therefore, the inclusion of China’s A-shares in the MSCI indexes will generate considerable capitals to the A shares involved.

It is estimated that, with the inclusion of China’s A-shares, the initial inflow of funds will stand at US$17-18 billion (or about 116-123 billion yuan), and if China A-shares are fully included in the MSCI index in the future, the expected inflow of funds will possibly reach US$340 billion (about 2.32 trillion yuan).

A-shares are a money-driven market. With their inclusion in the MSCI, a considerable number of funds will be attracted and it's not hard to imagine the significance.

In addition to attracting investment, MSCI's decision to include China’s A-shares in both the MSCI EM Index and the MSCI ACWI Index will be conducive for investors to have a better understanding of the status of A shares in the international stock market. Drawing on the experience of mature markets, A-shares will increasingly grow more mature and more robust themselves.

At the same time, the move can help investors establish the right investment philosophy, and particularly help retail private investors to form a unique "investment culture" in the A-share market.

When buying A shares, international institutions and investors tend to choose blue chips with outstanding performance and liquidity, while ignoring theme, concept and junk stocks. Being hotly sought after, blue chip stocks will certainly generate a wealth effect, and then guide investors to pay more attention to investment in this field and gradually form a reasonable investment philosophy.

MSCI’s decision means China needs to improve related systems, strengthen market supervision and better protect investors, and thus enhance growth of the A-shares market. Thus, A-shares will become more attractive to international investors, more conducive to the integration of the A-shares and the global capital market, and more helpful for China's own capital market to grow continuously.

The author is a financial commentator.

The article was translated by Li Jingrong from an unabridged version published in Chinese.

Opinion articles reflect the views of their authors, not necessarily those of China.org.cn.

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