Credit rating agency Moody’s Investors Service has announced that MSCI’s decision to include China A-Shares into its MSCI Emerging Markets Index is positive for inflows into Chinese equity markets.
MSCI has decided to adopt a partial inclusion policy of Chinese A-Shares in its global indices.
Moody’s writes: “The MSCI inclusion is significant in that it will pave the way for global capital inflows into China’s A-shares by linking them to the most dominant trend in asset management – the increasing adoption of low-cost passive index funds. Over $11 trillion of investor capital is linked to MSCI indices worldwide. The partial inclusion will start with an approximately 0.73% weighting of China’s A-shares in the MSCI Emerging Markets Index (Exhibit 2), which translates into approximately $11 billion of near-term fund inflows into China’s onshore markets from funds benchmarked to that index.”
A-shares are Renminbi-denominated securities of Chinese incorporated companies that trade on either the Shanghai or Shenzhen stock exchanges. They can only be traded by residents of the People’s Republic of China or by foreign investors via an official quota scheme such as the Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) programmes.
China’s involvement in MSCI’s mainstream indices had previously been limited to Hong Kong-listed H-shares and Red chips.
MSCI has engaged in an annual review on whether to adopt A-Shares into its global indices since June 2013. Until this year however, the verdict was to postpone inclusion until various investor issues such as quota accessibility and repatriation restrictions had been addressed.
MSCI believes concerns over capital mobility have been partially allayed by the launch of the Shanghai and Shenzhen Stock Connect programs, which promote two-way capital flows into the local A-share market. As Moody’s notes: “The December 2016 launch of the Shenzhen Connect, which gave investors access to approximately 1,480 Shanghai and Shenzhen stocks with no licensing or quota requirements – and, importantly, no capital mobility restrictions – was a primary factor which made it feasible for MSCI to include A-shares.”
MSCI did not opt for full inclusion of Chinese A-Shares this year however. Instead it will include mainly large cap companies that are accessible through the Shanghai and Shenzhen Stock Connect programs. This move is to more accurately reflect the progress China has made thus far in opening up its markets.
Commenting on the impact of the decision, Moody’s writes: “MSCI Emerging Markets indices will have representation from the world’s second-largest domestic equity market by market capitalization. Accordingly, they will be better able to satisfy investor demand for broad-based index exposure to China’s economy and also enable investors to build additional strategies using the domestic Chinese market. This should lead to increased client demand and diversification benefits for investors. Furthermore, increased foreign participation has the potential to raise corporate governance standards in China and further promote passive investing.”
Moody’s continues: “We expect ongoing regulatory liberalization in China’s onshore market to lead to a full index inclusion of A-shares in the next few years, with an estimate of a 20% weight within the MSCI EM Index. Full inclusion is key for China to attract fund inflows, which would spur renminbi internationalization, and bolster investor confidence. Additionally, increased foreign participation could help improve corporate governance in China and, as a result, make Chinese equities as an asset class more suitable for indexing and passive investing. We expect that more international institutional investor participation in the onshore, largely retail-driven market will improve corporate governance and align the market more with mature international peers over time.”
Over $1.5 trillion of assets were benchmarked to MSCI’s Emerging Markets index family as of 31 December 2016. MSCI is the second global index provider to include A-shares into its emerging market index after FTSE Russell’s inclusion in May 2015.
Several large ETFs that track the MSCI Emerging Markets Index will be affected by MSCI’s decision to add A-shares, including the $32 billion iShares MSCI Emerging Markets ETF and the $32.4 billion iShares Core MSCI Emerging Markets ETF. To align their portfolios with MSCI’s updated index constitution, these funds will also have to buy A-shares.