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IPE special report May 2018

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China A-shares added to MSCI indices for first time

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An estimated $17bn (€15.3bn) could flow into China’s domestic market as a result of MSCI’s decision to include A-shares in two of its leading index series for the first time.

The index provider has approved 222 large-cap stocks listed on China’s Shanghai and Shenzhen stock exchanges for inclusion in its emerging markets and all-countries indices, effective from next year.

It follows an “extensive consultation” with asset owners and asset managers, both passive and active, said Sebastien Lieblich, global head of index management research at MSCI.

The new stocks will make up roughly 0.73% of the MSCI Emerging Markets index and will be added in two tranches in May and August 2018. Dimitris Melas, managing director and global head of equity research at MSCI, estimated that this could trigger inflows of roughly $17bn based on the volume of passive assets tracking this benchmark.

MSCI also outlined plans to include more A-shares in the future, including mid-cap stocks. This expansion would require further reforms to open up China’s equity market to foreign investors, such as the removal of trading limits and a “significant” reduction in share suspensions, Melas said.

The addition of A-shares to global benchmarks was widely anticipated following the Stock Connect project, which opened up access to and improved communications between domestic Chinese exchanges. Investors responding to MSCI’s consultation said this had proven to be a more flexible path to access domestic equities than via Qualified Foreign Institutional Investor (QFII) and Renminbi Qualified Foreign Institutional Investor (RQFII) licensing regimes.

Yannan Chenye, head of China equities research at Harvest Global Investments, said: “Inclusion in the MSCI index family is a strong signal of greater market openness, and it will undoubtedly help the A-Share market to attract broader attention and participation of international investors. This sharp increase in international market participants will substantially change fundamental features of the market.”

Although the initial impact of the additions would be “slight”, Chenye said a “more balanced investor structure with a higher proportion of institutional investors (both domestic and overseas) will likely result in a change of investment style” in the domestic markets.

In commentary issued this morning, specialist emerging markets manager East Capital urged investors to “speed up the development of their research capabilities and infrastructure operations” if they plan to properly access this market.

“It will take a few years but at the end of the process, China A-shares might represent as much as 20% of the MSCI Emerging Markets index,” East Capital said.

Gary Greenberg, head of emerging markets at Hermes Investment Management, was more cautious, as many of the firms due to enter MSCI indices next year had not fully grasped the requirements of being a listed company.

“We continue to encounter managements of large A-share companies who have yet to appoint an investor relations officer and who see no reason for senior management to meet shareholders,” HE said. “The ability to communicate with foreign investors, even in companies with worldwide operations, tends to be less than world class. For businesses with top line revenues that can top $15bn, this should have been fixed by now.”

Investors can already access Chinese domestic companies via listings on exchanges in Hong Kong, Singapore, the US, and the UK.

In addition to the China A-shares decision, MSCI announced that it would consult on adding Saudi Arabia to its emerging markets universe next year.

The index provider delayed decisions on the future classification of Argentina and Nigeria. Argentina, it said, would not be upgraded to emerging market status as investors had warned market reforms “needed to remain in place for a longer time period to be deemed irreversible”.

For Nigeria, MSCI said it would postpone until November a ruling on whether the country should be cut from its frontier markets index to allow investors to assess a new trading window introduced by the country’s central bank.

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