CHINA – Investors should consider the potential impact on their benchmarks and asset allocation of China's project to open its equity markets to international capital, warned MSCI's newly appointed head of index business in EMEA and India Deborah Yang.

"The opening of China and the potential inclusion of China A shares into the emerging markets universe could be a landmark event," Yang told IPE.

"Should the Chinese regulators lift the quota and enable greater mobility of capital, we could potentially see China's weight go from 18% of our emerging market universe today to 30%."

Yang moved to Paris to take on her new role at MSCI at the end of January, having previously worked as head of client coverage for MSCI Asia ex Japan in Hong Kong.

"This is just hypothetical at the moment, and dependent on the regulators making these changes, but it is something we have spoken to a lot of institutional investors about because we want to make sure they are prepared for the impact it could have," she added, pointing out that more than $1trn (€765bn) of assets follow MSCI's emerging markets indices.

Mat Lystra, senior research analyst with Russell Indexes, also indicated the changes could be meaningful.

"If the entire A-share market were to suddenly open to all global investors, and assuming Russell were to hold a significant portion of that in our indexes, it could more than double China's weight within the Russell Global index and the Russell Emerging Markets index," he said.

But he added that the current qualified foreign institutional investor (QFII) programme had been "slow to allocate quota" and that there was  "a long road ahead" for the opening of China's equity and currency markets.

In April 2012, the authorities raised the available QFII quota from $30bn (€23bn), where it had been set in 2007, to $80bn (€61bn).

Later that year, China indicated that it could raise that limit if it were reached.

In addition, the authorities raised the Renminbi Qualified Foreign Institutional Investor (RQFII) quota, which allows investors to channel offshore yuan-denominated funds into mainland stocks, from CNY70bn (€8.4bn) to CNY270bn (€32.4bn), at the request of the authorities in Hong Kong.

In January 2013, China Securities Regulatory Commission (CSRC) chairman Guo Shuqing said it could increase both programmes' quotas tenfold.

Qualifying terms have also changed, including the requirement for companies to have been operational for 30 years – now reduced to just five.

Jessie Pak, managing director for Asia at FTSE Group, said: "Many view these developments as a strong signal reforms are underway that would ultimately lead to the reclassification of the China A-share market for inclusion in international equity benchmarks."

Under the FTSE Country Classification process, China A shares have been one of four markets included in the 'Watch List' for potential inclusion as a secondary emerging market since 2004, according to Pak.

While the company does not speculate about the market impact of potential changes, it does calculate a Watch List Index Series as an indicator of what current market performance would look like if certain 'FTSE Watch List' events had already taken place.

"Using this framework," Pak said, "FTSE is engaging with China's regulators, exchanges and market practitioners to examine development of the China A-share market and will keep investors informed of progress."

David Blitzer, chairman of the Index Committee at S&P Dow Jones Indices, said his firm expects the process of China opening its economy to continue, but "we do not have any timetable in mind".

He added: "If and when markets become open to global investors, S&P Dow Jones Indices will review relevant index rules and align indices to market conditions and regulations.

"We do not have an estimate of the percentage allocation [to China in revised emerging market indices]. Any number depends on when China opens its equity markets, what restrictions are placed on certain sectors and what the rest of the world equity markets look like at that time."

Should index providers decide it is time to include Mainland China's stocks in their benchmarks, it would be an important move both for the asset allocation of passive investors and the stock selection of active investors.

"Our China A-shares index has 505 securities, while our current International China index has just 140, so you can see the number of securities that would be added could be substantial," said Yang. "That means a significant addition of securities investors may need to take a view on."

The performance of the A share and offshore H-share markets diverged quite dramatically during the second half of 2012.

Over the past 12 months, the Shanghai Stock Exchange A-Share index is down 5% while the Hang Seng index is up 7.6%.

Between July and November 2012, A shares were down 7.2% versus a rise of 9.7% in H shares – a 17 percentage point divergence in just four months.