China A-Shares Get Closer To MSCI Inclusion

China A-Shares – According to HSBC, the events of the past few weeks mean that it’s highly likely Chinese A-shares will be made part of the MSCI index family this month, when the index compiler makes an announcement on the subject on 15 June.

There have been calls for MSCI to include Chinese A-shares in its global indexes for some time, but the limits placed on domestic equities by the Chinese authorities have, thus far, prevented their inclusion.

However, over the past few weeks, there have been some significant developments which have indicated that the Chinese authorities are now more open to international investment in domestic equity markets.

For example, on 27 May both the Shanghai Stock Exchange and the Shenzhen Stock Exchange published a “Memorandum on Trading Suspension and Resumption for Listed Companies”. Significantly, the English version was released at the same time as the Chinese version, implying that the target audience was the foreign investment community. What’s more, MSCI has already made it clear that the problem of widespread trading halts in the A-share market is a barrier for a share inclusion in international indexes. Without changes to the problem of widespread trading halts, MSCI warned that the inclusion of 5% of RMB-denominated shares would be unlikely to go ahead. The recent memorandum seeks to address this issue.

China A-Shares – Access expanding 

Access to China’s financial markets for large asset managers has expanded rapidly during the past two months. On 31 May, BlackRock Inc., the world’s largest money manager, received a RMB20 billion (US$3 billion) quota to invest in mainland Chinese stocks and bonds. The State Administration of Foreign Exchange awarded the extra quota to BlackRock’s Singapore unit under the Renminbi Qualified Foreign Institutional Investor (RQFII) programme.

This is the second biggest quota given to asset managers outside Hong Kong, the largest award was picked up by Vanguard Investment Australia, which was awarded a quota of RMB30 billion. Other asset managers also won the right to invest in China’s domestic equity markets last month. Templeton set up China WFOE (Wholly Foreign-Owned Enterprise) in the free trade zone of Shanghai in May, and the US hedge fund Bridgewater Associates also won approval to register a WFOE in Shanghai in May.

The other significant event that shows China’s determination to open up its equity markets to international investors was the granting of a RMB250 billion (US$38 billion) RQFII quota awarded to the US for the first time at the US-China Strategic and Economic Dialogue conference, which concluded on seven June in Beijing. China has approved total quotas of US$81 billion for the QFII scheme and RMB502 billion (US$76 billion) for the RQFII programme. The RMB250 billion RQFII quota to the US is second only to that of Hong Kong’s, or RMB270 billion.

China A-Shares – Moving in the right direction

So, it seems that China is making all the right noises when it comes to MSCI inclusion.

Analysts at HSBC estimate that there is up to $500 billion of capital waiting to flow into the Chinese A-share market over the next five to ten years if 100% of the A-share market is included in MSCI indexes. It is expected that the index compiler will include around 5% of the A-share market this month, which could see inflows of US$28 billion or RMB196 billion into the market. A 10% inclusion factor would likely see inflows of $57 billion according to HSBC’s research and an inclusion factor of 100% would see inflows of $492 billion or RMB3, 546 billion. Based on the experience of other Asian nations, it may take several years for China to hit this 100% hurdle. In South Korea’s case, from its initial 20% inclusion to full inclusion, it took six and a half years, from 1992 to 1998. Also in Taiwan’s case, initial inclusion of 50% to full inclusion took almost ten years, from 1996 to 2005.

At 100% inclusion, foreign funds could make up 10% of the total floatable market cap in the domestic A-share market. By global comparison, 10% foreign holdings in the next 5-10 years’ time is a conservative estimate, as the average foreign holdings for emerging markets is around 25%.

China A-Shares

China A-Shares – Stock connect 

It’s widely expected that as China gears up for MSCI inclusion, there will be further news flow on the much-anticipated Shenzhen-Hong Kong Stock Connect over the next few weeks. Getting Shenzhen-Hong Kong Stock Connect off the ground will help to improve global investors’ access to the A-share market, one of the key considerations for MSCI’s decision on A-share inclusion. 

The Shenzhen Stock Exchange is the world’s biggest bourse with the smallest global following according to HSBC. With a market cap of over US$3 trillion, the market is the world’s sixth-largest. By turnover, the bourse ranks fourth globally, with a daily average of over US$50 billion for the past three months.

The development of this connecting network finally seems to be making progress. On 19 May, Shanghai-listed A-share company Hundsun Electrics announced that the design and development of Shenzhen-Hong Kong Stock Connect trading system was complete. This was the first progress report on technical preparations for the programme.