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Class A shares in global index? Hopes mount

By Ye Zhen | May 13, 2013, Monday | Print Edition

TALKS are underway about integrating China's yuan-denominated Class A shares into the MSCI Emerging Markets Index, but Chinese investors better temper their enthusiasm because the upgrading isn't likely to happen any time soon.

After the China Securities Regulatory Commission disclosed the talks at a media briefing last month, hopes were stoked that inclusion in the MSCI would unleash a flood of new money from index-linked funds. But it all depends on how fast China is willing to open up its markets to global investors.

Launched in 1988, the MSCI Emerging Markets Index is a gauge of equity market performance covering more than 2,700 securities in 21 economies. In addition, MSCI has more than 6,200 clients across the world, ranging from global pension funds to boutique hedge funds.

Its indices are used as benchmarks in allocating portfolios of stocks and other investments. Any significant adjustment of an MSCI index can lead to a substantial flow of funds from global investors.

Analysts said including Chinese A shares in the Emerging Markets Index could bring added liquidity to the domestic markets in Shanghai and Shenzhen.

"The communication between the CSRC and MSCI indicates that regulators are seeking to boost the foreign appetite for A shares, and that has lifted investor expectations," Beijing-based Citic Securities said in a note to clients.

The addition of A shares into the MSCI index could bring about 1 trillion yuan (US$161 billion) into China's stock market, the broker said.

Z-Ben Advisors said global asset managers would increase their exposure to A shares in order to reflect China's weight as the world's second-largest economy.

But the investment consultancy cautioned that "any movement to add A shares to global indices will take many years, due to restrictions on foreign investment and China's capital account."

Currently, Chinese shares have a weighting of about 18 percent in the MSCI Emerging Markets Index because of the inclusion of Hong Kong-listed H shares and foreign-currency denominated Class B shares listed on the Shanghai and Shenzhen markets. No Class A shares have been included to-date because of market access restrictions.

If China's A-share market were completely open to foreigners, China's index weight would expand to about 30 percent, according to Diana Tidd, head of the MSCI Americas index business.

However, that could be a long and very gradual process. Market accessibility for non-domestic investors is an important criterion for inclusion in the MSCI Emerging Markets Index. That means foreign investment accounting for at least 5 percent of a market's capitalization, said Citic Securities, citing the experience of other markets.

Currently, foreign money accounts for only about 1 percent of market capitalization on the Shanghai and Shenzhen exchanges. The main channel now for foreign investors is the Qualified Foreign Institutional Investors program. The quota for that program is set at US$80 billion. It would have to be raised significantly to begin to make a big difference in market capitalization.

Meanwhile, there are also investment caps that pose difficulties for investment fund managers.

Except for sovereign wealth funds, central banks and foreign monetary authorities, most investors participating in QFII are still subject to a ceiling of US$1 billion in investments. Also, QFII participants are allowed to hold up only to a 30 percent combined stake in a listed company.

Capital controls

"For large, passive exchange-traded funds with assets of more than US$45 billion, they need at least a US$5 billion A-share investment quota to fully replicate the MSCI Emerging Markets Index," China International Capital Corporation Ltd said in a research report. "That would not be possible under the current market restrictions."

As if all that weren't impediment enough, Chinese capital controls play into the mix. For example, under the QFII program, which allows participants to invest yuan raised in Hong Kong in mainland securities, funds must be remitted to the designated account within six months of participatory approval. Lock-up periods for the funds range from three months to one year, depending on the type of institutions.

"Such restrictions affect liquidity and flexibility, and prevent funds from investing based on market timing," said the CICC report.

China has reiterated its intention to further open up the country's capital markets, but analysts said the changes will not happen overnight.

"Drastic deregulation could unleash an influx of foreign funds, push up the Chinese currency and raise inflationary pressures while weakening Chinese exports," David Chu, chairman of Hua Nan Securities Co, told the Taipei Times.

Chu said he does not expect an aggressive relaxation in restrictions governing fund inflows in the near future.

The inclusion of a market's shares in global indices depends on how fast the market is opened. It took Taiwan nine years to become fully included in the MSCI Emerging Markets Index and six years for South Korea.

Guotai Junan Securities predicts China's A shares be added to the MSCI index within three to five years and get up to full weight in 10 years, if China maintains its current momentum of market deregulation.

Last year, Chinese regulators raised investment quotas under the QFII program to US$80 billion from US$30 billion and the quota for the Renminbi Qualified Foreign Institutional Investors (RQFII) program, which allows participants to invest yuan raised in Hong Kong in mainland securities, to 270 billion yuan from 70 billion yuan.

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