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MSCI announces inclusion of China A-shares in emerging market indices

On 20 June 2017, the index provider MSCI announced that China A-shares would be added to the flagship MSCI emerging market indices from May 2018, ending four years of consultations.

On 20 June 2017, the index provider MSCI announced that China A-shares would be added to the flagship MSCI emerging market indices from May 2018, ending four years of consultations.

The MSCI proposal, revised in March, is now based on the “Stock Connect” framework, which contributed to alleviate a number of hurdles to the inclusion. Our Greater China Equities investment team, managed by Caroline Yu Maurer, believes MSCI inclusion marks a positive catalyst for Chinese equities and represents a landmark step in China’s integration into the global financial system.

MSCI says ‘yes’ to A-shares inclusion

MSCI’s 5% partial inclusion factor covers 222 A-shares, resulting in an initial weighting of 0.73% in the MSCI Emerging Markets index and 0.85% in the MSCI AC Asia ex-Japan index.

This time, the proposal to include China A-shares was based on the Stock Connect framework rather than the QFII/RQFII framework covered in an earlier proposal. All stocks to be included by MSCI will be large-capitalisation shares currently accessible to foreign investors through the Stock Connect schemes. This includes onshore China large-cap shares that have offshore-share equivalents in the MSCI China index. The offshore yuan exchange rate (CNH) will be used for index calculation instead of the onshore  (CNY) rate.

Why did MSCI approve inclusion this time?

The three past hurdles to inclusion were:

1) capital mobility/repatriation;

2) stock suspensions;

3) local exchanges’ approval to launch products.

By aligning the request for inclusion with Stock Connect, some of the concerns of MSCI and international investors were addressed:

„With the Stock Connect framework, investors can now access domestic Chinese stocks without being constrained by the quotas and repatriation restrictions imposed under the QFII/RQFII schemes.

New trading suspension rules are introduced under Stock Connect. The proposal excludes securities that have been suspended for more than 50 days in the past 12 months from the eligible universe, limiting the number of stocks that are frequently suspended.

Chinese exchanges have loosened their requirements to pre-approve index-linked investment vehicles.

A-shares are due to be included from May 2018, during the index review. We believe the weighting could increase over time and reach full weight depending on the extent to which the government continues to enact further reforms and facilitate investment in China.

Exhibit 1: The A-shares inclusion in numbers

China A-shares

Source: BNP Paribas Asset Management, UBS Global Research, as of 21 June 2017

How should investors be positioned?

We believe inclusion marks a positive catalyst for Chinese equities. The A-share market's progress towards globally accepted rules and regulations should help ease foreign investor concerns. Inclusion should boost investor sentiment and, over the long term, flows into China. It also helps advance President Xi Jinping’s ambitions to make the renminbi a global currency.

Regarding the sector impact, financials and industrials should see their share of the index increase the most, with the information technology sector’s weighting dwindling. The Greater China Equities investment team has been investing in A-shares since the launch of the Stock Connect programme. As such, they should be well-positioned to benefit from this decision which they anticipated by actively investing both in offshore and onshore Chinese equity markets.

This text was written on 21 June 2017 by Jessica Tea and Caroline Yu Maurer

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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