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LONDON, March 12 (Reuters) - Index compiler MSCI plans to include China's mainland-based A shares in its benchmark emerging market index from May 2015, as the country gradually opens up its domestic yuan markets to foreign investors.
MSCI has started consultations with investors and will make a final decision in June, the firm said in a consultation document. (here)
China, the world's largest emerging market, is already the biggest component of the MSCI emerging market index, benchmarked by more than $1.3 trillion of global assets under management.
Its part of the index is currently taken up by shares listed in Hong Kong, or listed in China but denominated in U.S. or Hong Kong dollars.
But the country has been allowing foreign investors access to its yuan-denominated domestic share base, listed on the Shanghai and Shenzhen exchanges, in recent years through a quota system. Expansion of the quota system has accelerated in recent months, as China looks to liberalise its markets.
"There are over 300 (foreign) investors who already have exposure to A shares," said Chin Ping Chia, head of index research in Asia for MSCI, adding that this group of investors would like to benchmark their performance against an index that includes the asset class.
"Because A shares are not in the benchmark, it creates a benchmark misfit issue."
The inclusion of the Chinese A shares is planned in steps, starting from May 2015 with a small 5 percent of the A shares' market capitalisation.
This would bring China's weighting in the emerging market index to 19.9 percent from the current 18.9 percent.
When China fully liberalises its capital markets, the country's weighting could potentially rise to as high as 27.7 percent, MSCI said.
The move by MSCI makes sense as China aims to eventually make its currency fully convertible and allow greater foreign investment, investors said.
"It's well in line with the roadmap of liberalising the Chinese financial markets," said Karine Hirn, head of Asia at East Capital in Hong Kong.
"It's potentially very good news for the Chinese market but less so for another emerging market whose weight will have to decrease."
The increased weighting for China may disturb investors unwilling to ramp up their exposure to the world's second largest economy, whose stock markets have consistently underperformed in comparison with the country's growth trajectory.
Corporate governance issues have often been blamed for Chinese stocks' poor performance, with the country's shadow banking sector currently coming under scrutiny.
"It's probably valid (to include A-shares) but these are based on a relatively narrow set of criteria and do not reflect real world risk for investors, which is governance at sovereign as well as corporate level," said John-Paul Smith, head of emerging equity strategy at Deutsche Bank. (Additional reporting by Sujata Rao; Editing by Toby Chopra)