MSCI's China index inclusion risks liquid headache

An investor reacts in front of an electronic board showing stock information at a brokerage house in Shanghai, China, March 7, 2016. REUTERS/Aly Song

HONG KONG (Reuters Breakingviews) - MSCI’s latest China plan still has some holes. The U.S. index provider will decide later this month whether to add yuan-denominated shares to key equity benchmarks. Scandals and trading halts at Hong Kong-listed mainland firms have made passive fund managers’ jobs difficult already. Bringing in onshore tickers could complicate things further.

MSCI will announce on June 20 whether A-shares traded on mainland exchanges will finally join its $1.5-trillion emerging markets index. The odds look skewed towards inclusion. In March MSCI slashed its original list of 448 candidate stocks down to 169, all of them tradable via the Stock Connect programmes linking Hong Kong to exchanges in Shanghai and Shenzhen. By doing so MSCI partly addressed issues of concern among its constituents, namely worries about market access and cross-border profit remittance.

Graphic: Doing much better:

Less clear, however, is how asset managers will cope with the continued proliferation of prolonged trading halts on the mainland, one of three main reasons cited for not including A-shares last time around.

Suspensions of mainland shares in Hong Kong have already caused problems. China Huishan Dairy and Hanergy Thin Film, for instance, grew big enough in market capitalisation to be added to MSCI’s China benchmark. Unfortunately they both got suspended from trade afterwards, trapping the cash managers had invested in order to replicate the benchmark.

On the mainland, where companies can easily request a trading halt, the problem is more acute. In Shanghai, 77 stocks, or 5.8 percent of the total, were suspended as of June 1. MSCI reckons the proportion of shares suspended from trading in China is the highest in the world. At the peak of 2015 market crash around 300 mainland names stopped trading, many with only vague explanations. Some of the firms that halted so can be found among the 169 stocks that would be ported into MSCI’s index under the new plan.

MSCI is trying to reduce this risk by excluding Chinese companies that have halted trade for over 50 days. Embarrassed Chinese regulators are also moving to discourage whimsical suspensions. But new halts are still possible, and when they follow allegations of fraud or other governance problems they ding confidence. If MSCI decides to wait another year, this might be the reason why.


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