March 11, 2019 / 3:01 AM / 4 months ago

Breakingviews - Chinese stock xenophobia is a problem for MSCI

The MSCI logo is seen in this June 20, 2017 illustration photo. REUTERS/Thomas White/Illustration

HONG KONG (Reuters Breakingviews) - Chinese financial xenophobia has thrown a wrench in MSCI’s plans to offer up smaller local companies. Days after expanding the weight of mainland shares in its benchmarks, the index provider had to drop a popular tech stock thanks to policies capping foreign shareholdings. If happens too often, its indexes will be less representative of demand, and economic reality.

    On Feb. 28, MSCI announced it would quadruple the weight of A-shares in its Emerging Markets Index, tracked by an estimated $1.9 trillion in funds. Some of the new joiners will come from Shenzhen, including the technology-heavy Chinext growth board; by November the global benchmark should host 168 mid-cap mainland stocks. Their inclusion will better reflect the new Chinese economy, where sectors like biotechnology, automation and consumer services are playing an outsize role driving growth.

    But Beijing’s mixed feelings about foreigners have resulted in a policy snag. Officials desperately want overseas institutions to help stabilise volatile, retail-driven exchanges. To make it easier for funds tracking MSCI to trade constituent shares, regulators relaxed quotas on the “Stock Connect” programmes linking Hong Kong to markets in Shanghai and Shenzhen, eliminating the total cap for foreign inflows in 2016. That helped foreigners acquire a net $44 billion worth of mainland equities in 2018.

     Yet China left in place a 30 percent limit on foreign ownership in individual firms. When offshore investors bought up shares in Han’s Laser Technology, a $6.7 billion manufacturer from Shenzhen, regulators froze their purchasing as it approached the threshold. MSCI reacted by deleting the ticker from its China indexes, and proactively slashed the weighting of white goods giant Midea for the same reason. Shares in both companies dropped sharply.

    Funds tracking any index must be able to easily trade its constituents, so MSCI had little choice. But the more investors plough into Chinese firms, the more they might crowd out passive managers. If they get under-weighted or evicted as a result, those companies lose access to stable long-term investment. That’s a quandary for MSCI, as well as rivals FTSE and S&P, who are preparing to import A-shares into their indexes too. And it’s a bad look for China’s market opening.   

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