June 14, 2017 / 4:11 PM / 2 months ago

China A-shares likely to win key MSCI index inclusion, asset managers say

Investors look at computer screens showing stock information at a brokerage house in Shanghai, China, April 21, 2016.Aly Song/File Photo

NEW YORK/HONG KONG (Reuters) - U.S. index provider MSCI will likely open up its Emerging Markets Index .MSCIEF next week to the so-called A shares that make up the majority of China's stock market after previously rejecting them on three occasions, investors and analysts said.

The company has been in discussions with Chinese regulators and global investors for nearly four years over whether to add yuan-denominated shares listed in Shanghai and Shenzhen to the benchmark – tracked by around $1.6 trillion in assets – but has so far left them out because of concerns over restricted access to China’s equity markets.

China has yet to fix all the problems that make it tough for managers to get money in and of the country’s stocks, but investors said the likelihood of inclusion dramatically increased after MSCI this year relaxed its criteria.

"We detect a marked change in MSCI's accommodation this year," Nick Yeo, head of Chinese and Hong Kong equities at Aberdeen Asset Management, said in an email. “The index creator has modified its own admission criteria to such a degree that China’s entry now appears a formality."

In March, MSCI proposed reducing the weighting of Chinese shares for potential inclusion, cutting the number of stocks to 169 from 448 in a bid to address curbs on repatriating capital from China and concerns over the country’s high number of suspended stocks.

The revised proposal helps address these issues because the 169 stocks can be easily accessed by foreigners through a trading link between the Hong Kong and Chinese exchanges launched in 2014 and significantly expanded in December.

If included, A shares will initially make up just 0.5 percent of the MSCI Emerging Markets Index, but they will be diversified with a focus on high quality large-cap stocks that have a low track record of trading halts. The plan would also cut the weighting of financials and increase that of sectors like consumer discretionary, consumer staples and real estate.

"This does provide a better balance of stocks at the sector level," said David MacKenzie, head of Asian equity management at Schroders. "The move toward a larger cap focus does hopefully take care of the issues with share suspensions.”

CAPITAL CONTROLS

Still, China has some way to go to fully open up its market.

Chinese regulators have been working in recent years to meet MSCI's demands that they free up repatriation of foreign capital, reduce the number and length of share suspensions and loosen other rules. But the country's reform agenda has stalled lately as the authorities have battled to prop up the flagging yuan through capital controls.

MSCI Chief Executive Henry Fernandez told Reuters in January that capital controls were a concern, but according to one individual briefed on the matter in April the index provider was still eager to take the first inclusion steps.

A spokesman for MSCI declined to comment on Wednesday. The China Securities Regulatory Commission, the country's markets regulator, and the State Administration of Foreign Exchange, which controls China's capital account, did not immediately respond to requests for comment.

Although such a small initial weighting mostly represents a symbolic victory for China, over time its companies could make up as much as 40 percent of the total index drawing at least $272 billion into China’s equity market, said Luke Oliver, managing director and head of ETF capital markets at Deutsche Asset Management.

Qi Wang, a former MSCI executive director and current chief executive for asset manager MegaTrust Investments, said in a release that he anticipates capital flows could be even greater, bringing $640 billion to the A-share market.

"If you like active management and stock selection, this will be the ideal battleground," Wang said. "No global equity opportunity set would be complete without China A shares."

Reporting by Dion Rabouin, Michelle Price; Editing by Christian Plumb and Steve Orlofsky

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