18 December 2018
MSCI has hinted that even if China's A shares are not added to the emerging market indexes in June, their inclusion may come in the near future as long as Beijing steps up its reform initiatives. Photo: Getty Images
MSCI has hinted that even if China's A shares are not added to the emerging market indexes in June, their inclusion may come in the near future as long as Beijing steps up its reform initiatives. Photo: Getty Images

Enjoy the pre-MSCI inclusion euphoria

We all know that one of the most exciting moments in a romance is when a man and a woman, who have yet to formalize their relationship, drop hints of affection at each other in a subtle, if ambiguous, manner.

We can see exactly the same thing happening in investment circles. As rumors fly fast and thick, people are watching closely whether Morgan Stanley Capital International will include China’s A-share markets in its emerging market indexes when it announces the results of its market classification review on June 10.

If the A shares are included, it will surely be big news both in Hong Kong and mainland China.

From my perspective, it may not be a definite “yes” or “no” this time but something as ambiguous as the song “Quizás, quizás, quizás” (perhaps, perhaps, perhaps).

It seems that MSCI knows all the tricks of keeping the market in suspense.

The annual review will decide whether any equity market can make it to the shortlist and its corresponding weighting. The market has been looking forward to the inclusion of A shares for years yet obstacles like China’s relatively closed capital markets and renminbi convertibility restrictions are in the way. Some have a sinking feeling about the odds this year.

“There is flexibility in the timing of adding A shares to MSCI indexes, given the massiveness of the markets”, Chia Chin-ping, head of equity research and managing director at MSCI Asia Pacific, told the Hong Kong Economic Journal in a recent interview.

Chia also revealed that the timing is not necessarily limited to the upcoming release of the review results.

These remarks are now fueling hopes that MSCI may make an exception – if A shares cannot make it this June, the market may not have to wait for another 12 months.

Typically, MSCI senior executives won’t discuss sensitive matters during the “quiet period” shortly before the review results are released, but Chia’s rare comment is another factor supporting the optimism.

All of these are indeed not hard to understand.

There are three major stakeholders in this matter: Beijing has made it clear it wants to see a swift inclusion and MSCI itself is equally keen especially after its archrival FTSE Group added Chinese shares into its two new emerging market indexes. MSCI needs to catch up to avoid losing ground to competitors.

But the other group of stakeholders – the buy side, mainly composed of major fund houses – has reiterated their objection. Their reasons concern accessibility, exchange rates, taxation and regulatory transparency.

If MSCI insists on pressing ahead, their funds that track emerging markets will be forced to purchase Chinese stocks and it means extra costs and operational difficulties.

Their stance is that inclusion can only come after the mainland markets make enough improvements.

Chia’s remarks about “flexible timing” therefore imply some sort of a compromise – A June inclusion won’t happen, but it won’t take one more year either.

That is like sending a message to Beijing that if it can roll out liberalization initiatives in the following months like the Shenzhen-Hong Kong Stock Connect, optimization of the link-up between Shanghai and Hong Kong, exchange rate marketization, enlarged quotas for Qualified Foreign Institutional Investor and Qualified Domestic Institutional Investor schemes, then, say, in six months, there would be no more reason to object to the inclusion of China.

In that sense we have reasons to believe that the next few months may usher in intensive market reforms, which could become positive trading catalysts.

If the initial weighting of the Chinese shares is set at 1 percent, given that global funds that track MSCI now total US$1.7 trillion, an estimated HK$156 billion of funds could flow into the mainland markets. That figure would just be one-tenth of the A shares’ recent daily turnover, but the psychological impact could be large.

The high expectations and chances to reap some quick gains may matter more to investors than what the inclusion can actually deliver.

When there are months to go and Beijing is expected to act proactively to enhance access and regulation, Chinese shares do look sexy. We hope investors enjoy the bull run.

This article appeared in the Hong Kong Economic Journal on June 2.

Translation by Frank Chen

[Chinese version 中文版]

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MSCI’s Chia Chin-ping said there is flexibility in the timing for the inclusion of A shares. Photo: EJ Insight

Hong Kong Economic Journal columnist

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