Mainland Chinese stocks fail to make the MSCI's emerging market index, but that won't be the case for long

China Photos/Getty Images

Aside from the question on how long the rally in Chinese stocks can last, there’s been one other question that many market pundits have been asking themselves in recent weeks — Will the MSCI, a global giant when it comes to index funds, admit mainland Chinese stocks (“A” shares) to its emerging market index?

The move, particularly if granted full inclusion in the index, would have the potential to see hundreds of billions of funds move from other emerging markets into mainland Chinese equities.

After much speculation, the MSCI announced its decision this morning.

The answer is no, not yet, but it could happen before the next MSCI annual market classification review scheduled for June 2016.

On a posting on its website the MSCI noted that it “expects to include China A‐shares in its global benchmarks after a few important remaining issues related to market accessibility have been resolved”.

Here’s Remy Briand, MSCI managing director and global head of research, on the decision announced this morning.

“Substantial progress has been made toward the opening of the Chinese equity market to institutional investors. In our 2015 consultation, we learned that major investors around the world are eager for further liberalization of the China A‐shares market, especially with regard to the quota allocation process, capital mobility restrictions and beneficial ownership of investments. Because MSCI’s client base is so large and diverse, we have a strong interest in ensuring that remaining issues are addressed in an orderly and transparent way.”

The three key concerns that prevented mainland Chinese equities from entering the index on this occasion — quota allocation process, capital mobility restrictions and beneficial ownership — are outlined below.

  • Quota allocation process. Global investors told MSCI that having reliable access to quota is a critical requirement. They believe that large investors should be given access to quota commensurate with the size of their assets under management. This is especially important for passive investors, whose investment processes replicate benchmarks. In addition, all investors said that they need sufficient flexibility and assurance to secure additional quota should the need arise. Most international investors have indicated a preference for a more streamlined, transparent and predictable quota allocation process.
  • Capital mobility restrictions. Liquidity is a critical component of the investment process. Regardless of the channel they use, investors say that they need access to daily liquidity. They believe that this access should apply to all investment vehicles, including open‐ended funds, ETFs and separate accounts. Some investors have continued to express concerns about restrictions on capital lock‐up and the limit on the amount of repatriation. Finally, in the context of Stock Connect, investors feel that the daily limit imposed on the “northbound access” (access to Shanghai‐listed A‐shares through the Hong Kong Stock Exchange) should be lifted because it is a great source of trading uncertainty for passive investors, who typically trade on market close.
  • Beneficial ownership. MSCI applauds CSRC’s recent clarification on the Stock Connect beneficial ownership issue. MSCI expects this clarification to make international investors more confident in using the Stock Connect scheme. Time and actual experience, however, are needed for investors to provide their final assessments. A large number of asset owners invest through separate accounts. Because they typically delegate investment and operational decisions to their fund managers, recognizing clear title to ownership for the ultimate beneficial owners is a crucial concern.

While Chinese stocks weren’t admitted on this occasion, it looks like they will be as soon as the issues surrounding market accessibility are resolved. The MSCI note that “this may happen outside the regular schedule of its annual market classification review”, meaning it may occur before the next scheduled review in June next year.

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