Caixin
Jun 01, 2018 04:44 PM
FINANCE

MSCI Milestone: Stock Markets Mature With Global Index Inclusion

MSCI’s emerging market indexes now include more than 230 Chinese mainland companies. Photo: IC
MSCI’s emerging market indexes now include more than 230 Chinese mainland companies. Photo: IC

* A total of 226 A-share companies made the final cut, including representatives of both the old and new economies

* The inclusion is expected to trigger initial capital inflows of about $18.4 billion, compared with the market’s $3.4 trillion capitalization

(Beijing) — Chinese stocks passed a major milestone on Friday in their bid to go global, as more than 200 of the nation’s biggest publicly listed companies were officially included in a group of widely tracked indexes published by U.S. giant MSCI Inc.

Some 226 A-share companies, a reference to yuan-denominated shares listed in Shanghai and Shenzhen, made the final cut, including representatives from the old and new economies. The former category included names like premier-liquor maker Kweichou Moutai, while the latter included game developer Perfect World Inc.

Despite their relatively small representation in the benchmark MSCI Emerging Markets Index, the inclusion caps a years-long campaign for such a move, as Beijing slowly exposes the nation’s young stock markets to foreign participation. Global funds that mirror the MSCI indexes will now be required to buy shares of A-share companies included in those indexes.

“China will be in the magnifying glass now. The market is going to be shared between retail investors and institutional investors in and outside of China,” MSCI CEO Henry Fernandez told Caixin in an interview ahead of the change. “I think that China, as a global economy, will need to have the financial system that goes with its position and stature in the global economy.”

Under a phased inclusion plan, selected A-shares initially will have an aggregate weight of 0.39% in the MSCI Emerging Markets Index, with a 2.5% partial inclusion factor starting Friday. Another 2.5% inclusion factor will be added after MSCI’s quarterly index review on Sept. 3, sending the aggregate weight of A-shares to 0.78% in the index.

Mainland stock exchanges aren’t expected to see significant inflows of foreign money initially, and many regulatory hurdles remain in the relatively closed market. But analysts believe the move could lift broader investor sentiment over the short term.

On Friday morning, the Shanghai Composite Index was down 0.42% by the mid-day break, trading near 19-month lows reached earlier in the week over fears of renewed trade frictions between the U.S. and China.

Optimism over the MSCI development has been largely priced in to the market since the decision was first announced nearly a year ago. Many funds that track the indexes have been building up their positions in the run-up to the actual inclusion, said Jiang Feng, the newly appointed general manager of the Shanghai Stock Exchange.

Gradual process

Though marked as a key step in China’s drive to expose its financial markets to outside influences, the process of inclusion in MSCI indexes tends to be gradual and is thus unlikely to have a big short-term impact, analysts say. Foreign ownership of A-shares is now around just 2%, well below the levels of as much as 60% for some developed markets.

The index inclusion is expected to trigger initial capital inflows of about $18.4 billion, a sliver of the A-share market’s $3.4 trillion capitalization, said Shi Bin, head of China Equities at UBS Asset Management Co.

Fresh inflows on the first day the stocks are included are likely to total a relatively modest 20 billion to 30 billion yuan, accounting for less than 5% of the A-share market’s total daily volume, estimated Zhou Wenqun, a Shanghai-based fund manager with Fidelity International.

Looking ahead, newly included A-share companies will also face a more stringent assessment of their environmental, social and governance (ESG) performance, Hua Nan, head of China operations at MSCI, suggested at a Shanghai forum on Wednesday.

ESG ratings have become an investment allocation tool for fund managers in Europe and North America, but remain in an early stage of development in Asia. Such ratings cover a wide range of areas, including management incentive systems, a company’s independence and the proportion of independent directors on its board.

Most such measures are currently low priorities for domestically listed companies, especially large state-owned enterprises that don’t pay dividends or offer stock incentives to managers because they have other political priorities.

As a global index complier, MSCI would give all companies ratings based on its own internal system with seven categories. The first batch of A-shares included on Friday has been going through the process, Hua said, adding that Chinese companies have rated relatively low compared with other emerging markets.

He said MSCI would eventually publish an ESG ratings index for all included A-shares, “to promote the listed companies to make related information disclosures, and improve market transparency.”

China’s status as the world’s second-largest economy, accounting for 14.8% of global economic growth and home to the world’s fourth- and seventh-largest stock exchanges by market capitalization, has led many to focus more on the positive aspects of the MSCI inclusion at bringing China into the global financial system.

J.P. Morgan Asset Management, the fund management arm of U.S. investment bank JPMorgan, said last month it will seek a controlling stake of its China joint venture and will double its research coverage of the A-share market to more than 200 stocks over the next 12 to 18 months.

“It’s a market that is not highly correlated with the other markets, so for a lot of investors it has significant diversification benefits,” Fernandez said, talking about the attraction of mainland stock markets for foreign investors. “It’s not in the future, it is here, it’s happening this week, and therefore you have to get going immediately to understand the market, invest in the market.”

Contact reporter Leng Cheng (chengleng@caixin.com)

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