Wider access to China’s markets ‘not a matter of if but when’

Decision by MSCI not to list A-shares is a minor setback
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Index provider MSCI’s decision this month not to include mainland Chinese A-shares in its global indices was widely unexpected by analysts. Yet investors largely consider greater access to China merely a matter of time given the country’s growing economic clout and the size of its market.

“It’s not a matter of if but when,” says Mark Valadao, head of portfolio strategists for Asia ex-Japan at State Street Global Advisors. “Despite MSCI’s decision, China A-shares should still be on the table as an opportunity set as global investors prepare for its inevitable inclusion into MSCI.”

MSCI said the reasons behind its decision were chiefly technical, including a wariness over Chinese capital controls.

Foreigners hold less than 2 per cent of China’s onshore stock markets and roughly the same percentage of its giant interbank bond markets. In recent years, tracking the opening up of China’s capital markets has become as turbulent as investing in its sentiment-driven stocks.

Investors have benefited from launch of the Shanghai-Hong Kong Stock Connect, linking the two stock exchanges, and the widening this year of access to mainland bond markets — already collectively the third largest in the world.

Yet watchers have also contended with a brutal market crash last year, which informed MSCI’s third decision in as many years to hold off including mainland stocks in its indices.

“The decision by MSCI to delay . . . is, naturally, mildly disappointing for us and for other investors in the Chinese stock market,” says Anthony Cragg, senior portfolio manager of Wells Fargo’s China Equity Fund.

The key theme of MSCI’s diplomatically phrased reservations nonetheless sent a clear message to Beijing: prove you will do what you say you will.

This applied not only to reforms, announced in May, to limit companies’ ability to suspend their shares at will, but also to investors’ reports that a smoother approvals process to get money into China, announced in February, was not yet working.

“It is one thing to implement a new policy, but it takes a bit of time for the policy to run smoothly,” said Remy Briand, global head of research for MSCI, after the decision not to include A-shares.

Abuse of the previous system left more than half the mainland equities market suspended during last summer’s rout, resulting in fund managers being unable to meet redemptions or even value their holdings.

Yet in the same week MSCI decided against including Chinese mainland shares in its indices, HSBC announced it had set up the first access for an international investor to China’s interbank bond markets.

Crucially for those following the wider opening of China’s markets, Beijing has delegated approval of would-be bond investors to a select group of banks that, essentially, vouch for their clients. This is a far cry from the cumbersome approval needed to invest in stocks under the QFII (qualified foreign institutional investor) programmes, where fund houses need to be approved individually.

“The scheme being followed by the bond market is almost better than the one for equities,” said Mr Briand following the MSCI decision. “[But] we can only highlight what we hear to regulators and watch for them to make their decisions.”

As with any move by MSCI to include A-shares, international inflows to the bond markets are likely to happen gradually in spite of the smoother approvals process.

Banks are still building teams to cover A-shares and credit analysis is at an early stage. Analysts at Standard Chartered estimate that international money will count for only 4-7 per cent of the $7.4tn market by 2020.

Another issue is the suspicion of China among investors, particularly those outside the region. Hong Kong-based analysts admitted they underestimated the scale of international scepticism when most predicted MSCI would decide to include A-shares this year.

“The key problem for China equities isn’t because it has not been included in international indices. The real issues include rising leverage, the renminbi and credit-fuelled growth,” says Frank Benzimra, head of Asia equity strategy at Société Générale.

While Beijing considers the reforms it will need to enact to win MSCI approval — which it does want — it will also have to consider how to change that sentiment.

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