China’s domestic stock markets look set to be denied entry into international benchmarks for the fourth year in a row next year unless Chinese regulators remove “major obstacles” before June.
Dimitris Melas, head of equity research at MSCI, provider of the benchmark MSCI Emerging Markets index, gave a downbeat assessment on Thursday of the prospects for China’s A-shares to be included in the index next year in spite of the imminent opening of the Shenzhen stock market to international investors.
“Clients have recognised that a lot of the obstacles [to A-share inclusion] are being removed, so there is progress,” said Mr Melas. “Having said that, clients also recognise that there are still some major obstacles.”
The inclusion of an initial proposed 5 per cent of A-shares into the MSCI Emerging Markets Index would be seen as a pivotal moment in China’s gradual opening to flows of global capital. Accession to the benchmark, which includes 833 stocks from 23 emerging markets, would oblige fund managers who track the index to invest in Chinese A-shares, triggering huge inflows of capital to China.
Optimism over the potential inclusion of A-shares has grown in recent weeks as China prepares for the launch of the Hong Kong-Shenzhen Stock Connect, which may open as early as next week. The stock connect, together with an existing trading link between Hong Kong and Shanghai, will be the only direct route available for foreign investors to trade mainland stocks without prior approval from Beijing.
The scheme eases accessibility for foreign investors to China’s domestic markets — one of the key sticking points that has prevented MSCI from granting A-share inclusion. “This is quite important because it gives, through stock connect, the possibility for foreign investors to access the opportunities on the two main exchanges,” Mr Melas said.
However, he also gave a list of impediments that combine to create the “major obstacles” to A-share accession to MSCI next year. One problem is that foreign investors who sell domestic Chinese shares can repatriate only 20 per cent of their holdings a month, meaning it would take them a full five months to trade out of China’s domestic markets.
Maximum proportion of Chinese holdings a foreign investor can sell in a month — one of the obstacles to MSCI inclusion
A further issue is a “preapproval” requirement that the Chinese exchanges impose on the launch of financial products, meaning that if, for example, a foreign financial institution wanted to launch an exchange traded fund (ETF), it would have to win prior regulatory approval.
“This is unusual, it is unique in emerging markets and in developed markets in fact,” Mr Melas said.
In addition, moves by the Chinese authorities last year to rescue plummeting stock prices by suspending hundreds of shares created real problems for foreign fund managers. Many of these stocks remain suspended, Mr Melas said.
“Investors gave us feedback that they need to see suspensions coming down even more,” he said.