A while back in “Visualizing The Invisible Gorilla,” we showed you the following set of charts which suggest China is grossly under-represented relative to its global clout…
(Goldman)
Well on Tuesday, MSCI will decide (again) on whether to let China into the cool kids’ club by including Chinese domestic stocks in its benchmark share indexes.
Here’s what Goldman said last month about the ongoing efforts to internationalize China’s financial markets:
Size (Chinese equity/bond market the 2nd/3rd largest globally) remains the key justification for inclusion, as well as continued policy initiatives targeting improved accessibility for global investors, a reasonable valuation profile and low foreign ownership (from an investor’s standpoint), and policy incentives to attract capital inflows. That said, capital controls, the effectiveness of the trading and regulatory framework, and administrative issues are key obstacles. We see the forthcoming June inclusion for A-shares as likely (a 60% chance) although bond inclusions are more likely to materialize starting in 2018, with the JPM GBI EM index potentially kicking off the globalization process of China bonds, followed by Bloomberg Barclays Global Aggregate and Citi WGBI by 2019-2020.
But there’s reason to believe this might not be as big a deal as it sounds. Here’s Goldman again, from a note called “Why Bother?”:
Similar arguments on both sides vs. last year…
Pro-inclusion arguments remain that China A is the 2nd largest equity market globally by market cap and turnover; Chinese authorities have made noticeable efforts to improve foreign investors’ accessibility to the capital market (SZ Connect), and market micro-structure concerns (e.g. stock suspension) have been addressed at least from a regulatory standpoint. Arguments against the inclusion continue to revolve around the capital repatriation restrictions for QFII, effectiveness of the suspension oversight, and the pre-approval requirements focused on by MSCI.
…but a different universe, and index/flow impacts
Unlike in the past 3 episodes, MSCI proposes to base the inclusion universe on 169 select A shares, which are all tradable on Connect and aren’t subject to QFII repatriation rules, instead of the standard MSCI China A Int’l index (448 constituents) in which 22 stocks are currently suspended (vs 2 stocks from the 169 universe). This narrower universe could raise China’s index weight in EM by 0.5pp and usher in US$7bn of initial net buying on 5% inclusion factor (IF), vs 1.0pp and US$15bn on MXCN-A.
This is a “watered down” plan, WSJ noted on Monday. “China’s $7.8 trillion domestically listed A shares are bigger than London and Frankfurt combined, but MSCI has suggested adding only 169 of China’s 3,261 A shares, giving them a weight of just 0.5% of the EM index, in line with the ability of investors to get money in and out of China via Hong Kong’s Stock Connect mechanism,” the Journal continued, adding that “for an investing algo, this makes perfect sense [but] the result is that the supposed benchmark is neither a sensible measure of what’s happening in emerging markets, because China’s weight is too small, nor a useful tool for big investors who have secured preferential access to the market.”
In short, it’s between having a benchmark that accurately represents China’s weight versus ensuring that the stocks included are actually some semblance of liquid because as we saw in the summer of 2015, Beijing has little patience for turmoil and will freeze the entire fucking market if that’s what they think is necessary:
On top of all that, there are questions as to whether this is as meaningful as it once was given that the world seems to have moved on from caring about what happens in Chinese equities.
“While the decision still holds weight for investors, the swings of the nation’s $6.9 trillion equity market are losing relevance for traders in London and New York more attuned to a global technology rally and signals from the Federal Reserve,” Bloomberg observes, adding that “even if yuan-denominated shares are added, they would be dwarfed by overseas-listed Chinese stocks, which have an increasing sway over MSCI’s developing nation gauge.”
Whatever the case, this is worth watching and it’s something a lot of folks will be talking about come decision time at 4:30 a.m. Hong Kong time Wednesday.
Meanwhile, Reuters reminds you that last month, “overseas investors bought a net 19.8 billion yuan ($2.90 billion) of mainland shares via the Connect schemes that link the Hong Kong and China markets, pushing up volumes by 56 percent from the previous month.”
That’s pretty clearly a bet on inclusion. “We believe this was due to foreign investors’ expectation that MSCI will announce the inclusion of A-shares this week,” UBS’ Gao Ting said.
Goldman has the odds at 60/40 in favor. Morgan is at 50/50.
*****
