MSCI inclusion ‘only a matter of time’, feels China

Index provider MSCI Inc's decision to keep mainland-listed shares out of its key emerging markets index was a blow to China's regulators, who had stepped up reforms in recent months to win over the index provider, reports CNBC.

But the initial reaction from China was largely pragmatic, with state news agency Xinhua commenting that inclusion was "purely just a matter of time".

The Shanghai composite and the Shenzhen composite opened down more than 1 per cent each, but then retraced their losses to trade up 0.33 per cent and up 1.44 per cent, respectively, by mid-morning SIN/HK.

MSCI announced on Tuesday evening that it had once again decided not to include A shares in its EM index.

Remy Briand, MSCI's global head of research, said in a conference call after the decision was announced that even though there had been moves by the Chinese government to improve market operations, it was still lacking in some areas.

The high number of voluntary suspensions also need to be brought down, Briand added. He told the call that 6-10 per cent of the A-share universe was suspended at any given time, compared to an average of 0.2 per cent across all emerging markets.

"The number of [A share] suspensions hasn't gone down significantly," he said.

Chinese stocks currently listed in MSCI's EM index are traded in Hong Kong or the US, which means the world's second-largest economy makes up only about one-fourth of the benchmark index, while projected full inclusion of A shares would bring that ratio to more than one third.

With about $1.5 trillion in assets under management tracking the index, China is keen to tap those funds as foreign investors search for returns outside their home markets.

Adrian Mowat, JPMorgan's chief emerging market and Asian equity strategist, said that recent talk about inclusion missed the point that China's markets needed to meet "very specific criteria the MSCI has set out - which it has not fully met".

"This is not a judgment issue, they are not snubbing China. It's simply you have to meet certain requirements for the benchmark and those requirements haven't changed," said Mowat.

And JPMorgan's chief China economist Haibin Zhu said that inclusion could take "a few more years".

In the case of South Korea, it took six to seven years to be included in the EM index, he noted, adding, "In China's case, 10 years is probably not surprising."

But Goldman Sachs' global macro research analysts wrote in a note after the decision that they were surprised by MSCI's call. On 30 May the analysts had raised their estimate of the probability of inclusion from 50 per cent to 70 per cent, given the strides Chinese regulators had recently made in addressing investors' concerns.

Goldman Sachs said that if reforms continued apace, it expected MSCI to do a special, out-of-cycle, review of inclusion before the next annual review was due in 17 June, and that that review would likely find "significant breakthroughs" on the remaining hurdles.

Angus Nicholson, market analyst at spreadbettor IG, was pointed in his analysis of the decision.

"In some ways, it was more surprising how many investment banks came out saying inclusion was more likely than not. I think this may reflect just how aggressive Chinese government campaigning was for inclusion at this round," he wrote in a note on Wednesday.

"But very recent changes to stock suspension laws was unlikely to make everyone forget about the massive state intervention in the market of the past year. Or the disastrous introduction of trading 'circuit-breakers' in January that did an excellent job of accelerating the market selloff, and eventually cost Xiao Gang his job as the head of the China Securities Regulatory Commission (CSRC)."