Hong Kong-based China and Emerging Markets specialist, Luke NG from FE Research runs through the key issues surrounding MSCI’s rejection of China’s A-Share market.
“This is not the first time that A-shares have been rejected by the MSCI. In the last review in 2015, the company rejected A-share inclusion due to five key reasons that caused concern.
- Clarification of investment quota allocation – the QFII scheme is a key channel for foreign institutional investors to access the China onshore market. Previously, investors were required to go through a lengthy process in order to get an investment quota. Since Feb 2016 the process for approval has been largely relaxed.
- Capital mobility issue – the 20 per cent monthly repatriation limit remains a major concern.
- Stock suspension issue – there are voluntary suspension practices in the onshore market, especially in extreme conditions. For example, nearly half of the A-share market was halted from trading as the market went into a sharp correction in the third quarter of 2015, and that triggered serious liquidity concerns. In May 2016, the Chinese regulator detailed a guideline aiming to curb the voluntary suspension issue.
- Beneficiary of ownership – the lack of clarity on ownership of securities invested through separate accounts. However, this was addressed in May 2016 by the China Securities Regulatory Commission (CSRC)– the commission now recognising the concepts of ‘nominee holder’ and ‘beneficial owner of securities’.
- Financial products pre-approval restriction issue – Any financial products that link with A-shares require pre-approval from local exchanges, even in instances where the products are setup or listed internationally. It raises concern for foreign investors and the issue remains unaddressed.
Still, over the past year China has been making significant progress to deal with the above areas, although some of the policies were announced as recently as May 2016. Even with the new policies coming into force - points 2 and 5 remain concerns as they are largely unresolved and have seen little in the way of policy reform.
China’s rejection highlights not just the on-going problems facing the A-share market, but that MSCI is being suitably prudent in trying protect foreign investors' interest, which is a good thing.
But what will this mean for A-shares?
With China being the second largest economy in the world, and the MSCI inclusion was widely expected and it is likely to bring on short-term volatility into the market. However, capital market liberalisation of China will likely continue in order to bring it closer to the international standard and ease foreign investors’ concerns.
Will China be successful in addressing the concerns of the MSCI?
I believe there are three key issues that require further improvement: Firstly - the 20 per cent monthly repatriation limit remains a hurdle to be resolved, especially for mutual funds as they may face redemption pressure during extreme market conditions. Secondly – the financial products pre-approval restriction issue, and thirdly, the effectiveness of the implementation of recent policy changes. With these, we need to see further efforts from Beijing in order for the market to meet international standards.
Having said all of that, I believe it is only a matter of time before China catches up and meets MSCI’s requirements. The Chinese regulator certainly seems to be moving in the right direction to address the issues.
In fact, one could even look at the delay of China’s MSCI inclusion as a positive – in that this may be the trigger that helps to further aid liberalisation of the country to better meet international standards.