MSCI says no to China

Last night, MSCI, the world’s largest indexing firm, announced that it will not be adding China’s A shares as constituents of its widely followed EM index.

It has also made a number of comments which were of interest to global emerging funds following Pakistan, Nigeria, Argentina and Saudi Arabia.

In summary:

1. For passive EM funds, the MSCI EM index is the most significant globally by far, with around $1.5 trillion of indexed investment. For active investors, any change in the weighting of the index (which they are benchmarked against) forces them to reassess the composition of their portfolios.

2. MSCI pointed to a number reasons behind their decision regarding China’s A share market, the main one perhaps being capital mobility. First and foremost, the monthly repatriation limit (the amount of his total capital the investor is able to withdraw from the market during one month) of 20% is considered too low, especially should the fund be faced with redemptions. The time-consuming and opaque process of receiving approval for a quota (allowing investors to invest in Chinese stocks) is also a factor. On top of this, the need for preapproval of financial products on foreign stock exchanges that are linked to A-share indices has not been yet addressed.

It is important to note that China is already the largest component of the MSCI EM Index, making up over 25% of the index. This is made of up of ADRs of Chinese companies listed in NY or Chinese shares quoted in Hong Kong. The domestic (A-share) stock market – the largest in the world after US – is not included in the index.

3. MSCI announced that Pakistan will be reclassified as an Emerging Market. Given its current account deficit and need for capital to drive steady growth, many observers agreed that Pakistan was the biggest winner from yesterday’s announcement.

4. Argentina will be reviewed for a potential upgrade. In December 2015, the Argentinian Central Bank abolished foreign exchange restrictions and significantly relaxed the capital controls that have been in place for a number of years. These changes have resulted in a floating currency, the elimination of cash reserves and monthly repatriation limits on the equity market, as well as a significant reduction in the capital lock-up period for investments.

5. Nigeria may be removed from MSCI’s Frontier Markets Index and reclassified as a stand-alone market due to capital mobility issues. This may even come as soon as November this year. Early last year its Central Bank pegged the local currency to the US dollar resulting in a sharp decline in liquidity on the foreign exchange market. Hence, the ability of international institutional investors to repatriate capital has been significantly impaired to the point where the investability of the Nigerian equity market is being questioned.

6. MSCI said that it welcomes the recent market enhancements announced in Saudi Arabia, which opened its market for the first time to foreign investors last summer. These include changes to the rules for qualified foreign investors, settlement cycle of listed securities, elimination of the cash prefunding requirement and the introduction of proper delivery versus payment. Many of these are on course to be implemented by mid-2017 and will bring the Saudi equity market closer to EM standards.

Sources: MSCI, FT, Natixis

China’s place in the Emerging Market Club

[Some IR professionals may find our guide to China’s equity market as good background reading]

Last week saw the resolution of a long-running saga in the emerging markets investment community: the inclusion of China’s restricted main market ‘A-shares’ in the MSCI Emerging Markets index.

The decision was watched very carefully by active and passive investors alike. For passive EM funds, the MSCI EM index is the most significant globally by far, with around $1.7 trillion of indexed investment. For active investors, any change in the weighting of the index (which they are benchmarked against) forces them to reassess the composition of their portfolios. After the recent 12-month rally, China’s equity market (which is worth around $10 trillion) is now the second largest in the world after the US.

Although China’s A-share remains on course to be accepted onto the EM index, the MSCI is holding off for the time being. The index provider says it needs assurance from authorities that foreign investment quotas are transparent and predictable, and also that there is enough liquidity, capital mobility as well as a defined account ownership structure in its new StockConnect programme.

MSCI will revisit the topic in May 2017; the focus for now is on how investors plan to allocate assets to China as part of the broader market opening.

A recent FT piece made an interesting point – if all A-shares were to be included at their full weighting, China would take up 43.6 per cent of the emerging markets index. This is a good illustration of China’s importance to the emerging world, although there are profound practical implications for fund managers looking for diversified exposure to global EMs.

Speculation in the press is already mounting over the likely emergence of a spate of “EM ex-China” funds.




Brief Guide to China’s Equity Market

Mainland China has two stock exchanges, the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE). As of June 2015, The total market capitalization of all stocks listed on these two exchanges exceeded $10trillion, making it one of the largest equity markets in the world.

There are a number of different share types listed on these exchanges (see below). While all of them offer access to companies whose main business proceeds are derived from mainland China, they usually differ in one or more characteristics, such as company domicile, listing venue or investor geography (domestic vs. foreign).


Some Chinese companies choose also to list their shares in the United States, London or Singapore. The most popular form for overseas listings is American Depositary Receipts, 105 of which are currently listed and traded on the NYSE or Nasdaq, including Alibaba, Baidu and China Mobile.

Although there are multiple share types providing exposure to Chinese companies, A-shares are the principal instrument for accessing the domestic growth story. However, this segment of the market has also historically been the most difficult for foreign investors to access. Mainland Chinese stock exchanges were previously closed to foreign investors due to tight controls, which restrict the movement of capital into and out of the country. In 2002, in an effort to mitigate this limitation, Chinese authorities began implementing the Qualified Foreign Institutional Investor (QFII) system. The QFII is a program that allows licensed foreign investors to buy and sell yuan-denominated A-shares on China’s Shanghai and Shenzhen stock exchanges.

China’s A-Share Market

The Chinese domestic equity market has become one of the key foundations of the country’s economy since the establishment of the Shanghai and Shenzhen exchanges in 1990. Today, the Chinese stock market is one of world’s largest in terms of market capitalization. There are 2,469 A-share companies listed on the Shanghai and Shenzhen stock exchanges with a total market capitalisation of over $10 trillion.

Participation of Retail Investors in the ‘A-Share’ Market

The heavy involvement of retail investors in daily stock trading is one of the main characteristics of the Chinese stock market. Although individual investors hold just 26% of the total, they account for 78% of daily trading volume, which is the main source of the market’s volatility. Along with retail investors, domestic institutions, including stock funds, are also frequently engaged in short-term speculation.

Over the last 12 months the A-share market has witnessed a 148% surge (as of June 2015) in value driven mainly by individual investors. There is strong evidence to suggest that this has been driven by momentum rather than fundamentals. New data from the a China Household Finance Survey show that the most prominent new investment group in China’s equity markets this year is relatively inexperienced retail investors. China has a large population with substantial savings and limited alternative investment options.

Accessing China’s market

Another key characteristic of the market is that it is still largely closed to the outside world. At the end of 2014, the total value held by foreign investors made up only 1.5% of total market capitalisation.

QFII Program

The Qualified Foreign Institutional Investor (QFII) scheme allows foreign investors access to securities markets in China through their home currency.The QFII scheme allows foreign institutions to trade Chinese A-shares and other financial instruments via special accounts opened at designated custodian banks.

But not just anybody can become a QFII. Applicants must meet strict criteria set forth by the China Securities Regulatory Commission (CSRC), including minimum thresholds of capital and assets under management, as well as a certain number of years of business experience. For example, to become QFII eligible investors must demonstrate they have two years’ experience and have managed at least USD $500Mn in securities assets over the past year.

Of the $298bn available through the QFII scheme and its renminbi-based sister programme (RQFII), only $162bn has been granted so far.

QFII and RQFII Quota Breakdown by Investor Type

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TOP QFII Quota Holders


The Renminbi QFII (RQFII) program is a modified version of QFII that facilitates foreign investment in the mainland via offshore renminbi accounts. RQFII participants can invest in the same range of investment products as QFIIs and are subject to many of the same restrictions. However, a RQFII uses renminbi to purchase securities, whereas a QFII uses their home currency.

Previously the RQFII program was limited to Hong Kong subsidiaries of Chinese financial institutions, but this year the program has expanded to include additional Hong Kong banks and asset managers, and also to financial institutions in London, Singapore, Taiwan, and other as yet unnamed locations.

The total RQFII quota stands at RMB270bn ($43.5bn), a fraction of that allowed through the QFII program. So far this year, less than half of this quota has been apportioned, likely due to continued fears surrounding the Chinese equities market.

The RQFII program is notable because it has facilitated the creation of several A-share ETFs and bond funds domiciled in Hong Kong. As the RQFII program expands, this market will likely grow as well.

QDII Programme

Since April 2006, China’s Qualified Domestic Institutional Investors (QDII) program has given Chinese investors access to markets outside the country, opening new opportunities for investment funds.

QDII products issued by Chinese fund managers show that they tend to allocate investment to the Hong Kong market, to Chinese related securities or to top performing foreign funds. Most banks’ QDII products tend to replicate an index and invest in a single asset class, or replicate an international investment fund.

Stock Connect 

The Shanghai-Hong Kong Stock Connect program was set up in November 2014, establishing a bridge between the two markets. It allowed international investors to trade in a number of shares listed in Shanghai without having to apply for individual licenses and quotas, and for domestic Chinese investors to trade in some Hong Kong stocks.

International investors have had limited access to China’s domestic stock market using an individual quota system. At the same time, retail investors in China have been restricted from investing in stocks listed overseas. Stock Connect allows more international investors (including individuals and hedge funds) to trade Shanghai-listed shares directly for the first time, while also allowing retail investors in China to trade Hong Kong-listed stocks directly.

Each direction has a quota — RMB300 ($48bn) going north (from Hong Kong to Shanghai) and RMB250bn ($40bn) heading south — and limits the value of daily trade. ‘Going north’, aside from the first few days during which foreigners snapped up A-shares, take-up has been slow: a mere third of the quota has been filled, equating to $16bn. Mainland ‘going south’ buyers have invested even less: only $4bn, a tenth of the money permitted.

Shenzen Connect

Just months after piloting the Shanghai-Hong Kong program, Chinese regulators announced the launch of an additional trial program connecting the stock exchanges in Shenzhen and Hong Kong.

The Shenzhen market is home to a number of so-called new economy companies in sectors including technology, pharmaceuticals and clean energy, which many global investors prefer to the heavy industry and financial stocks that comprise the Shanghai Stock Exchange. Such sectors could emerge as potential beneficiaries of China’s drive to develop a consumer-focused economy.

However the announcement of the launch date of the landmark Hong Kong-Shenzhen stock market link is at present on hold due to technical issues, putting at risk China’s pledge to have the scheme ready by year-end.

Index Inclusion

By giving foreign investors more access to the market, China hopes to paves the way for domestic Chinese stocks to be included in global indices. This in turn will increase foreign ownership of Chinese companies.

Sources: Deutsche Bank Research, “China’s Financial Markets—A Future Global Force?” as of 3/16/09.

Earnnst and Young : Your bridge between Europe and China: Luxembourg

BlackRock launches its first China A share ETF for international investors

As China is opening its stock market to greater foreign investment, licensed fund managers are using their own Renminbi Qualified Foreign Institutional Investor (RQFII) quota to offer new products to their clients. BlackRock has today launched an ETF focused on the hard-to-access A shares in China, that aims to track the performance of the MSCI China A International Index. This index represents a broad and diversified basket of over 300 large and mid cap stocks.

The fund is listed on the London Stock Exchange, giving BlackRock’s international institutional and retail clients direct access to China’s A share equity market. A shares are mainland China incorporated companies listed on the Shanghai and Shenzhen Stock Exchanges. China A shares represents about 45.6% of the Chinese equity market, as defined by the MSCI China All Shares Index, which contains A shares, B shares, H shares, red chips and private chips.

Further References:

Fund Fact Sheets

Fund Prospectus

How Developed Market Investors are investing in Emerging Markets – perspectives from the IMF

The IMF’s recent report on financial stability makes a few interesting points about the evolution and concentration patterns of equity investments into Emerging Markets (EMs). In its recent paper titled “Curbing Excess while Promoting Growth”, it studies investment flows from advanced to emerging economies and leaves us with some food for thought from an IR standpoint.

First, the study quantifies a number of investment trends going back over a decade. It notes that global EM equity portfolio allocations increased substantially from 7% in 2001 to almost 20% in 2012. Fixed-income allocations followed suit, from 4% to 10% respectively. The data are in line with other similar studies, underlining the increasingly global focus of many investment portfolios as domestic biases, broadly speaking, steadily decline.

 Second, the study examines patterns relating to geographical concentrations of global EM portfolios. Out of the $2.4tr of equity assets under management in EMs in 2012, roughly 80% was invested in only 12 of the 190 emerging market economies, with China accounting for a large share of this.

 Third, and perhaps most striking, is the concentration of investors amongst the advanced economies. In 2012 over half of all equity portfolio investment in major emerging market economies came from the US, the UK, Singapore and Hong Kong, with the US alone accounting for about a third.

 The study goes on to suggest that given this degree of concentration, the possibility of tighter monetary policies in the US and UK could have a considerable impact on flows into the largest EMs, as well as on the synchronisation of asset price movements and volatilities.

 A few thoughts for Investor Relations teams in Emerging Markets

 These dynamics could be consequential for EM IR teams planning an investor outreach strategy in 2015. A few additional questions may be helpful to consider:

  •  What key external factors are influencing the decisions of my top foreign shareholders? Which of those factors have the strongest influence on my share price? How can I stay ahead of this issue?
  •  Have I compared my shareholder base with that of my country, region or peer group and analysed how it has changed over the last two years? Have I identified key targeting opportunities?
  •  How correlated is my share price and volatility to that of other main market indices?

Equity Allocations of Advanced Economies to EM Economies by Source Advanced Economy, 2012 (Billions of U.S. Dollars)

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Equity Allocations of Advanced Economies to Emerging Market Economies by Source Advanced Economy, 2012 (Billions of U.S. dollars)

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Equity Allocations of Advanced Economies to Emerging Market Economies by Receiving Emerging Market Economy, 2012 (Billions of U.S. dollars) 

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Source: IMF, Global Financial Stability Report, October 2014