MSCI China A shares inclusion decision – what it affects?

Key times - When MSCI Inc. conduct their Annual Market Classification Review on June 20th, on the plate for consideration would be MSCI China A shares’ possible inclusion to the Emerging Markets index amongst others. The decision would be made known after 4.30 am (Singapore / Hong Kong time) on June 21st, prior to the market open in Asia.

Key markets to watch - China 300 and China A50

Background - Third time had not been a charm for the attempt with obstacles including repatriation limit concerns, access to the markets and voluntary trading suspension concerns being cited by MSCI as reasons for refusal.

For Asian markets, the significance of the inclusion would be the prospect of inflow into the mainland Chinese equity market and, indirectly, a lift for regional markets. Recognized by asset managers and investors as a benchmark in portfolio building, the inclusion by MSCI could gear up interests for Chinese stocks in the longer run. Goldman Sachs has estimated that an additional $7 billion worth on investments could flow through to mainland shares with the move. While this is not a remarkable amount for the $7 trillion stock market of China, it has been seen as a step towards market liberalization. Foreign investors currently own less than 2% of A shares according to computation from Capital Economics[1] and further liberalisation is expected to bring in more demand. A positive change in the tone from the consultation paper ahead of the decision has raised the market’s optimism in seeing the representation of the yuan-denominated Chinese shares in the MSCI Emerging Market index.

The odds - When Bloomberg polled analysts in late March, only 6 of 13 strategists and fund managers had expressed that inclusion would occur this year. Goldman Sachs has chiefly arrived at a lower conviction at 60% compared to the 70% chance accorded to last year’s evaluation. Concerns with regards to repatriation limits and excessive trading suspensions lingers, though there may be reasonable basis to believe that we could see a good chance of the inclusion this year.

For the upcoming evaluation, the noticeable reduction to 169 names have been made from the 448 companies in the previous attempt. The companies proposed for inclusion are also all classified as large caps that are already accessible to foreign investors through stock connects with Hong Kong, lowering the concerns of investment quotas and repatriation limits. The use of the subset has also essentially been seen as an attempt to sidestep issues brought about by trading suspensions and wild fluctuations of prices that mostly come with illiquid and mid-caps stocks respectively.

Additionally, the relative calm seen in the Chinese stock market and the positive growth picture at the start of the year, contrasted with the turbulence in 2015 and concerns over growth slowdown in 2016, could certainly be a bonus in China's bid to gain a foothold for its yuan-denominated shares with MSCI.

The trade - With the inclusion, MSCI has estimated that China’s A shares would form 0.5% share of the Emerging Market index. This by itself may not be a significant proportion as compared to its foreign currency denominated counterpart, but could certainly see expansion in the longer term. Upsides for China stock market could be expected should we see the inclusion come into fruition. Specifically, focus on the CSI 300 index which covers the top 300 mainland Chinese companies.

For the near term, eye upsides towards the 3600 psychological level. On the flip side, the market could see limited downsides should an upset result be seen and likely shrug off just another disappointment. Stop-losses would nevertheless be recommended for the highly speculative market.