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China A Gains Entry to MSCI Emerging Market Index June 21, 2017
We pen down some of our thoughts in regards to the inclusion of China A into the MSCI Emerging Market Index.
Author : iFAST Research Team


China A Gains Entry to MSCI Emerging Market Index [21 June 2017]

Morgan Stanley Capital International (MSCI) announced that it has officially incorporated A shares into the MSCI Emerging Markets Index. MSCI plans to gradually add 222 A-share large-cap stocks in June 2018, which will account for 0.73% of the MSCI Emerging Markets Index. Previously, due to capital controls and stock suspension, MSCI decided to postpone its decision to include A shares into its index. However, a result of the positive impact on the accessibility of the China A market of both the Stock Connect program and the loosening by the local Chinese stock exchanges of pre-approval requirements that can restrict the creation of index-linked investment vehicles globally, China A finally gains entry to MSCI emerging markets index this year.

MSCI is a well-known US index company, whose index products are used by more than 90% of global portfolio manager as benchmark. So far the company has designed more than 240 indices to reflect the A share performance, such as MSCI Golden Dragon Index, MSCI China A Index, MSCI China Index etc. However, unlike the above indices, the MSCI Emerging Market Index is included in the MSCI Global Market Index, which has around 1.5 trillion US dollars (about 10.24 trillion yuan) tracking fund. The MSCI Emerging Markets Index covers 24 markets: five markets in the Americas, 10 markets in Europe, the Middle East and Africa, and nine markets in Asia (Table 1), with the Chinese market gaining 28% of the index.

Table 1: MSCI Emerging Markets

 
Emerging Markets
America
Europe, Middle East & Africa
Asia
Brazil
Czech Republic
Russia
China
Pakistan
Chile
Egypt
South Africa
India
Philippines
Colombia
Greece
Turkey
Indonesia
Taiwan
Mexico
Hungary
United Arab Emirates
Korea
Thailand
Peru
Poland
Qatar
Malaysia

Source: MSCI, iFAST compilations. Data as of 21 June 2017.

According to the announcement issued by the company, it plans to implement the initial inclusion of A shares in two steps. The first inclusion step would coincide with the May 2018 Semi-Annual Index Review followed by the second step which would take place as part of the August 2018 Quarterly Index review. At the same time MSCI pointed out that if Shanghai Hong Kong and Shenzhen daily trading volume was cancelled or greatly improved before the schedule, MSCI does not rule out the possibility to implement the inclusion in one step.

In the short term, the impact of the A-share inclusion is quite limited: firstly, from the incremental capital point of view, the A-share market will bring about 60 billion Rmb international funds. However, in comparison to the current A-share daily trading volume, which is around 400 billion Rmb, and also more than 51.4 trillion Rmb stock market capitalization, the impact will be very limited; but the news will boost the market confidence. Second of all, since MSCI will only include large-cap stocks, the blue chips are expected to benefit from the inclusion, such as consumption, finance, medicine and technology sectors. However, according to international experience, the inclusion of the MSCI Emerging Markets Index is a gradual process: it will take around 5 years to 10 years to increase the initial proportion of 5% to 100%. Therefore, we believe that the analysis of MSCI events impact should focus on the long-term.

In the long term, the inclusion of the MSCI Emerging Markets Index will enhance the international status of China's capital markets and improve the regulatory level of the market. Considering the past experience of incorporating Korea and Taiwan shares in the last century, the process will ameliorate the structure of the local market investor, alongside with lower turnover rate. Besides, with the guidance of overseas investors, the domestic investors are expected to pay more attention to long-term value investment. Not only that, taking into account the MSCI reputation in the international financial market, the event may well will drive the A-share market valuation and the global market convergence.


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