A trader works at the BFAM Partners Ltd. office in Hong Kong, China (Photographer: Justin Chin/Bloomberg)  

Why China's First Steps Into MSCI Are Such a Big Deal: QuickTake

(Bloomberg) -- More than 200 of China’s large-cap domestic stocks are getting a significant new inflow of investment. They are among the companies that MSCI Inc., the New York-based provider of financial tools, has added to its major emerging-market indexes from today. The inclusion of these so-called A shares -- stocks that historically were available only to Chinese investors -- is a stamp of financial credibility that will open China to more global investment. MSCI had long rejected the inclusion of Chinese A shares until finally approving them last year.

1. Which companies have been listed by MSCI?

Heavyweights including Kweichow Moutai Co., China’s biggest liquor maker, and surveillance camera maker Hangzhou Hikvision Digital Technology Co., were added to the Emerging Markets Index, MSCI China Index and the MSCI All Country World Index. They’ve been among foreigners’ favorite purchases through the Hong Kong-mainland stock links and have surged more than 55 percent over the past year. Other companies include SAIC Motor Corp., Midea Group Co. and Gree Electric Appliances Inc.

2. Why did MSCI finally say yes to China?

MSCI had denied China’s bid for inclusion for three straight years, largely because of the government’s control over its financial markets. In granting approval last June, MSCI said China had adequately improved market access for global asset managers by letting foreigners buy shares on the Shenzhen stock exchange, its version of the Nasdaq stock market.

3. Why does this matter?

MSCI is the world’s biggest index compiler, with roughly $12 trillion in assets benchmarked to its products. Its embrace of China is expected, over time, to send billions of dollars flowing into the world’s second-biggest equity market. Citigroup Inc. expects $48 billion of annual inflow to A shares on the inclusion, while MSCI has said the initial inclusion is expected to channel around $17 billion in passive funds which could rise to $35 billion in coming years. Beyond dollars, there’s the symbolism of China taking another step into the mainstream global financial community.

Why China's First Steps Into MSCI Are Such a Big Deal: QuickTake

4. What does this mean for investors?

Some exchange-traded funds, international retirement plans and endowments that track an MSCI index will, for the first time, have to buy many of the A shares that are being added. But China will remain a market that’s dominated by local retail investors and prone to state intervention. China’s domestic markets are still under-researched by the standards of many foreign investors, which is why brokerages and investment banks have been increasing their coverage. Investors looking to hedge will find that short-selling opportunities are scarce to non-existent.

5. What will be the impact on MSCI’s indices?

Modest, to start. Only 5 percent of the stocks’ market capitalization are being added, and in two steps: the first after the May 31 close and the second on Aug. 31, effective Sept. 3. That means A shares will initially represent about 0.39 percent of the weighting on the MSCI Emerging Markets Index in June before increasing.

6. Why so small?

China still has work to do before MSCI will increase the weighting of its shares. In April, China quadrupled the daily quota on cross-border trading channels between Hong Kong and mainland exchanges, which are also known as China’s so-called stock connect programs. MSCI welcomed the move. The expanded quota paves the way for MSCI to raise the A shares’ weighting to 20 percent from 5 percent, according to Bloomberg Industries. But some restrictions remain, such as the 10 percent daily limit in stock moves that quash trading volatility, as well as a cap on foreign ownership.

7. What happens next?

The nation’s mid-cap stocks will be the next candidates as MSCI expands the universe of eligible shares, Chief Executive Officer Henry Fernandez said in June last year.

The Reference Shelf

  • Get ready for Chinese stocks to appear in your pension plan.
  • MSCI outlined its decision to include China in a press release.
  • QuickTake explainers on China’s managed markets and its moves to quash financial risks.
  • A Bloomberg story on support for China’s inclusion.
  • Global banks are rushing to a Chinese black box, Nisha Gopalan and Anjani Trivedi write in Bloomberg Opinion.

©2018 Bloomberg L.P.