China Stocks Win MSCI Inclusion; Initial Market Reaction Muted

(Bloomberg) -- Chinese stocks were little moved by their addition to MSCI Inc.’s benchmark indexes, as investors weighed the symbolic importance of inclusion against the limited impact on short-term inflows.

While MSCI’s announcement was a landmark step in China’s integration with the global financial system, it will initially have a small effect on the amount of foreign money entering the nation’s $6.9 trillion stock market. Domestic shares will comprise just 0.7 percent of MSCI’s global emerging-markets gauge as inclusion begins in two steps: the first in May 2018 and the second in August of next year.

The Shanghai Composite Index swung between gains and losses for much of the trading session on Wednesday, before a late-afternoon rally lifted it to a 0.5 percent advance.

“We view this announcement as an important milestone in the integration of China’s equity markets with the rest of the world,” Jonathan Garner, chief Asia and emerging-market strategist at Morgan Stanley in Hong Kong, wrote in a report. “But there is unlikely to be a significantly positive impact on A share index performance near term.”

Despite the muted market reaction, MSCI’s decision punctuates an extraordinary period during which China has sought to enter the mainstream of international finance while still maintaining a semblance of control over its markets. Since MSCI first considered adding Chinese shares to its indexes in 2014, the market has experienced an epic boom and bust, a bout of heavy-handed government intervention and -- more encouragingly for foreign investors -- a steady stream of initiatives to connect local exchanges to the outside world.

Read More: A QuickTake explainer on how China won inclusion

MSCI, which has been working directly with China’s securities regulator to resolve hurdles to inclusion since at least 2015, helped bridge the gap between Beijing and reluctant global asset managers with a less ambitious proposal unveiled in March.

To address investor concerns about the number of suspended shares, stocks halted for more than 50 days in the past 12 months weren’t eligible for inclusion. All companies to be added are large-cap shares accessible to foreigners through China’s cross-border exchange links with Hong Kong, including those with dual listings.

In addition to the China announcement on Tuesday in New York, MSCI said it put off decisions on whether to reclassify Argentina as an emerging market and demote Nigeria to standalone status. It included Saudi Arabia on its watchlist for potential classification as an emerging market.

Read More: Argentina reforms fail to persuade MSCI to upgrade status

The index compiler, which applauded China’s efforts to improve accessibility and relax control over index-linked investment products, signaled that it’s open to a bigger role for A shares if China further liberalizes its markets. Potential next steps include a bigger so-called inclusion factor, which would increase the weighting of Chinese shares in the index, and the addition of mid-cap stocks, Henry Fernandez, MSCI’s chief executive officer, said in a Bloomberg Television interview.

“We’d like to expand the universe of shares that are available to international investors," Fernandez said.

The addition of mid-cap shares would depend on factors including further improvements in accessibility for foreign investors, the relaxation of daily trading limits through the Hong Kong exchange links and additional efforts to curb trading suspensions, according to MSCI’s roadmap.

The China Securities Regulatory Commission said on Wednesday that it welcomed MSCI’s decision and will improve its rules to meet the needs of foreign investors.

International money managers can buy and sell more than 1,400 domestic Chinese stocks after authorities opened the Shenzhen Connect in December, about six months after last year’s MSCI rejection. The first link with Shanghai started in late 2014.

Inclusion in MSCI gauges could spur about $17 billion of inflows into Chinese shares, the index compiler said. By comparison, the turnover on China’s stock market on Tuesday was about $58 billion.

Given their tiny initial weighting, domestic Chinese shares will be dwarfed by the nation’s overseas-traded stocks. The country already has the largest position in the MSCI Emerging Markets Index, thanks to Hong Kong-listed companies like Bank of China Ltd. that joined the gauge years ago. The nation’s dominance has only increased recently with the addition of U.S.-traded firms including Alibaba Group Holding Ltd.

Read More: Saudi Arabia seen luring billions with MSCI indexes now in sight

In 2017, internationally-listed Chinese stocks have proven a better bet than their local counterparts. The MSCI China Index has advanced 24 percent, trouncing a 1.7 percent gain in the Shanghai Composite.

For many investors, China’s local shares represent the future. Not only is the market massive -- the second-biggest worldwide after America’s -- it’s also home to many of the companies most aligned with China’s consumer and service industries, which are seen as key drivers of the $11 trillion economy’s long-term expansion. And while the yuan has been under pressure recently, so-called A shares in Shanghai and Shenzhen give global investors exposure to a currency that’s likely to play a growing role as China expands its economic clout overseas.

Read more: A Gadfly columnist’s take on the MSCI decision

“This is the start of a process through which Chinese equities will achieve a prominence in global investors’ portfolios that reflects the size and significance of China’s domestic stock market and its economy,” Helen Wong, HSBC Holdings Plc’s chief executive of Greater China, said in a statement.

--With assistance from Allen Wan Isabella Cota George Lei Lillian Chen Aline Oyamada Lisa Pham Maria Jose Valero Ben Bartenstein and Rita Nazareth

To contact the reporters on this story: Sam Mamudi in Hong Kong at smamudi@bloomberg.net, Ben Bartenstein in Lima at bbartenstei3@bloomberg.net.

To contact the editors responsible for this story: Sarah McDonald at smcdonald23@bloomberg.net, Chris Nagi at chrisnagi@bloomberg.net, Rita Nazareth at rnazareth@bloomberg.net, Michael Patterson, Richard Frost

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