Singapore Markets close in 1 hr 40 mins

EXPLAINER-What is China's A-share MSCI inclusion?

SHANGHAI, May 15 (Reuters) - Global market research and index company MSCI Inc said on Tuesday it would add 234 China-listed shares to its emerging market benchmark in a two-step process in June and September, a move expected to drive a surge of foreign inflows into the country's stock markets.

While some foreign investors are still haunted by memories of China's 2015 stock market crash and concerns about Sino-U.S. trade frictions, a deeper fear of missing out is widely expected to boost overseas investments in mainland stocks.

MSCI's decision last June to include yuan-denominated Chinese stocks, known as "A-shares", into its emerging market (EM) index triggered a rally in Chinese blue-chips in 2017, though the market has corrected this year amid fears that a trade war will undermine the world's second-largest economy.

But with the MSCI inclusion nearing, there are signs of renewed interest in Chinese big-caps as asset managers have been rushing to launch funds tracking MSCI A-share indexes.

For a story on the final list of shares to be included, see


WHAT, EXACTLY, IS THE MSCI INCLUSION?

MSCI, a U.S.-based creator of widely-watched stock indices, will add 234 mainland traded big-caps to its benchmark Emerging Markets and All Country World Index indices. The companies are predominantly blue chips, like Shanghai-listed SAIC Motor Corp or famed liquor maker Kweichow Moutai Co Ltd .


WHY IS THIS IMPORTANT?

MSCI's indices are closely watched and trusted. Its EM index has funds with assets under management in excess of $1.6 trillion benchmarked to it. That means that when Chinese shares are added to the index, money that follows the benchmark will have to buy Chinese stocks to avoid deviation.

Some analysts estimate about $20 billion will initially flow into Chinese stocks. That amount could rise to $300 billion if there is full inclusion, as many market watchers expect. Some investors, however, predict much smaller inflows in the short term.

The 234 yuan-denominated stocks, or China A-shares, will represent an aggregate weight of 0.39 percent in the MSCI Emerging Markets Index at a 2.5 percent partial inclusion factor during the first step of the China entry. The second phase of the entry will take place in September.

Further inclusion could potentially include an increase of the weighting as well as the addition of mid-cap A-shares. A full inclusion will see China A-shares account for about 18 percent of the MSCI EM index.


WHY DIDN'T IT HAPPEN SOONER?

In 2013, MSCI put A-shares on a review list but declined to include them in any indexes, citing issues including capital mobility restrictions and uncertainties around taxes. It continued to reject A-shares in 2015 and 2016.

Finally, in June 2017, MSCI announced the partial inclusion this year following a fourth consultation with global investors, recognising China's efforts to reform its capital markets.


HOW CAN FOREIGNERS BUY CHINESE SHARES?

China's markets are not fully open to foreigners, but there are a handful of ways they can get exposure.

- QFII, or the Qualified Foreign Institutional Investor scheme, allows certain institutions to directly invest in Chinese stocks, within limits. The State Administration of Foreign Exchange has granted $99.5 billion worth of quotas for QFII investment.

- RMB QFII. This allows the use of offshore yuan to invest in Chinese shares.

- Shanghai and Shenzhen "stock connect". These two-way investment schemes between Hong Kong and the mainland's two main bourses allow investors to buy Chinese shares through the former British colony, and vice versa. The daily quota for "northbound" purchases of shares quadrupled to 52 billion yuan from 13 billion yuan on May 1.

There had been concern among global investors that money flows from Hong Kong into China via the stock connect scheme around the time of the MSCI inclusion may breach the daily quota, as passive index funds need to buy the new A-share constituents to avoid tracking error.


WHAT HAS THE TREND BEEN WITH FOREIGN INVESTMENT IN CHINESE SHARES?

Foreign investment in Chinese shares has been on the rise, but remains relatively small. There are restrictions on inbound investment but even so the "northbound" quota through the connect schemes has rarely been maxed out. Foreign investors have cited a litany of concerns, from unfamiliarity with Chinese companies to worries about corporate governance.

Some funds tracking the MSCI A-share inclusion index have seen heavy inflows since announcement of the China entry.



DO ANALYSTS EXPECT FURTHER INCLUSION?

Yes.

MSCI has said further inclusion will be subject to China's moves to deregulate its capital markets, including granting foreigners more accessibility to its markets, making continued progress on trading suspensions, and further loosening restrictions on the creation of index-linked investment vehicles.

MSCI said it would continue to monitor the situation and launch a public consultation to solicit feedback from investors once warranted.

UBS strategist Gao Ting expects foreign ownership in the A-share market to be raised to 10-12 percent in coming years, from less than 2 percent currently, partly helped by MSCI's further inclusion of China stocks.

New York-based, China-focused asset manager KraneShares forecast that China's weight within MSCI Emerging Markets Index - including both A-shares and overseas-listed Chinese companies - will grow from 30 percent today to over 40 percent over the next several years due to the MSCI inclusion.

(Reporting by John Ruwitch and Samuel Shen; Editing by Kim Coghill & Shri Navaratnam)