MSCI wrong to include China in key index - investor survey

By Alun John

HONG KONG, July 24 (Reuters) - Global index provider MSCI was wrong in its landmark decision to include mainland China-listed "A" shares in its emerging markets index in June, according to nearly half of the international investors surveyed for a new report into Chinese corporate governance.

MSCI's decision to add domestic Chinese stocks for the first time to its benchmark global emerging market indices, tracked by an estimated $1.9 trillion, was seen as a milestone in the opening up of China's markets to international capital.

Yet 48 per cent of foreign investors surveyed by the Asian Corporate Governance Association (ACGA) said that MSCI was wrong to include China's A-shares in its indices, compared to just 27 percent who felt that inclusion was correct.

The survey results were contained in an ACGA report, which examines what it called "China's unique system of corporate governance".

When MSCI announced that it would add A-shares to the index MSCI said it had tried “to obtain feedback from the entire investment ecosystem” which included asset owners, asset managers, brokers consultants and custodians worldwide.

Governance has long been a hot topic for investors looking at China, but the MSCI decision put it under an even brighter spotlight because fund managers who benchmark to its indices must now invest onshore.

Chinese authorities are working to improve corporate governance in domestic firms, but their goals can differ from those of international institutional investors.

The survey reported that 59 percent of investors felt they did not understand corporate governance in China, including practices around the roles and responsibilities of non-executive directors, supervisory boards and Communist Party committees.

In June, China's securities regulator published new corporate governance rules, which required listed companies to do more for "Communist Party building", including studying the party’s theories and conducting social activities in line with party doctrine.

Last year state-owned enterprises amended their company laws to include the role of Communist Party committees for the first time. Some companies stated that boards must first consult the party committee before making decisions.

The ACGA survey suggests that Chinese authorities, who hope to see more A-shares added to the MSCI benchmark over time, need to do more to assuage overseas investors' fears, particularly when it comes to listed Chinese companies' governance structures.

"Corporate governance concerns one of the major reasons why foreign investors felt that A-shares should not be added to the MSCI EM index," said Nana Li, senior research analyst at ACGA.

Of the investors surveyed by ACGA, whose members have a combined $30 trillion of assets under management, 68 per cent described dealing with domestically-listed Chinese companies as "very difficult". Only 2 per cent said there was no problem.

Chinese companies - mainly U.S and Hong Kong-listed ones - currently make up just over 31 percent of MSCI's Emerging Markets Index, with A-shares accounting for only 0.8 percent of the total. If China's domestic A-shares were to be given their full weight, China would account for more than 42 percent of the index. (Reporting by Alun John; editing by Jennifer Hughes and Eric Meijer)