Is China a three-time loser?

Added 30th June 2016

Earlier this month, the MSCI rejected the inclusion of A-shares on its key indices for the third time. Luke Ng, senior VP of research at FE, outlines the concerns.

Is China a three-time loser?

The MSCI's rejection of China A-shares on June 15 brought a terse response from China's market regulator, which stated "[A]ny international indices without A-shares are incomplete." 

Ng answers several questions surrounding the index provider's decision.

What were the key reasons for rejection?

This is the third time that China’s A-shares have been rejected by the MSCI. The last time the company rejected the A- share inclusion was at the last review in mid- 2015, citing five key areas of concern.

(1)Clarification of investment quota allocation, (2) capital mobility issues, (3) stock suspension issues, (4) beneficial ownership and (5) the financial products pre-approval restriction issue.

Over the past year China has been making significant progress to deal with the above areas, although some of the policies were announced as recently as late May 2016.  Even with the new policies coming into force, points 2 and 5 remain concerns as they are largely unresolved and have seen little in the way of policy reform.

China’s rejection highlights not just the on-going problems facing the A-share market, but that MSCI is being suitably prudent in trying protect foreign investors' interest, which is a good thing.

What does the third rejection mean for A-shares?

China is the second largest economy in the world and the MSCI inclusion was widely expected, so it is likely to bring some short-term volatility into the market. However, capital market liberalisation of China will likely continue in order to bring it closer to the international standard to ease foreign investors’ concerns.

Will China be successful in addressing the concerns of the MSCI?

There are three key issues that require further improvement: First, the 20% monthly repatriation limit remains a hurdle to be resolved, especially for mutual funds as they may face redemption pressure during extreme market conditions. Second, the financial products pre-approval restriction issue, which limits the flexability to launch a fund that has links to the onshore capital market, and third, the effectiveness of the implementation of the recent policy changes I mentioned.

Generally government intervention remains a common concern for foreign investors. For example, investors recall the market `circuit breaker' that regulators introduced and quickly withdrew. Given this background, we need to see further clarification of regulatory action from Beijing in order for the market to meet international standards.

Having said all of that, I believe it is only a matter of time before China catches up and meets MSCI’s requirements. The Chinese regulator certainly seems to be moving in the right direction to address the issues. 

In fact, one could even look at the delay of China’s MSCI inclusion as a positive – in that this may be the trigger that helps to aid further liberalisation of the country to meet higher international standards.

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