MSCI changes tack on A-share inclusion

MSCI issued the new proposal on 24 March for consultation with the investment community in the run-up to the index provider’s annual decision on China A-share inclusion expected in June. The decision would affect, in particular, MSCI China Index, MSCI Emerging Markets Index, MSCI Asia ex-Japan Index and MSCI All Country World Index (ACWI).

The proposal reduces the number of A-shares that would be included in the MSCI China index to 169, compared with 448 under last year’s framework. A-shares would account for 1.8% of the weight of the index, compared to 3.7% under the previous proposal.

The new framework limits the equity universe to large cap companies accessible through the Shanghai-Shenzhen-Hong Kong Stock Connect program. It also excludes A-shares of companies that have H-share listings included in the MSCI China Index. (H-shares are shares of mainland companies listed in Hong Kong.)

This addresses the issue of the QFII and RQFII limitations on monthly repatriation of assets, which MSCI cited as one of the main reasons not to include China A-shares in June 2016.

“The new proposal addresses two of the three obstacles that MSCI cited last year,” said Jackie Choy, director of ETF research for Asia at Morningstar.  On the other hand, limiting the China A-share universe to large caps “is not a good representation of China’s overall equity market,” he added.  

The proposal’s focus on the Stock Connect would make it easier for managers of index-tracking products to access Chinese securities, bypassing the cumbersome alternative of QFII and RQFII schemes.

Ineligible securities

The new framework also makes ineligible for inclusion securities suspended for more than 50 days in the past 12 months. Voluntary trading suspensions have been plaguing Chinese stock market since the crash in the summer of 2015, making life difficult for index providers and managers of index-tracking products.

In order to harmonise with Stock Connect processes, index changes linked to corporate events or quarterly index reviews would be postponed to the next day if the trigger event takes place on a holiday or if the daily trading limits of the scheme are breached.

For the same reason IPOs would not be included in the indices, as the users of Stock Connect don’t have access to them.

In order to minimise the potential tracking errors resulting from divergence of onshore and offshore renminbi exchange rate, the new proposal stipulates the use of the offshore CNH rate for index calculation, not the onshore CNY rate as before.

MSCI maintains its intention to include A-shares in steps, with the initial 5% inclusion factor. After the inclusion, China A-shares would constitute 0.1% of MSCI All Countries World Index, where Chinese companies today account for 3.1%;  0.5% of Emerging Markets (Chinese companies: 28.1%) and 0.6% of Asia Ex-Japan indices (Chinese companies: 33.1%).