After three consecutive unsuccessful attempts by China to have its A Shares included in the MSCI Emerging Market index, moments ago the fourth time proved to be the charm, when MSCI finally relented and agreed to add China's A shares to the much desired index.
The news means that China's $6.8 trillion domestic stock market will finally be added to the flagship EM index, forcing the $1.6 trillion in investment funds that track the index to buy mainland equities, even as they will likely remain dwarfed by overseas-listed Chinese stocks which have an increasing sway over MSCI’s developing nation gauge.
The inclusion comes as China’s Shanghai Composite Index has struggled to rise amid a government crackdown on risk in the financial sector and waning interest by the nation’s army of individual investors, who have instead discovered bitcoin and ethereum. The SHCOMP has fallen more 4% since its mid-April peak, sending correlation ratios with the rest of the world to below zero. It also means that China's offshore shares have become the priciest relative to Shanghai since 2014.
According to Bloomberg, the inclusion will be done in two steps: the first in May 2018 and the second next August. Also Tuesday, MSCI put off decisions on whether to reclassify Argentina as an emerging market and to demote Nigeria to standalone status. It listed Saudi Arabia on its watch list for potential classification as an emerging market.
Perhaps the token move was greenlighted as the allocation would ultimately be quite de minimis: under the approved proposal, the weighting of yuan-denominated A shares would be just 0.5% of the index, half the previous suggested level.
The MSCI inclusion "will provide a modest boost to sentiment and flows into China," David Loevinger, an analyst at TCW told Bloomberg. "More importantly it strengthens Chinese reformers that want to open China’s markets. The small index weight looks like a compromise between those asset managers that wanted China in and out."
Additionally, as Bloomberg's Heidi Lun writes, there are numerous caveats when it comes to higher MSCI representation of A-shares, with the indexer wiling to wait until China "magically becomes an open, accessible, institutional-driven market."
Caveats aplenty on higher MSCI representation of A-shares i.e. when China magically becomes an open, accessible, institutional-driven market pic.twitter.com/P1eyJbQniU
— Haidi Lun ??? (@HaidiLun) June 20, 2017
In some ways, today's decision is comparable to the IMF's inclusion of the massively manipulated Yuan in the SDR basket, a move which was supposed to boost the currency's liberalization and instead came just as China unleashed a unprecedented round of outbound capital controls.
Meanwhile, as the FT notes, the decision opens a new front in investors’ long-running debate over whether, and how, to introduce domestic Chinese securities into international portfolios. While China’s domestic equity and bond markets are the second- and third-largest in the world, foreigners hold just roughly 2% of each.
Another caveat: this year’s proposal only includes A-shares that are already traded through the Stock Connect that links Hong Kong with Shanghai and Shenzhen. The Stock Connect operates as a closed system where international investors buy A-shares in Hong Kong dollars and also cash out in that currency, meaning they are subject to fewer capital restrictions than if they bought the shares in the mainland using renminbi.
Ironically, the three previous proposals by MSCI to include mainland stocks were rebuffed by the index provider’s stakeholders, mostly the large asset managers themselves who would have to buy China's opaque, frequently fraudulent stocks.
Oh well, at least now stories of Chinese stock market fraud will become global, and we look forward to the upcoming class action lawsuits that result from losses after one after another Chinese listed company, and bought by the EM investors, turns out to be fraud. Even more amusing will be another stock market bubble-bust cycle which will leave countless investors nursing massive losses.
In any case, the Yuan is happy, if only in kneejerk reaction, with the CNH rising to 6.8212 following news of the inclusion.