Highlights – China Steps Closer Towards Integration into Global Equities with MSCI Inclusion

The China A-share market marked a milestone after MSCI announced that it would include 222 A-share names into the MSCI Emerging Market (EM) index, with a 5% inclusion factor as a first step. The implementation will occur over two phases in May and August 2018. MSCI’s landmark decision is a nod to measures that the Chinese authorities had taken to improve market access for international investors over the last few years, with the Stock Connect a key supporting factor for its decision.

MSCI’s selection of the 222 China A-share names (out of the 448 from the MSCI China A International Index) are among the largest and most liquid names in the China onshore market. That said, the inclusion factor of 5% cited by MSCI significantly reduces the initial weightings of China-A shares – instead of a 100% market cap weighting for each stock, MSCI has given each stock an initial weighting of only 5% of its market cap. This translates to a 0.73% weighting in the MSCI EM index, which is small given that China has the second largest stock market globally (by exchange-listed market cap).

Nonetheless, the initial MSCI inclusion will provide a boost to sentiment and liquidity for China’s onshore equity markets in the short term, although the overall impact should be relatively mild. Longer term, the gradual move towards full inclusion is a positive development and is a key step towards the internationalisation of China’s onshore equity markets (see Charts 1 and 2 in full article). To that end, MSCI highlighted that further inclusion of China A-shares would hinge on additional structural changes to the A-share market. These could include measures to improve corporate governance, transparency, market access and information disclosure. 

Long Term Benefits of Inclusion

The MSCI inclusion should be positive for inflows into the China A-share market over the longer run. Looking at emerging markets such as Korea and Taiwan, their journey from initial to full inclusion in the MSCI indices had taken 6-10 years; during that time, market participation among foreign and institutional investors rose continuously. In a similar vein, institutional investors globally could be encouraged to participate more actively in the mainland stock markets in time to come. This would help to diversify the investor base – currently dominated by retail investors – and contribute to the maturing of the onshore equity market. 

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