Not if, but when – A breakdown of MSCI’s decision on China’s onshore equity market
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Not if, but when – A breakdown of MSCI’s decision on China’s onshore equity market

China is gradually shifting focus from the QFII and RQFII programs in favor of even more accessible “connect” programs. The first connect program to go live was the Shanghai-Hong Kong Stock Connect that linked the Shanghai Stock Exchange to the fully internationally accessible Hong Kong Stock Exchange. We believe the Shenzhen-Hong Kong Stock Connect program should follow soon, which will make the entire onshore market fully accessible to international investors.

The three issues:

  • Quota Allocation Process: In its announcement MSCI stated that QFII and RQFII quota is still an issue because: “Large investors should be given access to quota commensurate with the size of their assets.”8 We believe this issue will be settled in the near future because quota restrictions are consistently being loosened.
  • Capital Mobility Restrictions: The Shanghai-Hong Kong Stock Connect has a daily limit on the amount of stocks that can be purchased, which, if reached, could leave managers without access. MSCI would like to see this limit removed. Additionally the QFII program has a weekly redemption window, which MSCI would like to see increased to a daily window.
  • Beneficial Ownership: Unlike ETFs and mutual funds, investors in separate managed accounts own the actual underlying securities held by their custodian. MSCI wants to ensure that investors with separate accounts are confident in their ownership in Chinese stock.

Before the June 9th announcement there were lingering questions around how the onshore markets would be phased in. MSCI clarified that initially 5% of the onshore Chinese equities’ free float market cap would be included into their broad indices and that this weight will be increased incrementally. At full inclusion, China’s weight within MSCI Emerging Markets would be 43.6% overall, 20.3% Hong Kong listed companies, 20.5% onshore Chinese companies, and 2.8% U.S.-listed companies9. An incremental increase of onshore equities within broader indices is a logical strategy based on the large amount of money needing to be reallocated.

We previously wrote about how the lack of a formal announcement on the Shenzhen-Hong Kong Stock Connect program could be problematic for inclusion. We suspect an official announcement about the launch of this program in the next several months. Ultimately the impediments are coming down as MSCI calls the launch of the Shenzhen–Connect program “imminent” and believes “further liberalization of the RQFII program”8 is coming.

China’s leadership is motivated to continue opening up its economy to international investors. Having China’s onshore markets included into international indices helps bolster this goal. We believe investors should consider taking a position in the onshore China markets today as their inclusion within broad MSCI indices – and the accompanying international fund flows – are imminent and China is enacting policies to sustain the onshore market rally.

  1. Source for KBA being the only ETF with onshore exposure to track an MSCI index ETF – ETF Trends, “What Would A-Shares Look Like in Broad EM ETF? The Answer Already Exists” 6/3/2015
  2. Return based off the MSCI United Arab Emirates IMI Index from January 2012 to May 2014. Definition: The MSCI United Arab Emirates Investable Market Index (IMI) is designed to measure the performance of the large, mid, and small cap segments of the UAE markets. With 22 constituents, the index covers approximately 85% of the UAE equity universe.
  3. Return based of the MSCI China A International Index from start of market rally 3/1/2014 through 5/31/2015. MSCI China A International Index Definition: The MSCI China A International Index captures large and mid-cap representation and includes the China A-share constituents of the MSCI China All Shares Index. It is based on the concept of the integrated MSCI China equity universe with China A-shares included.
  4. Source: World Bank as of 2013
  5. Source: World Bank as of 2013
  6. Source: China Securities Depository and Clearing Corporation as of 5/2015
  7. Source: CEIC Data as of 2/5/2015
  8. Source for quote – MSCI, “Results of MSCI 2015 Market Classification Review” 6/9/2015
  9. MSCI as of 6/2015

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