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Including China A-shares in MSCI EM Index: Is It the Time?

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Including China A-shares in MSCI EM Index: Is It the Time?

Including China A-shares in MSCI EM Index: Is It the Time? MSCI will announce its annual market classification review results on June 11

MSCI announced in June 2013 that it included China A shares in the review list for potential inclusion to its Emerging Markets (EM) index, which currently include only some of the Chinese shares listed overseas and B-shares listed in China. In March 2014, MSCI initiated a consultation on a proposed roadmap for inclusion of China A shares. MSCI will announce its decision in the morning of June 11, 2014 (Hong Kong time). If MSCI decides to include China A shares, the first change will be implemented in May 2015. In addition, Korea and Taiwan are also in the review list to be promoted from EM to DM.

A small step, but an important milestone in opening up China’s equity market

MSCI proposes to include 5% of China A shares’ float market cap as the first step (60 bps in MSCI EM, and 2.9% in MSCI China). China’s country weight will increase from currently 19% to approximately 20%. While this is a very small step, it is the first time China A shares included in a global benchmark.

China has made significant progress in market liberalization

The pace of reform and market liberalization in China has been accelerating in the past 12 months. A number of key changes (MSCI roadmap, RQFII expansion to Paris, Shanghai/Hong Kong Connect, “New National Nine Rules”, etc.) announced in the past 3 months. The timing and magnitude of these changes exceed the expectations of many investors.

Three possible outcomes from MSCI’s annual market classification review.

While China has made significant progress in opening up its capital market, obstacles still exist. We see three possible outcomes from this review. The first is that MSCI will confirm the proposed roadmap to include China A shares in May 2015. MSCI may also continue to exclude China A share at this time, and will review it again in the next review in June 2015 (then the implementation will be in May 2016). Another option is to postpone the decision to December this year for implementation in November 2015. Our view is all three outcomes are likely, but the last one is a better solution.

Index inclusion may act as a positive catalyst to the A share market

China’s equity market has been under pressure recently. Year to date, CSI300 and FTSE China A50 have been down 8.4% and 6.1% respectively. Inclusion of China A shares in MSCI or other major benchmarks could improve the sentiment and provide significant support for the market going forward. We estimate the proposed 5% inclusion could potential attract over $7bn inflow to China A shares. Other benefits include shift in investor base toward long-term institutional investors, and a boost in liquidity in equity markets.

Korea and Taiwan are unlikely to be upgraded to DM in MSCI.

We believe the most likely scenario is that MSCI will maintain these two countries in the EM index at this review, while we cannot completely rule out the possibility of an upgrade given the subjective nature of the assessment

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