Will MSCI include China’s A shares in its EM index and what would the impact be? Axa IM’s Aidan Yao assesses the chances

3rd June 2016


Aidan Yao, Senior Emerging Asia Economist at AXA Investment Managers (AXA IM), discusses the conditions for the inclusion of China’s A-shares in the MSCI, given the absence of significant market changes.

“It is that time of the year again – the MSCI’s annual review (June 15) to decide whether to include China’s A-shares in its emerging markets (EM) index. On May 30th, A-shares jumped more than 3% on no obvious news, and continued to outperform the next day. Market chatters point to a renewed excitement of a potential inclusion, which was fanned noticeably by Goldman Sachs raising the odds of a positive outcome to 70%, from a previous coin-flip. Last week in Europe, I was asked by journalists about the upcoming MSCI decision. But with all the turmoil in A-shares over the past 12 months, my immediate response was, given it wasn’t included last year, I cannot see what has changed since that would swing the decision this time around. But clearly there are different views in the market, and so let’s dig a little deeper.

“An obvious starting point of the analysis is to take a look at MSCI’s assessment last year for not including China, and see what were the constraining factors. In the brackets that follow, I also explain the progress, if any, made since then to ease these constraints:

“In light of the market turbulence and official interventions since last June, MSCI raised two additional issues in this year’s consultation paper, namely:

“Apart from the aforementioned factors, there are some additional hurdles for investing in A-shares, although they are not necessarily binding for the MSCI inclusion. These include:

1) a lack of hedging instruments in both equities and foreign exchange;

2) the connect train is open only to the Shanghai market, while the Shenzhen (and SME/ChiNext) market remains closed;

3) concerns about heavy government intervention since the rout last year;

4) high market volatility and valuation.

“Overall, China has clearly made progress on market accessibility, but this progress is built on existing channels (e.g. (R)QFII and the Connect; while the long-awaited Shenzhen-Hong Kong Train is not yet open). On beneficial ownership/stock suspension/anti-competitive clauses, whether the authorities have done enough to earn a tick mark rests on the judgment of the index operator. For the non-binding factors mentioned above, they could influence the decision to the extent that the inclusion may undermine the popularity of MSCI as a benchmark, given the prevailing bearish sentiment towards A-shares. Given these conflicting factors, we are not as confident in treating the inclusion as a high-likelihood event.

“A possible compromise: in terms of the outcome in two-weeks’ time, we think there are three options: ‘yes’, ‘no’, or ‘in-between’. The in-between could be either a delay of the decision (for inclusion) subject to China meeting all (or most) of the remaining criteria, or an off-cycle decision that brings A-shares into the index before the next annual review. It is worth remembering that the International Monetary Fund kind of used the first option in postponing the implementation of the renminbi’s (RMB) inclusion in the special drawing right. Therefore we think the ‘in-between’ option is very likely this time.

“Impact of an inclusion: another possible compromise is that MSCI can progressively include A-shares in the index. In fact, this is almost the market consensus that China will not command its full weight in the index in day one following the inclusion. According to the proposal last year, MSCI will adopt a 5% inclusion factor initially and progressively move it up to the full allotment over time. So how would this impact capital inflows?

“MSCI estimates that there are USD 10.5 trillion tracking various MSCI indices globally, passive and active funds combined. The A-shares inclusion will impact the ACWI, EM and Asia indices, with a combined AUM of USD 4.5 trillion (chart below).


Source: MSCI, CICC, AXA IM Research

“The charts below illustrate how the composition of the EM index will change after the A-shares inclusion, with a 5% inclusion factor and full allotment.


Source: MSCI, CICC, AXA IM Research

“Putting the numbers together, a 5% inclusion will translate in approximately USD 21 billion of inflows from the ACWI, EM and Asia indices, which will grow to approximately 360 billion as the full weight is allotted (table below). These numbers may overestimate the size of inflows as some actively-managed funds tracking the MSCI may not follow the inclusion in day one. In terms of the market impact, A shares (Shanghai + Shenzhen) is a USD 6.6 trillion market, so a USD 21 billion inflow accounts for merely 0.33% of the market cap. Daily trading volume in Shanghai and Shenzhen is around USD 5.5 billion post the market correction (it was as high as 18 billion mid-last year before the crash), so a 21 billion inflow alone is unlikely to have a major impact. That said, one should not underestimate the possible spillover effect from the feel-good mentality of an inclusion, as last year’s rampant rise before the June collapse was partly contributable to the anticipation of the MSCI inclusion.”

Source: MSCI, CICC, AXA IM Research

Source: AXA Investment Managers as of June 1.

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