MSCI's decision to include a selection of China A-shares in its indices shows China's financial reforms are working and marks the first step along the road to fuller inclusion in the future.
MSCI, a global index provider, will add a selection of China A-shares to its MSCI Emerging Markets (EM) Index from 2018, marking the first inclusion of mainland-listed shares into global indices, and passing a milestone in China's integration with global financial markets.
MSCI inclusion acknowledges China's progress with reform and opening
China has opened its financial markets to international investors through a series of steps in recent years, most notably the launches of the Stock Connect programs linking Hong Kong with Shenzhen and Shanghai, and MSCI's A-share inclusion acknowledges China's progress.
MSCI plans to add 222 China Large-Cap A-share stocks to its EM Index at a 5% inclusion factor, which means the stocks added to the index represent approximately 5% of the adjusted market capitalization of the A-share index.
Inclusion will take place in two steps, with stocks accounting for 2.5% of the adjusted A-share market cap added in May 2018, and stocks representing the remaining 2.5% being added in August 2018 (1). The included stocks will represent 0.73% of the MSCI Emerging Markets (EM) Index.
China's equity markets are too big to ignore
In our view, MSCI's inclusion of A-shares into its indices makes the benchmark more representative of emerging markets. That's a good thing for investors because China's A-share market is too big to ignore, and the market is predicted to grow over time.
More significantly, integration of A-shares in MSCI's EM index connects Chinese companies with global equity markets, and that should introduce more long term institutional investors and give foreign investors more choices when investing in China.
MSCI inclusion to have long-term impact on Chinese equities
In addition, as more global investors are attracted to the A-share market, we believe new investment strategies will emerge, such as long-term oriented and fundamentally-driven, and those strategies will change the market's structure significantly, with longer-term investors being more influential on the market, and that marks a change from now, because the market is predominantly driven by retail investors.
We also believe the inclusion of A-shares in MSCI indices will help improve corporate governance and many other aspects of the A-share market because Chinese companies will bring their standards in line with those expected by international investors.
Looking ahead, Remy Briand, MSCI Managing Director and Chairman of the MSCI Index Policy Committee, said (2) that, "When further alignment with international market accessibility standards occurs, sustained accessibility is proven within Stock Connect and international institutional investors gain further experience in the market, MSCI will reflect a higher representation of China A shares in the MSCI Emerging Markets Index.”
As such, we see the partial inclusion of 5% of the A-share market as the first step in a long process through which, ultimately, the A-share market gets fully included in the MSCI EM Index. That's because we believe the Chinese government is committed to opening China's financial markets and delivering precisely the reforms mentioned above.
Therefore, in our view, the inclusion of the selected shares in the MSCI EM Index marks the start of a process of integration that will bring investors closer to both China and the attractive opportunities in A-share markets.