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How to convert MSCI index change into real investments in China A-Shares
How to convert MSCI index change into real investments in China A-Shares
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How to convert MSCI index change into real investments in China A-Shares

29/06/2018

Gary O’Brien

Gary O’Brien

Head of Custody Product

BNP Paribas Securities Services

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The long-awaited inclusion of China A Large Cap shares to MSCI’s indexes is finally here. The big question now is whether global investors are prepared to handle the operational challenges of navigating the trading system and making the most of the rapidly growing access to China's onshore equity markets

MSCI’s move on June 1 - the first of its kind - to include in its market indexes China A-shares that until now traded only on local exchanges promises a new range of diversity for investor portfolios while allowing a flood of foreign funds into Chinese stock markets. Estimates of inflows range from an initial USD 20 billion to USD 300 billion at full inclusion[1]. The two-step partial inclusion of 2.5% each will reach 5% in September 2018 to account for the existing daily trading limits on Stock Connect[2]. When this occurs, China’s overall weight in the emerging market index could climb to 32%[3].

MSCI index review marks a big step forward in Beijing’s plans to provide greater access to Chinese markets, and follows three years of deliberations between MSCI, investors, Chinese authorities and other stakeholders. The main discussions focussed on longstanding concerns about the regulatory framework of onshore markets, including issues such as volatility, uncertainty around capital repatriation and stock suspensions.

The big question now is whether global investors are prepared to handle the operational challenges of navigating the trading system and making the most of the rapidly growing access to China’s onshore equity markets.

Expectations raised by China A-Share inclusion in MSCI market indexes 

There is no doubt about the growing interest for investments in onshore Chinese stock exchanges, which has only been growing in the run up to MSCI’s move. The advantages are clear-cut: greater exposure to the stocks of fast-growing Chinese companies operating across a range of sectors in a massive USD 13 trillion economy[4].

In turn, increased participation from foreign investors is expected to institutionalise China equities market and create fresh opportunities for investments, particularly as the Chinese government encourages more state-owned companies to list their shares with initial public offerings. The participation of international institutional investors should foster a more robust capital-raising mechanism and ensure the long-term sustainability of the country’s stock markets.

Meanwhile, long-existing QFII/RQFII schemes and Stock Connect with Hong Kong have so far led the way in improving access to and internationalising China’s markets. By March-end, Stock Connect northbound assets under custody stood at RMB 560 billion, and this is expected to increase to over RMB 600 billion after MSCI’s inclusion is complete later this year.

How to access to Chinese equity markets?

As investors become convinced of the merits of the inclusion of China A-Shares, the discussion is now focused on how best to capitalise on MSCI’s move, as well as other current and future market access schemes. Issues such as the creation of an operational framework facilitating the easy trading, clearing and settlement of these shares are now occupying the attention of investors, and rightly so.

For instance, most foreign investors, especially passive ones, will initially access China A-shares through the Stock Connect scheme instead of QFII or RQFII, mainly because of quota limitations in the latter schemes and the need to be better versed in local Chinese market regulations, both of which can cause delay.

One of the biggest challenges (possibly the biggest) for investing into China A-shares through any scheme has been the T+0 settlement cycle. It’s been a sticking point for international investors who are used to a T+2 cycle which allows for a smooth cross-border flow of securities and cash, and provides extra time to arrange funding. Investors in the U.S. for example have long found China’s T+0 market a real challenge, the close of which happens in the middle of the night in the U.S.

This is where a scheme like the upcoming London-Shanghai Stock Connect will help as it is expected to use a T+2 settlement cycle, and trading is expected to take place during UK hours, with settlement in US dollars.

Finally, as the global markets participants await these reforms and regulators prepare to usher in new levels of access to China’s dynamic, fast-changing markets, global investors would do well to review their strategies and prepare themselves for further changes. For instance, the MSCI full inclusion will bring to bear significant liquidity pressures on both buy-side and sell-side entities. This pressure comes from CNH being a not very liquid currency and organisations can either struggle to fund their obligations or pay high costs to do so.

This is where choosing the right solution to access China stock exchanges is critical. For example, 70% of Stock Connect activity at BNP Paribas Securities Services is settled through the company’s Multi Approved Partner model which provides real-delivery versus payment (DVP) settlement and greater flexibility around settlement timing, instead of the market standard Special Segregated Account (SPSA) Services model.

Inclusion in other market indexes?

Looking to the future e in the wake of MSCI’s move, it is a matter of time before other major global benchmark indexes begin to include Chinese stocks and bonds, enhancing access to one of the world’s largest equity and bond markets. The market is already anticipating and preparing for the inclusion of Chinese bonds into the Bloomberg Barclays Global Aggregated Index in 2019, and there is no doubt that we will continue to see institutional investors appetite and trading volumes increase.

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[1] What is China's A-share MSCI inclusion?

[2] China a shares inclusion

[3] Wei, Zhen. MSCI. MSCI on China, April 2018, p.3.

[4] Economic Watch: Softer but better growth expected for Chinese economy in 2018

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