MSCI foresees Asia ex-China benchmark

Jun 29, 2015

Indices provider says that China equities' weighting could eventually become so great that the country will need its own stand-alone benchmark. And its Asia head expects A-share inclusion in EM indices by 2017.

MSCI could introduce Asia ex-China benchmarks in the future because of A shares’ potential weight in emerging market indices, the firm has predicted.

Just weeks after the indices provider decided not to include China A shares in its EM index, the firm foresaw a situation developing similar to Japan’s experience in the 1980s.

In the meantime, MSCI’s Asia head said he expected A shares to be included in its EM indices by May 2017.

Goldman Sachs studies have found that full inclusion of A shares alongside freely tradeable equities such as H shares and ADRs could result in China stocks representing as much as 43% of the MSCI EM index by mid-2017, leading to fund manager worries over the dominance of China’s component in the index.

But China could follow the example of Japan, which by 1988 saw Japanese equity weighting at 90% in the previously commonly used MSCI Far East Asia index until the decision was made to spin off Japan from the benchmark.

“Once China gets over 50% [of the emerging markets index], how many asset owners willing to invest in EM would want to split China out just like how they did with Japan in 1980s,” asked MSCI’s Asia-Pacific head Chris Ryan. “There are not a lot of Asian mandates these days that still include Japan.”

And the chance of China reaching a significant threshold within the EM index is all the more likely, given that China is one of the largest originators of IPOs.

So far, less than 50 of China’s 500 banks are publicly traded, and with China pushing for greater financial reforms the remaining 90% could add greater pressure to existing indices.

“Say that they IPO’d the remaining 200 of those remaining 450 banks over 10 years, that’s still more than one bank per month for 10 years and that’s just one sector,” Ryan said at AsianInvestor and FinanceAsia’s Stock Connect 360 conference in Hong Kong yesterday.

“There is an enormous amount of capital raising yet to go in China and I am just picking on one sector. There is the rest of the securities companies and trust companies and brokers and insurance companies … and all the other sectors like healthcare and pharmaceuticals that is currently on the government balance sheet that needs to come off over time,” said Ryan.

But the inclusion of A shares in the index, which analysts generally suggest is a question of when and not if, will be a difficult journey.

“The reality is that you have got to understand that the job [China Securities Regulatory Commission] has within China is not a simple issue. They have to coordinate with nine ministries and bureaus,” said Ryan, listing the State Council, the central bank, the banking regulatory and tax bureaus among the bureaucratic minefield.

Referring to the MSCI statement earlier this month on its reasons for not including A shares into its EM indices, Ryan said the biggest problems for global fund managers included the need for greater accessibility, daily repatriation and clarification on beneficial ownership.

But a joint working group, an idea initially suggested by CSRC, could help accelerate the resolution of remaining issues, so much so that Ryan said he expected some form of A-share inclusion by May 2017.

“The clock is ticking on an almost 22-month clock with not a long time to align custodian practices, for example with internal systems and research teams and all those sorts of things,” said Ryan.