Landmark move enhances access to China’s markets

The long-awaited inclusion of China A Large Cap shares in MSCI’s EM indexes is finally here. In the first stage of a two-step process, more than 222 shares listed on Chinese exchanges are now available to offshore investors.

Until 1 June 2018, China A-shares were traded only on local exchanges. The MSCI’s move delivers a new range of diversity for investor portfolios while allowing a flood of foreign funds into Chinese markets with estimates of inflows ranging from an initial $20 billion to $300 billion at full inclusion.1

Gary O'Brien, head of custody product
BNP Paribas Securities Services

The second stage, partial inclusion of 2.5% each will be completed in September 2018, reaching 5% inclusion to account for the existing daily trading limits on Stock Connect 2. When this occurs, China’s overall weight in the index could climb to 32%. 3.

The move is a big step forward in Beijing’s plans to provide greater access to Chinese markets. It follows three years of deliberations between MSCI, investors, Chinese authorities and stakeholders concerning the regulatory framework of onshore markets, volatility, uncertainty around capital repatriation and stock suspensions.

Institutionalising the market
The advantages of the MSCI’s move are clear – providing greater exposure to stocks of fast-growing domestic companies operating across a range of sectors in a massive $13 trillion economy.4.

In turn, increased foreign investment will institutionalise the domestic market and create fresh opportunities for investors, particularly if China’s government encourages more state-owned companies to list shares.

Meanwhile, long-existing QFII/RQFII schemes and Stock Connect have led the way in improving access and internationalising China’s markets. As of March 2018, northbound assets under custody stood at Rmb560 billion with expectations of over Rmb600 billion at full inclusion.

Quotas and settlement
BNP Paribas believes investors need to capitalise on the MSCI’s move. Issues such as the creation of an operational framework to facilitate the ease of trading, clearing and settlement of these shares need resolving. For instance, most foreign investors will initially access China A-shares through the Stock Connect scheme instead of QFII or RQFII, mainly due to quota limitations and the need to understand Chinese market regulations, both of which can cause delays.

One of the biggest challenges for investing into China A-shares is the T+0 settlement cycle, a sticking point for international investors used to a T+2 cycle which allows for a smooth cross-border flow of securities and cash, as well as providing extra time to arrange funding. American investors find China’s T+0 market challenging, since it closes in the middle of the US night.

A scheme similar to the upcoming London-Shanghai Stock Connect could help. It’s expected to use a T+2 settlement cycle and trade during UK hours with settlement in US dollars.

As the markets await these reforms and regulators prepare new levels of access to China’s fast-changing markets, global investors would do well to review their strategies and prepare themselves for further changes.

For instance, the MSCI inclusion will bring to bear liquidity pressures on both buy-side and sell-side entities. This comes from offshore renminbi (CNH) not being a very liquid currency.

Choosing the right solution to access China 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 rather than the HKSCC’s Special Segregated Account (SPSA) Services model.

Looking ahead

It’s only a matter of time before other major global 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 preparing for the inclusion of Chinese bonds into the Bloomberg Barclays Global Aggregated Index in 2019, and there is no doubt we will see investor appetite and trading volumes increase.