MSCI to increase weight of China A shares in indexes

MSCI will increase MSCI China A large-cap and midcap securities to 20% from 5% of their respective free float-adjusted market capitalizations in three stages in 2019, the index provider announced Thursday in a news release.

Those stages will be an increase to 10% from 5% coinciding with MSCI's May 2019 semiannual index review, 15% from 10% in August coinciding with MSCI's quarterly index review and 20% from 15% coinciding with MSCI's November 2019 semiannual index review.

Remy Briand, MSCI managing director and chairman of the MSCI index policy committee, in a news conference said positive feedback from MSCI clients regarding the initial 5% A shares market inclusion from mid-2018, together with continued reforms by Chinese regulators, paved the way for Thursday's announcement.

With A shares pro forma weighting in the widely followed MSCI Emerging Markets index now poised to rise to 3.3% by late 2019, Mr. Briand noted that further reforms in areas such as expanding access to derivatives instruments needed to hedge investor exposures would be key to determining how quickly MSCI could push ahead to full market inclusion.

At the news conference, Chia Chin Ping, MSCI's Hong Kong-based head of research, said the increases in A shares weightings could prompt roughly $80 billion of inflows from overseas investors.

A number of big money managers welcomed MSCI's move.

Manish Mehta, BlackRock (BLK)'s global head of markets and investments for iShares and index investing, said in a email that the gradual addition of A shares to key indexes "deepens the investment opportunity for global investors."

Eric Moffett, an Asian equity portfolio manager for T. Rowe Price Inc., said another $40 billion of expected inflows from active overseas investors could raise the profile of more "fundamentals-based" factors in an A-shares market dominated by retail investors now, while boosting pressure for good corporate governance.

With subsequent rounds of index inclusion potentially boosting the weight of A shares in MSCI's emerging markets portfolio to as much as 20% over the next five years, Thursday's announcement — while not an overnight revolution — should "prompt investors to think twice before concluding that (China's) A-share market is more trouble than it's worth," said Nicholas Yeo, Aberdeen Standard Investments' Hong Kong-based head of China equities.

Mr. Briand declined to forecast when A shares could be fully included in MSCI's indexes. The pace of reforms and institutional investors' level of comfort with the market will be the key factors driving those timing decisions, he said.

MSCI launched its latest move in September when the company announced it would begin to consult with the industry on the potential of increasing the inclusion factor of China A large-cap securities. MSCI's original proposal was for two stages, but feedback during the consultation from international institutional investors suggested three stages to "alleviate potential execution pressure on the implementation dates," Mr. Briand said.

The strong commitment by the Chinese regulators to continue to improve market accessibility, evidenced by, among other things, the significant reduction in trading suspensions in recent months, was a critical factor in winning the support of international institutional investors, he said.

The original proposal also had MSCI adding China A midcap securities to indexes, with a 20% inclusion factor, as part of MSCI's May 2020 semiannual index review, but MSCI said in the news release that a "significant proportion of investors also highlighted that China A midcap shares should be included in the MSCI indexes jointly with the weight increase in large-cap shares to allow for a smoother implementation."

MSCI also announced it is adding ChiNext of the Shenzhen Stock Exchange to the list of eligible stock exchange segments, beginning with the May 2019 semiannual index review. ChiNext represents about a fifth of total China A-shares opportunity in terms of stock volume and market capitalization.

After the completion of the implementation, MSCI said there will be "253 large- and 168 midcap China A shares, including 27 ChiNext shares, on a pro forma basis in the MSCI Emerging Markets index, representing a weight of 3.3% in the pro forma index."

MSCI also added that international institutional investors have noted that any future weight increase of China A shares in the MSCI indexes beyond 20% would require Chinese authorities to address "a number of remaining market accessibility questions."