MSCI decision tells China it can’t always get its own way
Wednesday’s decision by MSCI to delay membership for Chinese A-shares in the MSCI Emerging Markets Index serves a number of purposes.
One of them is practical. MSCI has been studying the proposed inclusion of domestically traded A-shares into the market for a number of years, wrestling with a problem: China’s is one of the world’s largest stock markets, but its currency is not freely convertible.
MSCI has to balance the interests of investors wanting to get exposure, and the protections and freedoms those same investors have come to expect from an international benchmark.
So, it’s entirely reasonable for MSCI to want to take a little longer to assess the changes China has made.
Last year, when MSCI declined A-share inclusion, it did so with a specific list of requirements. It spoke about capital mobility, being able to get investment quota commensurate with a fund’s size, and the issue of beneficial ownership.
And by February, China had made improvements to all of these issues, sometimes using the same wording MSCI had done.
However, that was only February. Little surprise, then, that MSCI speaks of “the need for a period of observation to assess the effectiveness of changes in QFII [qualified foreign institutional investor] quota allocation and capital mobility policies, and to monitor the effectiveness of new trading suspension rules”.
It also raises another practical point, the 20% monthly repatriation limit, which “remains a significant hurdle for investors”. Pre-approval restrictions on launching financial products on local exchanges are also mentioned.
There’s a second point being made by the MSCI: that China does not dictate the speed with which the world accepts the country into its financial systems, and that there is no rush.
There was an undercurrent of concern in November when China was granted special-drawing-right status – membership of the international reserve currency created by the IMF – making the renminbi the fifth currency to participate, alongside the dollar, euro, pound sterling and yen.
The IMF agreed to this despite the fact that, under its usual criteria, China’s currency didn’t qualify: it is not freely usable internationally, and China’s capital account remains restricted. It is not a free currency.
The IMF was felt to have overlooked this in order to make sure China remained part of the world multilateral community rather than going it alone, as the foundation of the Asian Infrastructure Investment Bank seemed to suggest it would do.
Full MSCI inclusion so swiftly afterwards, despite the same questions of currency freedom and convertibility, would suggest China was getting its own way somewhat unchecked. What’s the harm, MSCI is saying, in taking a moment?
MSCI says “we don’t rule out a potential off-cycle announcement should further significant positive developments occur ahead of June 2017”. Indeed, HSBC on Wednesday says that MSCI might review its decision by the end of the year, rather than waiting for next June.
However, the point is, MSCI is reminding China and everyone else that it will decide the timing when it is good and ready, and when it is convinced investors can take the consequent exposure without suffering governance concerns.
It won’t make any difference in the end. As Mark Valadao, State Street’s head of portfolio strategists for ex-Japan Asia, says: “It’s not a matter of it but when.”
He also points out that when it does happen, China’s index weighting relative to the emerging markets index will be the same as what the US is to developed markets. So it’s a big step, and beholden on MSCI to get the timing right.