China’s MSCI entry will have little short-term effect on financial markets, big impacts elsewhere

Written by Josh Gibbs || June 29 2017

MSCI, the influential provider of stock market indexes, has made the long-awaited decision to add Mainland Chinese A shares to its emerging markets index. 222 stocks from the Shanghai and Shenzhen exchanges will be added to the index. These 222 shares will represent just 0.7% of the emerging markets index, which is tracked by and estimated $1.6 trillion in funds.

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China has been hoping for MSCI inclusion for years because it would help establish Shanghai and Shenzhen as international financial hubs. MSCI has considered adding Chinese A shares to their emerging markets index multiple times in recent years, but ultimately decided against it due to a slew of restrictions and abnormalities in the Chinese capital markets, and limits on moving money out of the country. In MSCI’s view, the Chinese market is opening up and normalizing relative to international standards, and this has given MSCI confidence that China’s capital markets will continue to make strides in the future.

Chinese A shares being added to MSCI’s emerging markets index is an important milestone for China and for investors worldwide. Due to the large amount of assets under management that are in funds that either track or closely track MSCI’s emerging markets index, it is estimated that roughly USD $17-18 billion will flow into the Chinese stock market. It is predicted that full representative inclusion of Mainland China shares in the emerging markets index will bring inflows of roughly USD $400 billion to China.

The impact that MSCI’s decision will have in the near term is extensive. Foreign money managers will pay more attention to Mainland capital markets, and they will also pay more attention to corporate governance. Higher demands will be made of Chinese executives’ business practices, specifically pertaining to financial disclosure and insider transactions. Furthermore, the move serves as an incentive for Chinese regulators to steer the Chinese stock market closer to global standards.

However, upward movement in the Chinese stock market should not be expected as a result of MSCI’s decision. The changes in the index do not take place until 2018, and the number and weight of stocks being added to the index is too small to cause an upswing in the value of the market as a whole, or even the 222 individual securities being included. In the grand scheme of things, a USD $17-18 billion inflow into a roughly USD $8 trillion Chinese stock market simply won’t have a large impact. However, in the long term, $400 billion of inflows will likely cause macro-scale movement.

Presently, foreigners own only 1.5% of Chinese stocks and bonds. For comparison’s sake, roughly 20% of American long-term securities are foreign owned. In the future, the percentage of Chinese securities that are foreign-owned will climb, with MSCI’s decision to include Mainland A shares in the emerging markets index being a key factor.