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MSCI delay a catalyst for China's capital market reform

BEIJING - Stock-index compiler MSCI's decision to defer inclusion of Chinese mainland-listed A-shares in its global benchmarks could be a catalyst for further reform.

Announcing the decision early Wednesday, MSCI said it "expects to include China A-shares" once "a few important remaining issues related to market accessibility have been resolved."

MSCI identified three issues it would discuss with regulators -- quotas for large investors, [Hong Kong company registration]capital mobility and details of beneficial ownership -- and is willing form a working group with the China Securities Regulatory Commission (CSRC) to address the concerns.

Waiting and hoping

The delay is certainly a setback for China's financial markets, but there may be more silver lining than cloud.

China International Capital Corp (CICC), the country's leading investment bank, described the decision as being in line with market expectations and suggested that inclusion would probably come in 2016.

Last month, an MSCI competitor, the FTSE Group, included China's A-shares in two new transitional indexes for emerging markets, and last week the Vanguard Group, the largest US provider of mutual funds, added the A-shares to its emerging-markets fund.

The A-share market was nonplused by MSCI decision and the benchmark Shanghai Composite Index ended down slightly. The Shenzhen Component Index gained 1.6 percent.

Brendan Ahern, chief investment officer at Krane Fund Advisors, does not believe the issues raised are insurmountable. "They won't wait until the 2016 review [...] It will happen sooner," Ahern told Bloomberg.

The Shanghai-Hong Kong Stock Connect, which was launched last November, allows investors from both sides to trade selected stocks on either exchange. A similar program will link Hong Kong-Shenzhen later in the year.

Previously, A-shares traded on the mainland were only available to foreign investors via two quota systems -- the 2003 Qualified Foreign Institutional Investor (QFII) and 2011's Renminbi Qualified Foreign Institutional Investor (RQFII).

"Substantial progress has been made toward the opening of the Chinese equity market to institutional investors," Remy Briand, MSCI managing director, said in a statement Wednesday. The RQFII program now covers 12 countries and regions and the situation with regard to capital gains tax is more clear.

Young and hot

The A-share market in China is only about 20 years old, still young in terms of capital mobility, currency convertibility and trading rules. Legal and regulatory systems clearly need to be improved. The MSCI decision will bring better market accessibility and transparency, criteria valued by global index providers.

China must continue to liberalize its capital account and ensure larger QFII and RQFII quotas. The RQFII program now covers 12 countries and regions, and the situation with regard to capital gains tax is more clear. The two programs give foreign investors the right to move money into the capital account to encourage more controllable flows. Overseas institutions have received quotas in excess of 383 billion yuan ($62.5 billion) under the RQFII program and $74.5 billion through QFII.

A better IPO registration system needs to replace current administrative approvals, but on the other hand, [Hong Kong Company Formation] the A-share market already has potential that is hard to ignore. It is currently valued at more than 63.3 trillion yuan, making it the world's second largest.

In the past year, the Shanghai Composite Index has climbed 152 percent, outperforming other global benchmark indexes by a large margin. Shenzhen rose 145 percent in the same period.


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