Index provider MSCI has again denied Chinese domestic A shares access to its emerging markets indices, marking the third year in a row that the index provider has delayed their inclusion due to fears over access and transparency. The decision means passive emerging market investors will not see their exposure to Chinese shares dramatically increased from 2017, as many had expected, as MSCI continues its wait-and-see approach.
This week, MSCI commended China's recent moves to liberalise its market, but said the country would have to make its shares more accessible to foreign investors in order to be added fully to the index. Remy Briand, MSCI managing director and global head of research, said: "International institutional investors clearly indicated that they would like to see further improvements in the accessibility of the China A shares market before its inclusion in the MSCI Emerging Markets Index."
Liquidity issues such as stock suspensions and quota restrictions have been sticking points for investors and China has taken steps to resolve those. But MSCI said it wanted to wait and see how recent changes played out before taking the plunge. Investors also continue to object to provisions, including preventions on taking out more than 20 per cent of their investment each month.
Catherine Yeung, investment director for Asia ex-Japan equities at Fidelity International, said: "What's important to note is that while we have seen some significant improvements in terms of how foreign investors access domestic Chinese stocks, regarding the MSCI criteria that were set last year, a lot of it still needs to be fulfilled."
Inclusion, when it happens, will be gradual. But adding China shares to MSCI's benchmark indices will mean a seismic shift for passive investors in emerging market indices. Chinese exposure was expected to increase from over 20 per cent to around 40 per cent within a matter of years if inclusion had been granted.
Offshore Chinese shares are already included in the index, including shares listed in Hong Kong and Chinese companies registered in the US. But those listed in mainland China are not, meaning that a large swath of the developing world is not included in broad emerging market indices. Many are keen to see the country fully reflected in these indices.
Responding to the news, a BlackRock spokesperson said: "BlackRock welcomes the progressive reforms made in China's capital markets over the past year. This is an important investment destination for our clients globally, so the opening of its markets to provide access to the world's second-largest economy is significant."
"As a long-term investor, we would welcome further progress in facilitating broader participation in the nation's domestic stock markets for international investors."
China could still be added to the index within the next year, outside of the normal review period, which falls every June, if the country satisfies MSCI's targets.
However, one major change was made in MSCI's 2016 review - it upgraded Pakistan from a frontier to emerging market country - a return to this status for Pakistan after seven years outside the club. The transition will be effective from May 2017. Index provider FTSE Russell already counts Pakistan as an emerging market.
Emily Fletcher, co-manager of BlackRock Frontiers Investment Trust (BRFI) said: "This is a validation of the substantial positive macroeconomic changes that Pakistan has witnessed over recent years. The country has seen improvements in fiscal and external balances, an increase in foreign exchange reserves (from $8bn in 2013 to over $21bn currently) and decade-low levels of inflation.
"While political risks remain, with a forward Price to Earnings ratio of around 9x, the Pakistani market is one of the cheapest markets globally. Therefore given the significant long-term growth opportunities, we believe it represents a compelling investment destination."
MSCI has also added its Argentina Index to its review list for a potential reclassification to emerging markets status as part of the 2017 Annual Market Classification Review.
