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MSCI faces opposition to China inclusion in key index: sources

[HONG KONG] China must make bolder market reforms before Chinese-listed shares can be included in key MSCI emerging market benchmark indexes, leading global fund managers and MSCI insiders told Reuters.

Anticipation that MSCI would push ahead with plans to include locally-listed China 'A' shares in its Emerging Markets Index, which is tracked by US$1.7 trillion of funds, increased following the November launch of the Hong Kong-Shanghai Stock Connect trading scheme, which has helped open up China's tightly-controlled capital market.

But, despite strong lobbying by Beijing, some of the world's biggest fund managers want China to go further with its market reforms. That lack of support is likely to scupper Chinese hopes that global index compiler MSCI would add China-listed stocks at its annual review in June.

MSCI, too, is disappointed by a lack of progress on several issues that make it difficult and expensive to move money in and out of China's capital markets. "In my view, most of those issues remain," said one MSCI insider who didn't want to be named because the subject is highly sensitive. "I'd be very surprised if we manage to get 'A'shares included even this time around going by the preliminary chats I've had." Chinese shares listed overseas already account for 18.9 per cent of MSCI's emerging markets index. Including all China's domestic shares could trigger the largest-ever global equity rebalancing, and drive up that figure to 27.7 per cent. Some predictions suggest US$300 billion will eventually flow into the China market.

A spokeswoman for MSCI declined to comment. The China Securities Regulatory Commission (CSRC) did not respond to requests for comment. China's State Administration of Foreign Exchange, which controls investment quotas, also did not respond to requests for comment.

MSCI is expected to discuss adding China 'A' shares - the yuan-denominated shares listed on the Shanghai and Shenzhen exchanges - in May, before announcing a decision in June. MSCI declined to confirm the date of its May meeting.

Chinese regulators, keen to attract more long-term institutional money, are scrambling to tackle other market constraints, and still hope to persuade global investors to give MSCI the green light, fund managers and lawyers told Reuters.

As part of its lobbying campaign, the CSRC last month sent a delegation to New York and Boston to reassure investors that China is committed to capital market liberalization.

A second individual familiar with MSCI's thinking said MSCI was still trying to persuade major clients, which include investment giant BlackRock and other index funds, to back its plan.

But these firms first want to see China solve critical investment obstacles relating to the Stock Connect system and its quota-based institutional investment programmes.

These investment restrictions include confusion over whether foreign investors can enforce their rights to assets held in China; limits on how frequently investors can repatriate capital out of China; uncertainty over whether China will raise caps on investment quotas; and a lack of clarity over taxation of capital gains.

"We welcome greater access to China's capital markets, which the inclusion of 'A' shares in global indexes could provide,"Kevin Hardy, head of Beta Strategies in Asia Pacific and Country Head of Singapore, BlackRock, said in a statement to Reuters."However, the key to the China 'A' share investment opportunity success lies in the majority of the regulatory and operational issues being resolved." Mr Hardy added that BlackRock was encouraged by China's plan to extend Stock Connect to the Shenzhen market, but the project required "greater transparency and improved operational efficiency." Reuters spoke to several large fund managers, who also highlighted ongoing barriers.

"For us as asset managers, Shenzhen coming on line, flexibility on quotas and a commitment on both sides to address some of the more technical issues around ownership and settlements, are key hurdles which must be overcome ... We also need full clarity on whether the capital gains tax exemption is permanent," Sunny Ng, head of portfolio strategists Asia ex-Japan at State Street Global Advisors, told Reuters, adding his firm had recently discussed the matter with regulators and index providers.

Shelly Painter, regional managing director for Asia at Vanguard in Hong Kong, told Reuters last month that the company had had several conversations with Chinese regulators to explain that investment quota caps would currently make it difficult for Vanguard to back 'A' share inclusion.

In a follow-up email, Ms Painter said that while Vanguard welcomed any move to enhance diversification for investors, "... the decision for inclusion of 'A' shares in global indices should be aligned with the ability for foreign investors to fully access those shares." A first attempt by MSCI to partially include China-listed shares in its index was shot down last year by large fund managers including Templeton, Vanguard and Fidelity. MSCI said last June it would reconsider China's inclusion pending the Stock Connect launch.


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