China A-shares: MSCI’s Announcement
MSCI conducts an annual review of all countries we include in our indexes. This review helps to ensure that our indexes remain relevant and accurate investment tools for our clients, and that they continue to accurately reflect the equity markets that they are measuring.
We take a consultative approach in this review, meeting with members of the international investment community to make sure our decisions reflect their perspectives and practices. Our discussions focus on three factors for each country we review: economic development, size and liquidity, and market accessibility.
On June 9th, we announced that we expect to include China A-shares in our global benchmark, the MSCI Emerging Markets Index, as soon as a few remaining issues related to market accessibility have been resolved. We learned in our 2015 consultation that although institutional investors are eager to invest in China, a few more improvements must be made before they will consider the market to be sufficiently accessible.
We also announced that MSCI and the China Securities Regulatory Commission, or CSRC, are forming a working group to accelerate the resolution of the remaining issues. MSCI’s role is to facilitate an exchange of information and ideas about the requirements of institutional investors as CSRC evaluates and implements its policy decisions.
Finally, we said in our announcement that we will include the MSCI Pakistan Index in our 2016 Annual Market Classification Review for a potential reclassification to emerging markets, and we will seek feedback from investors on the accessibility of the Saudi Arabia equity market before considering adding it to the review list for a potential inclusion in Emerging Markets.
Why have you delayed the inclusion of China A-shares?
Our clients, the world’s largest investors, told us in our 2015 consultation that they continue to have concerns about market accessibility. We have a higher threshold for accessibility than other index providers because of the size and diversity of our emerging markets investor base. As a result, feel a responsibility to ensure that the inclusion is executed in a smooth and orderly fashion.
If the working group can solve the three issues MSCI raised, will China A-shares be included in the index?
As things stand now, those are the primary issues standing in the way of inclusion.
Do you believe the working group with China Securities Regulatory Commission (CSRC) will speed up the inclusion of China A-shares in MSCI Emerging Markets Index?
That is our intention, and the intention of the CSRC as well.
Who will be in the working group?
The working group will be comprised of senior representatives from MSCI and the CSRC.
What is MSCI’s role in the working group?
Among other things, MSCI will facilitate an open exchange of views between the CSRC and international investors about proposed policy measures. In addition, MSCI will share our experiences with regulators in other countries, such as India, Korea and Taiwan, when they made similar policy changes.
What policy issues are being discussed?
Issues will include, but are not limited to: quota, capital mobility and beneficial ownership.
The beneficial ownership concern for separate accounts was not highlighted in the previous consultation. How did it come up this year?
While the beneficial ownership issue for the Stock Connect has been largely clarified by the CSRC, a large number of investors, such as MSCI’s asset owner clients, use separate accounts as their primary investment channel. These investors typically do not apply for quota themselves but delegate the investment and administrative decisions to their managers. Our understanding is that the current quota systems register ownership under the name of manager rather than the ultimate beneficial owners. The precise nature and rights of an investor as the beneficial owner of the securities under the current quota system is not well defined. We hope to work with the CSRC to address these investors’ concerns.
ROADMAP FOR INCLUSION
What has happened to the roadmap for inclusion of China A-shares in the MSCI Emerging Markets Index?
The roadmap, which was introduced in March 2014, proposes to partially include China A-shares in the pro forma MSCI China Index and its corresponding composite indexes, including the MSCI Emerging Markets Index, at 5% of its FIF-adjusted market capitalization. The updated consultation document incorporates a revised implementation timeline and can be found on MSCI’s website here.
Is the proposed 5% inclusion similar to what FTSE has announced?
MSCI’s proposed 5% initial inclusion is applied to the FIF-adjusted market capitalization of China A-shares in the pro forma MSCI China Index. In other words, we are proposing to only include 5% of the investable market capitalization of A-shares. This will translate into about 1.3% of index inclusion weight in the MSCI Emerging Markets Index, based on current prices.
As you cited in your announcement, MSCI is expecting further market opening, including the impending launch of the Shenzhen Stock Connect as well as potential harmonization of QFII/RQFII regimes. Would MSCI consider a larger inclusion factor should these developments take place smoothly?
We are maintaining the proposal for a 5% initial inclusion for now. Any further positive market liberalization will be evaluated accordingly after a period of observation.
MSCI MARKET CLASSIFICATION FRAMEWORK
How does MSCI assess the inclusion of markets in Emerging Markets?
The inclusion assessment is based on the MSCI Market Classification Framework described in the MSCI Global Investable Market Index methodology. For Emerging Markets, the classification depends on two criteria: (1) whether the equity market meets minimum size and liquidity requirements and (2) whether it exhibits accessibility levels for international investors that are sufficient in the context of Emerging Markets.
How is the size and liquidity of markets measured?
MSCI applies the global size and liquidity requirements used in the construction of the MSCI Global Investable Market Indexes. Specifically, the number of securities meeting these requirements will determine whether a given market meets the criterion for an investment universe. For example, any inclusion in Emerging Markets requires a minimum of three securities meeting the size and liquidity requirements.
How does MSCI gauge the accessibility level of a given market?
MSCI uses 18 distinct accessibility measures to assess the accessibility of markets. The detailed list of measures can be found in the MSCI Global Investable Market Index methodology.
How does MSCI assess each of these 18 accessibility measures?
MSCI relies on the feedback of market participants. For example, MSCI reflects regulatory changes in its accessibility assessment only after international institutional investors are able to provide meaningful feedback – in other words, only after they have fully tested and absorbed the changes.
What is the objective of MSCI’s consultation process?
We conduct an annual consultation to ensure that our indexes remain relevant and accurate investment tools for our clients, and that they continue to accurately reflect the equity markets that they are measuring.
With whom does MSCI consult? Are consultations reserved for MSCI’s clients?
MSCI consults with all market participants. We try to obtain feedback from the entire investment food chain: asset owners, asset managers (passive and active), brokers, consultants, custodians, etc. worldwide to ensure the broadest possible representation. In addition, MSCI also engages, if possible, with local authorities or regulators and stock exchanges.
Does MSCI interact regularly with local authorities and regulators?
Yes, MSCI is often in contact with authorities and regulators around the world. MSCI is an unbiased conduit for information from the international investment community to local stakeholders, and vice versa.
DECISION MAKING PROCESS
Who makes decisions regarding methodology and market classification?
A policy committee, comprised of senior members of MSCI’s index research team and firm leadership, have the final say on methodology and market classification questions. The committee bases its decisions on a thorough analysis of the feedback that is gathered in our consultation process. Any client who wishes to know more about MSCI’s decision committees can find this information in the publicly available document here.
Why does the senior decision committee need consultation feedback to make decisions?
MSCI bases its decision on market sentiment. We are careful to never force a decision and take market participants by surprise.
Are any outside parties either included in the senior decision committee or in the final discussions?
When do announced decisions take effect?
We try to give market participants plenty of lead time before the implementation of any methodology change. We announce market reclassifications at least 12 months in advance of implementation.