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MSCI, one of the world's most-followed index providers, has spoken up for the global investment community by keeping China’s A shares out at its annual review.
Quite simply, it is too soon for China’s domestic stock markets because their regulatory environment and levels of corporate governance still fall short of the standards required for them to enter the global investment mainstream.
Last summer, China’s market regulators approved mass trading suspensions to control extremely volatile retail investor-driven stock markets. And they may yet do so again, which poses an intolerable liquidity risk for the many global investors who track MSCI’s indices with their billions of dollars.
Other major technical hurdles include a monthly capital repatriation limit set at 20% of net asset value, a problem for investors that may be faced with redemptions such as mutual funds.
Another barrier to MSCI index entry and sound corporate governance are the pre-approval restrictions imposed by China's local exchanges on any A-share index-linked financial products launched anywhere in the world, due to competition concerns.
Since being included too early could spell disaster for investors in China, it's therefore best if China stays out of the limelight unless it wants to risk burning investors who might yet shun China in the long term.
If MSCI had bowed to pressure to include China, pension funds and other passive institutional investors with about $1.5 trillion benchmarked to MSCI's emerging markets index would have been forced by their mandates to plough into Chinese stock markets.
Given the market turmoil in January, when regulators hurriedly scrapped circuit breakers, and the calamitous slide from multi-year highs seen last summer, it seems strange that some pundits would have expected China’s inclusion so soon.
Remember, at one point last July over a third of mainland-listed stocks were suspended.
To be sure, Shanghai is now limiting companies' ability to withdraw from trading. But these limits were only constituted in May and remain untested.
China’s government could swiftly open up and clear any technical barrier if it was so minded, even before next year’s review.
The broader benefits would outweigh the potential inflows as inclusion would symbolise another step in the integration of China's onshore equity market into the global financial system. In the long run, this would gradually bring more global institutional investors into the A-share market and help it to achieve a better pricing mechanism.
After all, Pakistan’s elevation to MSCI’s emerging market index shows reform can pay off. The MSCI punished Pakistan in 2008 by downgrading it to frontier market status after the Karachi Stock Exchange imposed a rule that caused the market to freeze for more than three months.
