China Makes Final Push for MSCI Inclusion

FINTS: A-share market’s final push to MSCI

MSCI has raised three major concerns when it rejected A-share to its emerging markets index on June 10, 2015, namely a) process of QFII quota distribution, b) restrictions on capital mobility, and c) recognition of beneficiary ownership.

In response, China’s financial regulators have mapped out basic solutions to address them.
a. International investors want QFII quota allocation to be proportionate to the asset size managed by institutional investors and can be raised when demand increases. Meanwhile, a clear process with more transparency for quota distribution should be in place and ensure that the outcome of quota applications would be more predictable.

To deal with this concern, a new rule issued by the State Administration of Foreign Exchange (SAFE) in February this year removed the unified upper limit capped on individual QFII and set asset size as the basis for quota application. Now qualified foreign institutional investors, after filling with SAFE, are automatically given a basic QFII quota ranging between $20 million and $5 billion according to their asset management size; if their investment demand increases and exceeds the $5 billion upper limit, they need to secure approvals from the SAFE.

b. The new rule also scraps stipulation on requiring investors to remit in investment principal within six-month upon the date of securing an investment quota. Now open-ended fund is allowed to remit capital on a daily basis, while funds repatriation by trustees of non-open-ended fund is required to submit documents such as application or order from QFII and specific audit report on investment income.

The lockup period of investment principal is cut substantially to three months from one year. After the three-month lockup, investors may remit their principal and earnings out with a monthly cap of 20% of its total assets in China as of last year.

“Part of institutional investors will be surely unease about the 20% limit on outwards remittance, but it doesn’t constitute a substantial barrier for adding A-share to the MSCI index since there’re many ways to solve it,” the head of UBS QFII business Fang Dongming told Caxin, a respected Chinese news media. The substantive redemption of open-ended fund is unlikely to happen; and if it does, there would be many cards up in investors’ sleeves to deal with it. Among many would be channels provided by the Shanghai – Hong Kong stock and the pending Shenzhen – Hong Kong stock connect.

Fang believes that investment in emerging markets is bound to many risks such as market risk, regulatory risk, policy risk and credit risk. Under unusual circumstances, regulators of emerging markets will temporarily adopt various restrictions on capital flow regardless of an already intact “20% threshold”. Investors should try to deal with these risks instead of expecting MSCI to only take in “perfect markets”.

c. CSRC announced on May 12 last year that it recognizes the nominal holder system of Shanghai - Hong Kong stock connect and will ensure the interests and rights entitled to the offshore investors in their A-share investment via Hong Kong Securities Clearing Co Ltd. On May 6 this year, CSRC released another announcement to express its acceptance of the concepts of “nominal holders” and “owners of securities entitlements”. In the same announcement, CSRC also said that it respects the asset arrangements independent of asset managers by QFII and RQFII clients.

However, now there are new problems.