MSCI expects to include China A shares in global benchmarks

MSCI said on Tuesday it expects to include China A shares in its emerging markets index after several issues are resolved.
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The firm said it may announce the decision outside of its annual review, which usually occurs in June.

The issues highlighted included quota allocation process, capital mobility restrictions and beneficial ownership of investments.

Investors told MSCI they need the ability to invest in China relative to the value of their assets under management, the release said. Daily liquidity is also critical for fund management, investors said.

An important factor for building confidence in Chinese markets is clarity on corporate ownership, MSCI said in the release.

Clem Miller, investment analyst at Wilmington Trust Advisors, said China may take until early 2016 to resolve the issues and that the first two are the most challenging. "China has been moving in the correct direction," he said. But "they would have to remove almost all its controls to achieve them."

The Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR) fell as much as 1.25 percent in after-hours trade, following a 1.9 percent decline during Tuesday's session.

Another related ETF , iShares' EEM tracks the MSCI emerging market index and gained 0.3 percent in after-hours trade, reversing a 0.6 percent decline on Tuesday.

Analysts expect a slight disappointment in mainland stock performance on the Shanghai and Shenzhen stock exchanges on Wednesday.

"I think the A shares could take a pause. They're kind of due for a correction. That doesn't mean they'll fall apart," said Michelle Gibley, director of international research at Charles Schwab.

She and other analysts said in a market driven more by retail than institutional investors, Chinese traders probably did not position too much for an international announcement like the MSCI decision.

"The market in the short-term here is going to be more focused on domestic issues in the economy and the margin usage," said Nick Kalivas, senior equity product strategist at Invesco PowerShares.

He said with MSCI's methodical progress in moving towards A share inclusion, "you're going to see foreign investors position themselves with how China is weighted," Kalivas said. He does not expect immediate adjustment in the allocations for PowerShares' ETFs.

MSCI also said that it will include the MSCI Pakistan Index in its 2016 annual review for a potential reclassification to emerging markets.

Index giant MSCI was scheduled to announce around 5:00 p.m., ET, its decision on whether Chinese A-shares will be included in its $4 trillion emerging market index.

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Emerging market money managers try to match or beat the 27-year-old index. About $1.5 trillion in mutual funds, ETFs and other funds are benchmarked to the emerging market index, MSCI said.

MSCI's emerging market index currently has a 25 percent exposure to China through Hong Kong-listed stocks, known as H-shares. However, the bulk of China's recent rally so far this year occurred in the mainland Shanghai and Shenzhen exchanges, up more than 50 and 100 percent for 2015, respectively.

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In a weekend note, Deutsche Bank said that "inclusion of China A shares in MSCI or other major benchmarks could provide support for the market going forward."

The report noted that when MSCI announced in June 2013 it would include Qatar and the United Arab Emirates in its emerging market index and added the stocks the following year, the country-specific indices outperformed.

Still, a decision in favor of A-share inclusion wouldn't result in their addition to the benchmark emerging market index until next year. Full inclusion is expected to boost the index's exposure to China to 37.5 percent.

Last year, MSCI decided against including mainland stocks in its emerging market index due to restrictions on foreign investment in Chinese markets. Since then, China has taken many steps to open up its capital markets, such as the the launch of the Shanghai-Hong Kong Stock Connect, which gives foreign investors access to A-shares through Hong Kong's exchange.