China's Dream of World Class Stock Markets Suffers Intervention Blow

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It’s hard for Alex Wolf to believe that the Chinese officials he met four months ago are the same ones running the world’s second-largest stock market today.

When Wolf, an emerging market economist at Standard Life Investments, sat down with the nation’s securities regulators in Edinburgh in March, they had a clear message: China is enacting the free-market reforms needed to lure foreign investors and gain entry into MSCI Inc.’s global indexes.

Now, after a week of unprecedented government intervention to prop up the stock market, it’s clear to Wolf that reform has taken a back seat to easing the pain from a rout that many analysts say was inevitable. He’s among international investors at Aberdeen Asset Management and Clough Capital Partners who say market meddling threatens to further delay MSCI inclusion after the index provider decided to leave China’s domestic shares out of its equity gauges in June.

“What they’ve done goes beyond what I had expected,” Wolf, whose firm oversees about $380 billion, said in a phone interview on Thursday. “Recent reforms were meant to create a more professional and more mature market. Intervention definitely does undermine that view. It may be harder in the future to attract more offshore capital.”

Foreigners are already pulling out of Shanghai’s stock market. Even amid the biggest rally since 2009 on Thursday, they sold shares through the city’s exchange link with Hong Kong, extending a record four-day outflow, according to data compiled by Bloomberg. The Shanghai Composite rose 4.5 percent at the close on Friday.

Lobbying Power

Phone calls and emails to MSCI officials in London and New York weren’t answered. Fennie Wong, an official in Hong Kong for FTSE, another index provider, couldn’t give comments immediately.

“What has happened in the stock market gives opponents a reason to lobby against the inclusion as it’s not market driven,” said Nicholas Yeo, the Hong Kong-based head of Chinese equities at Aberdeen. “They will become more powerful.”

As China’s record-breaking equity boom turned into a bust over the past month, authorities responded with a series of measures aimed at stopping the rout. They suspended initial public offerings, restricted bearish bets via stock-index futures and banned major shareholders from selling shares. In one of the most extreme efforts to stop an avalanche of sell orders, local exchanges allowed more than 1,400 companies to halt trading in their shares.

Foreign Access

“We may see a delay in MSCI inclusion,” Eric Brock, a Boston-based money manager at Clough Capital Partners, which oversees about $4.4 billion and met with China Securities Regulatory Commission officials in March, said by e-mail. “Though that depends on how quickly these measures serve to re-open the locked markets, where many shares are suspended or not trading.”

Chinese authorities had been pushing for an MSCI endorsement -- sending a delegation of regulators to Europe and the U.S. in March to make the case for inclusion -- as President Xi Jinping’s government sought to elevate the status of mainland markets on the world stage and make the yuan a more international currency.

MSCI said in June that it will work with Chinese regulators to establish policies that resolve the “remaining accessibility issues.” Those include giving investors quotas commensurate with the size of their assets under management, improvements in liquidity and further clarification of share-ownership rules.

No Choice

“By intervening in the market, they are creating more uncertainty,” said Jorge Mariscal, the emerging-markets chief investment officer at UBS Wealth Management in New York, which oversees $1 trillion in invested assets. “Some of the MSCI concerns are surfacing.”

The possible addition of mainland equities to MSCI gauges has been a divisive issue among fund managers. Even as the Shanghai Composite Index rallied 152 percent in the year through June 12, foreigners had been cautious about entering a market where individual investors account for 80 percent of trading. The benchmark index is down 28 percent from its peak.

MSCI’s main consideration is whether foreign investors can freely access yuan-denominated A shares, said Shanquan Li, a senior portfolio manager at Oppenheimerfunds Inc. On that front, there are signs of improvement. China opened the Shanghai exchange link in November and has plans to replicate the program for the nation’s smaller bourse in Shenzhen this year.

“The latest market interventions won’t play a big part in MSCI’s consideration,” Li said by phone Thursday from New York. “Chinese policy makers intervened in the market because they don’t have a choice at this point.”

For Macquarie Asset Management’s Sam Le Cornu, extreme volatility in Chinese shares is one of the biggest turnoffs for global investors. Price swings in the Shanghai Composite approached the highest levels since 1996 this week.

“I’d say the volatility is the key hurdle to the inclusion,” said Le Cornu, who oversees about $3 billion in Asian equities in Hong Kong. “We have no A share exposure.”

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