China Buoys MSCI Inclusion Odds With Hong Kong-Shenzhen Link

Macquarie's Sanft: Link to Boost China Equities
  • U.S. investors say move could hasten index provider’s decision
  • Shanghai equities were made available to foreigners in 2014

China has boosted the chance of getting its domestic stocks included in MSCI Inc.’s main benchmarks after approving a program that will allow investors in Hong Kong to trade equities on the Shenzhen exchange.

By further opening its $6.5 trillion domestic share market to foreign traders, China is addressing limitations to mainland trading flagged by MSCI when it rejected the stocks for a third year in June. Global investors praised the regulator’s decision on Tuesday.

“Removing barriers to foreign investment makes sense as it should hasten inclusion of China’s market in MSCI global indexes,” Steven Einhorn, vice chairman at New York-based Omega Advisors, the $5.3 billion hedge fund founded by Leon Cooperman, said in an e-mail. “It internationalizes China’s market,” he said.

The long-delayed link, which had been expected for more than a year following a similar program between Shanghai and Hong Kong in 2014, may start in four months. The China Securities Regulatory Commission also lifted restrictions on asset flows, saying it won’t impose an aggregate quota for the Shenzhen link, and that it will remove the existing cap on the Shanghai program. There will be still daily limits on net purchases for both programs.

To read more about the link details, click here.

The announcement comes amid renewed stability in the market, which saw $5 trillion in equity values evaporate during a rout in 2015. While a botched government rescue campaign spooked global investors at the start of the year, policy makers have taken steps in recent months to ease curbs on international investors, including opening up the interbank bond market to encourage capital inflows and ease pressure on the yuan. Overseas fund managers can also trade in China through the quota-regulated qualified foreign investor programs.

MSCI spokeswoman Kristin Meza didn’t respond to an e-mail and multiple phone calls seeking comment on the impact of the Shenzhen link on the firm’s index decision-making process. New York-based MSCI is slated to review the Chinese market’s eligibility next year, though it hasn’t ruled out an earlier inclusion.

Tuesday’s decision “speaks to the fact that Chinese regulators are focusing on opening the capital market in general, whether it’s equity or debt markets,” John Malloy, who oversees $2 billion as co-head of emerging and frontier markets at RWC Partners in Miami, said by phone. “That’s the bigger story.”

MSCI Decision

In denying China’s inclusion in June, MSCI -- whose emerging-market index is tracked by investors with about $1.5 trillion in assets -- cited a need for improvements in market access. MSCI has said it will monitor policies on quota allocations, capital mobility and trading suspensions. Other hurdles include a 20 percent monthly repatriation limit and pre-approval restrictions on introducing financial products.

Opening the Shenzhen market is “in line with some of the recommendations from MSCI for formal inclusion in terms of making their domestic market more available for international investors,” Charlie Wilson, who manages the $1 billion Thornburg Developing World Fund at Thornburg Investment Management Inc. in Santa Fe, New Mexico, said by phone.

There are more than 1,800 companies listed in Shenzhen, with a combined market capitalization of $3.2 trillion, compared with $3.4 trillion in Shanghai. While the Shanghai exchange is mostly composed of large state-owned enterprises such as banks and oil firms, private tech firms dominate Shenzhen, which is 11 miles from Hong Kong. The Shenzhen Composite Index added 0.3 percent on Wednesday, while Hong Kong’s Hang Seng Index slid 0.5 percent on volume that was 27 percent above the 30-day average.

China’s Future

“The decision to approve the Shenzhen-Hong Kong exchange link is an important step in China’s process of opening its financial doors,” said Jordi Visser, head of investments at $1.4 billion U.S. hedge fund Weiss Multi-Strategy Advisers. “The city of Shenzhen, known as the Silicon Valley of Hardware, along with the Shenzhen composite represent the future of China. This side is rooted in entrepreneurship, innovation, efficiency and productivity.”

Visser predicted in March that the Shenzhen Composite would beat most of its global peers by the end of 2016, and that the measure should streak ahead of all the others over the next three to five years.

“This decision is another important step in China’s efforts to continue developing its capital markets,” said Adam Cooper, chief legal officer of Citadel, the $24 billion hedge fund and securities trader in Chicago. “It will enable more investment in Chinese companies, further integrate China into the world’s financial system and support the country’s continued development and economic growth.”

Limited Appetite

For all the fanfare, the immediate impact on the market is likely to be limited. Foreigners have used about half the 300 billion yuan ($45 billion) total quota for buying Shanghai shares since the program began. Chinese traders have shown more appetite for investing in Hong Kong stocks, with less than 20 percent of the 250 billion yuan quota left unfilled.

To read a Gadfly column about the link’s market impact, click here.

Still, in the longer-term, opening up would signal a new era for China’s 26-year-old stock market with deeper participation from global investors. Fidelity Management and Research Co., which oversees $2 trillion in assets, said it may participate in the Shenzhen connect program and is evaluating an application for an RQFII license for its U.S. funds.

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“We’re encouraged to see more ways to access them for foreign investors,” Miguel Canizares, vice president of equity investment at Fidelity in Boston, said in an e-mail, adding that his firm has been “an active participant” in the Shanghai program since its inception.

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