Markets

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

Memories can be short, especially when there's money to be made. Just 12 months after China stocks went into a tailspin, it's looking increasingly likely that the nation's companies will be included in MSCI's Emerging Markets Index later this month. But if MSCI really wants to keep its position as the go-to benchmark creator, it shouldn't yield for at least a few years.

New York-based MSCI is expected to announce whether China stocks will be included in the gauge, which is tracked by some $1.5 trillion of funds, on June 14. The country's recent liberalizing measures have convinced Goldman Sachs the odds of inclusion are now 70 percent.

Among those measures is a clampdown on frequent trading halts. Last month, regulators said that companies would need to have a "good reason" to request their shares be halted, moving away from the somewhat looser "material matter" language oft-cited last year when at one point at least half the market was suspended.

The China Securities Regulatory Commission has also moved to clarify concerns that foreign funds had surrounding beneficial ownership. Previously, small offshore money managers had to purchase A shares, or local-currency stock of Chinese companies traded on Chinese bourses, using a larger institution's Qualified Foreign Institutional Investor quota, so their ownership was recognized as part of the institution's. Now, they'll be allowed to open separate securities accounts in their own name.

Mainland Interest
Amount of Chinese stocks held by foreign investors through various avenues
Source: Credit Suisse
Note: Hong Kong Connect refers to the buying of Chinese stocks through the Shanghai-Hong Kong Stock Connect scheme; QFII refers to the Qualified Foreign Institutional Investor program; RQFII is the Renminbi Qualified Foreign Institutional Investor program.

There have been other concessions, too. QFII funds can be pulled from China after three months rather than a year , for example, and open-ended funds will be able to shift money in and out of the nation's stocks daily.

The adjustments come as authorities are also allowing individual investors to buy Shanghai stocks via the Hong Kong exchange, and vice versa. China is expected to expand that to Shenzhen shares later this year, further opening the door to foreign investment.

As the world's second-largest economy, China's inclusion shouldn't be an issue , in theory. It's also important to note that MSCI has said it will include only 5 percent of A shares initially. If all were to be admitted, China's weighting in the Emerging Markets Index would rise to 39.9 percent from 25.9 percent currently.

Hello, Shenzhen and Shanghai
Chinese stocks' weighting in the MSCI Emerging Markets Index would rise quite steeply should all A shares be included
Source: MSCI
Note: The current make up includes Chinese stocks listed in Hong Kong and the U.S., as well as a small portion of dollar-denominated China B shares; A 5% inclusion refers to the possibility MSCI will first include 5% of A shares.

But even though at 5 percent China's weighting won't increase that much, MSCI should have lingering concerns.

Beijing's recent market-easing measures are half-hearted at best -- about 10 percent of A-shares, or more than 300 companies, remain halted -- and there are still limitations on how much money funds can repatriate from China. Plus policies can always be reversed. Look how quickly authorities reverted to their old ways of pumping up the economy using debt despite earlier steps to move away from such credit-fueled growth.

Another consideration, any fund launching an ETF needs Chinese stock exchange approval, which MSCI views as anti-competitive. Also, once in, kicking China out may not be so easy. Peru, whose inclusion in the Emerging Markets Index is up for review this round, has been fighting tooth and nail to stay.

MSCI would do well to heed the experience of the International Monetary Fund, whose green light on giving the yuan reservere-currency status was predicated on it being "freely usable." Yet since last August's surprise devaluation, China's currency has remained within a narrow trading band.

MSCI still has two weeks to deliberate. It should use that time wisely and remember: one cool judgment is worth a thousand hasty counsels.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. Provided the net withdrawal in a month doesn't exceed 20 percent of assets held at the end of the previous year.

  2. The MSCI Emerging Markets Index does already include some Chinese stocks, but they're mainly the shares of Chinese companies that are listed in Hong Kong and in the U.S.

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Katrina Nicholas at knicholas2@bloomberg.net