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.

No investor likes to feel trapped. The 2008 financial crisis taught a painful lesson to many hedge funds and other money managers who faced closing gates as they rushed to sell.

Which is why one of the benchmarks that foreign investors watch most -- the MSCI Emerging Markets Index -- shouldn't allow mainland Chinese stocks in, despite next week's launch of the Shenzhen-Hong Kong connect scheme.

From Monday, international investors will be able to trade a whole host of new economy plays like Wanda Cinema Line Co. and Hangzhou Hikvision Digital Technology Co. Combined with the two-year-old Shanghai-Hong Kong link, the Shenzhen trading pipe will allow access to more than 1,400 yuan-denominated stocks, or about 80 percent of the total publicly traded A-share market capitalization. According to Goldman Sachs Group Inc., the connect scheme will create the second-largest equity market globally, at $11 trillion, and the biggest in terms of cash turnover, at about $82 billion a day.

Shares from China could account for almost 40 percent of the MSCI Emerging Markets Index if the Shenzhen-Hong Kong connect triggers inclusion.

Big Deal
China's weighting in the MSCI Emerging Markets Index, already the largest, will almost double if A shares are included
Sources: MSCI, HSBC
Note: Currently, Chinese stocks in the MSCI Emerging Markets Index are all listed outside of mainland China.

But there are many reasons why that shouldn't be the case.

For a start, it isn't easy to get money out of China, even after a slew of relaxed rules including allowing foreign fund managers beneficial ownership rights. International institutional investors that have been buying via existing quota schemes can still only repatriate 20 percent of a fund's proceeds every month, an issue MSCI Inc. cited when it rejected China's entry into the gauge for a third time in June.

So-called anti-competitive clauses haven't been resolved either. The clauses mean that if MSCI, or any other index creator, wants to set up a yuan-denominated exchange-traded fund, they first have to get approval from the Shenzhen and Shanghai stock exchanges. Since there's no certainty ETFs will be approved, that puts anyone hoping to start one in a tough position.

There's also the issue of widespread trading halts, which despite reforms are still a regular occurrence. Any company wishing to suspend its stock from trade must now disclose a proper reason, rather than saying something vague about a restructuring or the like. Even so, more than 150 firms comprising as much as 9 percent of the Shenzhen stock exchange's market value are currently halted, according to HSBC Holdings Plc.

Buying Growth
New economy stocks' weighting in Shenzhen is almost double Shanghai
Source: Goldman Sachs

MSCI has long played it safe as rivals such as the FTSE Group moved to include China in emerging-market indexes. Even when it does embrace mainland Chinese stocks (Hong Kong and U.S.-listed Chinese shares are already permitted), 5 percent of the country's free float will be brought in first before full inclusion.

With so many hot Shenzhen shares soon to be available, it may be tempting for MSCI to yield a little. But right now, the risks outweigh the rewards. MSCI can, and should, wait a bit longer.

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

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