MSCI Keeps China A-Shares Out of Emerging Market Index

China’s mainland-traded shares won’t be included in MSCI Inc.’s global indexes, while South Korea and Taiwan were removed from consideration for an upgrade to developed market status.

MSCI, which based its decision on limitations to investing in China’s so-called A shares, may consider an inclusion in 2015, the index provider said in a statement yesterday. The MSCI Korea and MSCI Taiwan indexes will be removed from potential reclassification because of the absence of “any significant improvements” in areas such as the limited convertibility of local currencies and market accessibility.

MSCI will introduce by June 27 a China A International Index as a standalone benchmark. The company had been consulting with investors on whether to categorize South Korea as a developed market since 2008, and Taiwan since 2009. Money managers wanted Korean shares to remain in the MSCI Emerging Markets Index because they’ll attract more money as the second-largest component of that gauge rather than as a small part of the developed-markets index, according to BNP Paribas Investment Partners.

“China is making some progress, but it sounds like MSCI wants to see the tradability of A shares before they put them in the index,” Alan Gayle, who helps oversee about $50 billion in assets as a senior strategist at RidgeWorth Capital Management, said by phone from Atlanta yesterday. “MSCI is clearly leaving the door open for the inclusion, but it is contingent on performance.”

Investor Consultations

About $2.3 trillion is benchmarked against the MSCI World Index of developed markets versus $1.3 trillion for the emerging-market gauge.

South Korea’s Kospi index gained 0.1 percent at 12:24 p.m. in Seoul, while the Shanghai Composite Index slid 0.3 percent. Taiwan’s Taiex index was little changed.

MSCI has been consulting with banks and funds on whether to include yuan-denominated A shares in its benchmark Chinese and developing-nation gauges for the past year. Some international investors who measure returns against the indexes have said the proposal is unworkable unless China removes the capital controls that limit access to local securities.

“Feedback from investors through this consultation is that they are generally supportive of an inclusion into the index over time,” Remy Briand, MSCI’s head of index research, said in yesterday’s statement. “But the current quota is still too constraining to warrant an inclusion in the mainstream index right now.”

Exchange Link

Under China’s existing rules, only overseas institutions that have been awarded licenses and quotas by two different regulatory bodies can invest in local securities. The combined approved quota of about $94 billion is less than 3 percent of the $3.2 trillion market value of locally-listed companies.

Exchanges in Shanghai and Hong Kong agreed in April to allow as much as 23.5 billion yuan ($3.8 billion) of daily trading, opening up the mainland market further to foreign investors while giving wealthy Chinese investors a route to buy Hong Kong stocks. The pilot program is due to start around October.

“To put them in an index when most of the investors can’t buy those shares, because of the various restrictions that the Chinese have, doesn’t make sense,” Mark Mobius, who oversees about $50 billion as the executive chairman of Templeton Emerging Markets, said in April.

China will expand its programs to allow foreign investors to buy local shares and will scrap quotas when conditions allow, the People’s Bank of China reiterated in its annual report for 2013 posted on its website today.

Emerging Outperformance

Investor sentiment toward emerging-market stocks is improving after more than three years of underperformance versus their developed-nation counterparts. The MSCI emerging markets index has climbed 13 percent since mid-March, more than twice as much as the MSCI World Index.

“It’s better for South Korea not to be added to the gauge of advanced markets as it will be easily neglected once it’s included,” Scott Seo, head of Korea equity research at JPMorgan Securities in Seoul, said by phone.

Chia Chin-ping, a Hong Kong-based managing director at MSCI, said discussions would resume over South Korea and Taiwan once there are signs of improvement in areas such as currency convertibility.

“We do not see any meaningful progress in the foreseeable future,” said Chia. MSCI took the two markets off the list to “reduce speculation about the potential upgrades.”

Two of MSCI’s competitors, FTSE and S&P Dow Jones Indices, already classify South Korea as a developed market.

The index provider also announced that it is no longer considering a consultation process on the potential exclusion of the MSCI Egypt Index from the emerging-market gauge, citing a “substantial” increase in Egyptian foreign currency reserves since the beginning of the year.

Tensions between Ukraine and Russia are being monitored and may result in a review of the treatment of their respective benchmarks if the situation deteriorates due to measures such as sanctions or capital controls, the New York-based firm said.

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