China's Handling of Market Volatility May Thwart MSCI Inclusion

  • Market uncertainty not a factor in MSCI's own evaluation
  • Investors' negative feedback may change firm's decision

China’s response to volatility in its stock and currency markets may have an impact on the country’s bid for entry into MSCI Inc.’s global equity benchmarks, according to the index provider.

While the recent turmoil in Chinese markets and concern that the economic slowdown is worsening have no bearing on MSCI’s own assessment, the way the government has responded may impact the decision on whether to include A shares in a number of international stock gauges. Negative feedback from institutional investors on the effectiveness of policy changes could affect the final decision which is expected in June, according to Sebastien Lieblich, MSCI’s global head of index management research.

“We are really looking at the structural element of a market, of its accessibility, so market volatility is not a consideration when we are looking at when deciding on the inclusion of a given market in the investment universe in general,” Lieblich said in a phone interview on Thursday. “But if international investors come to us and tell us ‘No, the way the government has acted is just completely crazy and we don’t want that,’ ” then that may be considered a negative for the classification, he said.

Government Intervention

The government’s unprecedented efforts to stem a stock rout since mid-last year, including banning stake sales from major shareholders and restricting short-selling, have drawn criticism from international investors. Sentiment deteriorated further after regulators scrapped an ill-timed circuit-breaker system in January and a slew of shifts in the currency policy whipsawed investors.

President Xi Jinping’s government last week relaxed some of its restrictions on foreign funds, as part of its effort to elevate the status of mainland markets on the world stage and make the yuan a more international currency. Attracting foreign capital has become more urgent in recent months amid record outflows, a weakening of the yuan and as local shares tumbled, though analysts cautioned that the rule change probably won’t attract major inflows any time soon and doesn’t guarantee MSCI inclusion.

‘Right Direction’

On Feb. 4, the State Administration of Foreign Exchange lifted its requirement for investment quotas from fund managers approved under its Qualified Foreign Institutional Investor program. Maximum allocations will instead be linked to assets under management and subject to a ceiling of $5 billion. Open-ended funds will also be able to shift money in and out of the nation’s stocks daily.

“By and large, the changes are clearly going in the right direction and we are pleased to see them,” Lieblich said. “From our perspective, for the time being, nothing has changed.”

Large international institutional investors may not feel the same way. It is unclear if the $5 billion ceiling is sufficiently high for investors and whether they see remaining restrictions on closed-ended funds or segregated accounts as hurdles, Lieblich said.

“This is not specific to China, but generally when changes are announced and implemented they look good and fine but once they want to exercise and take advantage of these changes, in effect they may just not be practical,” he added.

So far, MSCI has received no negative input regarding China and will begin actively consulting investors in early April, Lieblich said.

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