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China rejected, for now, from stock indexes

The Shanghai Composite Index Rises 2.2% To 4300 PointsThe Shanghai Composite Index Rises 2.2% To 4300 Points
This beats the Party meeting, huh?Photograph by ChinaFotoPress via Getty Images

Beijing badly wants China’s domestic stocks included in the indexes followed by global investors. It could mean billions more dollars buying yuan-denominated shares in Shanghai and Shenzhen, which helps the government promote its goal of expanding the currency overseas.

But the country was rejected yesterday by MSCI, whose emerging market indexes have $1.7 trillion tracking them, which said after its annual review it wouldn’t include the mainland A-shares. It said Chinese regulators hadn’t done enough to open their market to foreigners. It’s a reminder to China that even reforms that liberalize its financial markets and seem momentous within the country are considered incremental, at best, by outsiders.

This is the second time in as many years that China has been spurned by the index maker. Last spring, MSCI first proposed the idea of including A-shares and was met with cries from big fund managers like Fidelity and Vanguard who said China hadn’t passed enough reforms for access.

So China launched the ‘Shanghai-Hong Kong Stock Connect’ this past November, which allowed foreigners for the first time to buy Shanghai stocks directly via Hong Kong. Earlier in the year it also expanded quotas for foreign investors.

But MSCI said yesterday there are still enough unresolved problems to avoid including A-shares for now. The first involves those quotas. Big foreign investors feel their daily allotments are too small. The second is the ease of getting money out of mainland China. Capital controls are cumbersome. The third is the technical rules around stock ownership. Foreign investors feel jittery that Chinese regulations aren’t as clear as those in developed markets.

MSCI is the biggest authority on emerging market indexes, but its influence hasn’t kept other fund companies from adding Chinese shares. Vanguard said last week that its Vanguard Emerging Markets Stock Index Fund will add Chinese shares. The funds follow FTSE indexes, an MSCI competitor, which decided to include A-shares as an initial 5% weighting in some transitional indexes.

Beijing will eventually get its wish. MSCI’s statement also said A-shares were “on track for inclusion” in the next year if issues were resolved.

Unfortunately for global investors, the manic Chinese stock market has risen nearly 150% in the past year and the country’s economic troubles are mounting. By the time investors get to own a slice of China’s mainland market, the excitement could be wearing off.