Weighty move boosts Chinese stocks

Leading index provider moves to include A shares in two emerging market indexes
For years, investment constraints and regulatory restrictions in the country have kept China A shares away from any major global benchmark indexes. But recent key changes in the market for China A shares have started to change things.
FTSE Russell, one of the world's leading index providers, announced its transition to include China A shares in its widely followed global benchmarks with the launch of two new emerging market indexes. The move is expected to bring endorsement to and more confidence in China's financial market, as well as more opportunities for overseas investors.
The soaring skyline of Lujiazui Financial and Trade Zone in Shanghai. FTSE Russell, one of the world's leading index providers, announced its transition to include China A shares in its widely followed global benchmarks. Photos provided to China Daily |

The initial weighting in the FTSE Emerging Markets China A Inclusion Indexes will be around 5 percent and increased to 32 percent over time, according to a statement released at a briefing in Hong Kong.
"For global investors to accept China A shares in the major index series, the market has to be easily accessible for all. Previous objections to A-share inclusion were because this wasn't the case. Fund firms had to go down the fairly cumbersome route of QFII (Qualified Foreign Institutional Investors) to be able to access the mainland markets," says Robert Davis, senior portfolio manager at NN Investment Partners.
China has shown a strong willingness to open its market to international investors, as shown by the opening of the Shanghai-Hong Kong Stock Connect Program. Launched in November, the program allows investors in each market to trade shares on the other market using their local brokers and clearinghouses.
"I think feedback to the index providers has been that if the mechanics of Connect work and it opens an easy route into the A-share market, then it is fair for them to be included in the indices," Davis says.
Other clear evidence that Chinese regulators and stock exchanges have put in significant efforts to gradually open were the launches of the QFII/RQFII schemes.
QFII, started in 2002, is a program that allows certain licensed international investors access to participate in China's mainland stock exchanges by using foreign currency.
The renminbi QFII, known as RQFII, started in 2011, is a modified version of QFII that facilitates foreign investment in the mainland via offshore renminbi accounts by using the Chinese currency.
The allocation of China A shares is based on aggregate QFII/RQFII approved quotas, with the allocation of China A shares to FTSE's global benchmarks reflecting the accessibility available to international investors.
"From investors' point of view, the mechanism will allow them to expect the proportional increase of the A shares allocation in the benchmark based on up-to-date approved quota information," says Jing Hu, investment manager at Arbuthnot Latham & Co, a private bank in London.
"Any weighting has to be consistent with the total amount of investment allowed by foreign investors through the R/QFII allocations. If the allocations were used up in full before funds could match the index weightings, there would obviously be a problem," Davis says.
Andy Seaman, partner and chief investment officer at Stratton Street, a London-based fund management and advisory company, says that although access to China's capital markets is still largely controlled by quotas, these are likely to be phased out in due course.
The question whether to add China A-share stocks to global indexes has been a major challenge for index providers as A-share inclusion could force many active and passive fund managers to pour billions of dollars into the Chinese stock market, with the potential of drawing large sums away from other small emerging markets.
"In the short term, the impact may be limited, but in the long run, a reallocation to China will inevitably lead to reduced allocations elsewhere, and these markets may suffer more negatively from reduced portfolio allocations than China may gain from increased reallocation by investors," says Seaman.
Industrial experts and analysts say the inclusion will bring opportunities to the Chinese financial market, as well as potential challenges. For overseas investors in China the future is exciting, but not without risks.
"The direction of reform in China makes clear that in order to transform the economy from its old-fashioned supply-led model to a more sustainable demand and consumption driven base, China needs foreign capital and needs to address some of its historic imbalances," notes Davis.
Justin Stewart, co-founder of Seven Investment Management, says FTSE's move will help increase liquidity in Chinese stock markets, adding: "More inflow will help better price formation and thus create greater confidence in the prices being seen.
"Also, more inward investment will justify more company and market research, which can only improve the market by increasing confidence. Such research should also expose weaknesses in companies, but this, too, I see as a positive as it creates a greater opportunity for companies to take action and to be less covert in their reporting and disclosure."
Laurie Pinto, co-founder of NSBO, a London-based investment bank with a focus on China, notes that the announcement from FTSE will have positive effects on China's stock market.
"The process of opening-up has happened much faster than anyone has anticipated. China has long recognized the benefit of tapping foreign capital - most of its SOEs (state-owned enterprises) listed in Hong Kong to tap foreign investors," says Pinto.
"China now wants another round of foreign money to help fund its economic reform. The big question is, can China's legal framework, corporate governance and so forth improve quickly enough to appease global investors and warrant the inflows?" Pinto adds.
The inclusion of China will be a very big change for markets globally but it will help some of their clients who want early access to the Chinese market, according to Jonathan Horton, head of integration, governance and risk at FTSE Russell.
"What has driven toward this decision is dialogue with clients in line with dialogue we have been having with Chinese regulators and authorities," says Horton. "Three major developments that have been important to us in terms of our views on China: The expansion of the stock market, regulatory improvements, and easier market accessibility for international investors."
Horton advises that Chinese stocks at this stage have met seven of FTSE's nine criteria for inclusion in emerging market indexes, except for one on capital mobility and another on settlement and clearing.
Concerns over taxation also remain key barriers, but Horton is confident that China will continue to make progress in regulating the market and liberalizing foreign access.
The May 26 announcement from FTSE Russell reportedly stole some of the thunder from its rival MSCI, which is due to make the decision on China A-share inclusion on June 9, according to industry analysts.
MSCI, the most widely tracked benchmark of share-price performance outside the developed world, has been reviewing whether to add China A shares to its index for two years.
Some analysts anticipate that MSCI's decision will be more influential because more assets are benchmarked to MSCI indexes, whereas FTSE's news is likely to be less significant because it related to new indexes, FTSE Emerging Markets China A Inclusion Indexes, rather than more established ones.
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(China Daily European Weekly 06/05/2015 page19)