China’s A shares poised to go global

November 15, 2013 6:26 pm

China’s A shares poised to go global

By Kylie Wong

China has made significant strides in opening up its capital markets to foreign investors, but several key challenges need to be addressed before the mainland equity market can feature in broader equity benchmark indices. Mainland-listed equities traded in the renminbi, also known as A shares, are currently excluded from global indices as they are not freely accessible by the global investing public. The existing China representation within those indices is largely via H shares, which are Chinese securities listed in Hong Kong.With a sizeable market capitalisation of just under $4tn, the China A shares market could substantially alter the global investing landscape if it were to be incorporated into various broader indices, industry participants say.

Chia Chin-Ping, who is head of equity research for Asia Pacific at MSCI, says
A shares could account for up to 13 per cent of the MSCI Emerging Markets index if China were to be “completely opened up”. Together with the existing weighting of 16.8 per cent, China as a whole could represent close to 30 per cent of the index.

However, Mr Chia stresses that would be under a “very hypothetical” scenario, as there are still a number of hurdles that need to be overcome, such as quota allocation, capital mobility and taxation on capital gains.

When MSCI announced in June that it had started reviewing A shares for potential inclusion in the MSCI Emerging Markets index, it emphasised that the consultation did not imply that A shares had achieved emerging markets status in terms of market accessibility criteria.

Mr Chia counts the quota system and limited capital mobility as the biggest reasons holding back A shares from going global.

To access China’s capital market, foreign investors must rely on the qualified foreign institutional investor or the renminbi-qualified foreign institutional investor schemes.

Mr Chia says that, while the overall quota of the schemes is “fairly significant”, the issue is more about the alignment of that quota with the size of
investors.

“We’ve seen some sovereign wealth funds getting quotas beyond $1.5bn but they are a lot larger than that, $1.5bn is probably still a small amount,” he says. “More importantly, the majority of the QFII investors, who are sizeable investors and managers, are still waiting for more quotas to be awarded, so that process needs to take place.”

So far, only three QFII participants – the Hong Kong Monetary Authority, Norway’s Norges Bank and Singapore’s Temasek Fullerton Alpha – have been granted allotments above $1bn.

Capital mobility restrictions are also a major impediment to China’s inclusion in global indices. In terms of repatriation of capital, the procedure is particularly stringent under the QFII scheme, which requires a one-month wait, although weekly repatriation is possible with dedicated open-ended China funds. In the RQFII scheme, daily repatriation is allowed.

For asset managers, it is crucial that these two particular issues are addressed, says Kevin Hardy, head of beta strategies for Asia Pacific and country head for Singapore at BlackRock.

“There are a few other things as well but these two are very critical for the indexing space because if we can’t freely access or have a limited amount we can access, there’s no way we can track an index,” he says.

While Mr Chia and Mr Hardy are optimistic that the issues will eventually be resolved, they stop short of giving a timeframe for when they believe the
inclusion could become a reality.

Meanwhile, Jessie Pak, managing director for Asia at FTSE Group, says she predicts China A shares will be able to migrate to global indices as soon as
“a few years’ time”.

Ms Pak says China’s opening up of its capital market in recent years has gathered pace and that the developments are “getting more and more positive”. She cites the expansion of the RQFII scheme as an example.

Indeed, the past 18 months saw a number of positive regulatory moves by Beijing in an attempt to further open up the A shares market under the QFII and RQFII programmes.

On the QFII side, the overall quota was lifted in April 2012 from $30bn to $80bn, then was almost doubled in July to US$150bn. The foreign ownership limit has been increased from 20-30 per cent and the application process for a QFII licence has been streamlined.

On the RQFII side, not only has the overall quota been significantly increased from RMB70bn to RMB270bn, but the programme has also been expanded beyond Hong Kong to Taiwan, London and Singapore.

Nonetheless, Ms Pak acknowledges that it all boils down to whether the key issues of quotas and capital mobility will be resolved for China A shares to be included in the broader indices.

In the meantime, says Mr Chia. index providers and asset managers should maintain active communication with regulators as well as step up efforts to educate investors about China investing, because participating in the market will take time and it is uncertain precisely when A shares will be included in global indices.

“Of course, we are not going to rush through the process but, if tomorrow, the Chinese government decides to abolish some of these restrictions to make things easier, there’s no reason we should not see the inclusion happen,” he says.