Possible MSCI inclusion reverberates across Chinese equities

Retail market sentiment is often guilty of overreacting to event or news flow. With retail investors accounting for the bulk of trading volume in China, the response is bordering on the absurd.

 SGX CEO,  Loh Boon Chye
Source: Bloomberg

MSCI will announce on Tuesday 9 June (early morning on 10 June for Asia Pacific) the possible inclusion of A-shares into MSCI indices, specifically the MSCI Emerging Market Index and MSCI China Index.

This event appeared to be the main force behind the strong rally in China blue-chip shares on Monday.

Compounding this upsurge were expectations that banking stocks will be one of the main beneficiaries of such an inclusion.

Case in point, Bank of China and Bank of Communications traded limit up (+10%) yesterday, accompanied by an over 6% surge in share prices for China Construction Bank and Industrial and Commercial Bank of China (ICBC).

The trading bets seemed to be overdone because if any inclusion is announced, it will likely be on a partial, basis due to the sheer impossibility of a full inclusion.

According to MSCI, any full inclusions would demand the elimination of any quota systems as well as the removal of China’s restrictions on its capital account convertibility. Clearly, this is unlikely to happen this week.

What we could see instead is an initial 5% partial inclusion after the idea was mooted in March 2014. This means that for each selected A-share, its market weightage in the index will be capped at 5% of its market capitalisation.

Furthermore, there is a belief that investors would be given time to rebalance their portfolio before the inclusion becomes effective. In other words, we won’t see an immediate rush of foreign money into China A-shares in the event of a positive announcement.

Despite being the second largest equity market in the world, in terms market capitalisation, China A-shares are currently not represented in the MSCI indices.

A proposal to include them was rejected last year, primarily due to a lack of market accessibility according to MSCI. Since then, China has taken steps to open up the market further to foreign participation. This included expanding the quota system to more countries as well as the establishment of the Shanghai-Hong Kong stock connect. A similar trading link between Shenzhen stock exchange and Hong Kong is expected to be launched, widely expected to be later this year.

Implications of an inclusion

Based on a report from Morgan Stanley QDS, around 217 A-shares are identified to be possible candidates for inclusion and 5% of their total market capitalisation is estimated at USD 47.6 billion. This means a passive inflow of USD 2 billion. In addition, A-shares would take up around 1% of MSCI Emerging Markets Index and 3.4% of MSCI China.

The full inclusion of A-shares is expected to become a reality at some point, although this would entail taking a much longer-term view. Such an inclusion would yield passive inflows of USD 33 billion, where A-shares would make up 17.5% of MSCI Emerging Markets Index and 41.2% of MSCI China.

There is no doubt that any positive announcement will generate significant excitement in the market but the immediate impact for most international passive funds tracking the indices may be minimal.

While Chinese equity markets have on average a daily trading volume of over USD 140 billion, more than doubled that of the NYSE, according Goldman Sachs Portfolio Research, only 1% is contributed by foreign investors. Therefore, a gradual inclusion would complement efforts by the Chinese policy-makers towards liberalising its capital markets. As such, this should be seen as a positive step for China.

SGX finally announces new CEO

Veteran investment banker, Loh Boon Chye, was tapped as the new CEO for the Singapore Exchange (SGX). There will be no honeymoon period for the new SGX boss as he takes over the reins on Tuesday 14 July 2015.

The immediate challenge for Mr Loh will be to revive the moribund equity trading in the city-state, marked by years of declining trading volume. There has been a dearth of IPO activity in the country with only three listings so far this year, raising an aggregate USD 41 million.

In comparison, China has 166, so far this year, with over USD 16 billion raised from investors. By all accounts, Mr Loh is a well-regarded and well-known banker in Asia, and was a director with the local stock exchange for almost a decade. His good pedigree could afford him some goodwill with the local investing community. His oft-described unassuming and quiet character could also provide some stability to the state’s stock exchange, and more align with the reserved nature common in Asian culture.

The share price of SGX dropped 2.3% yesterday before the announcement, falling through SGD 8.00 for the first time in two months.

The counter has fallen 9.7% since its peak on Monday 18 May 2015. However, the revelation of the new CEO after months of having no words could put a floor in SGX shares. We expect some buying demand in the counter today, although any rebound may lack momentum as the challenges confronting the Stock Exchange still remain.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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