In June 2017, MSCI, a leading index provider, announced that beginning in June 2018, it will include China “A shares” in the MSCI Emerging Markets Index and the MSCI ACWI Index.16 This move has been under consideration for several years, and MSCI indicated that the decision was based in part on its conclusion that China A shares had become increasingly accessible by international investors.
The MSCI Emerging Markets Index is a leading benchmark for equity securities in the international developing markets. Together with an ETF that tracks it, the iShares MSCI Emerging Markets ETF, this index is an underlying asset for a significant amount of structured products, and it is a key means by which U.S. investors gain exposure to these markets, including mainland China.
MSCI indicated that it plans to add 222 China A large capitalization stocks, which would represent approximately 0.73% of the weight of the MSCI Emerging Markets Index. MSCI indicated that it may increase the number of securities, and/or change the timing of implementation, in the future.
What Are “A Shares”?
A shares are shares of mainland China companies that trade on the two Chinese stock exchanges and are traded in Chinese renminbi. Historically, A shares were only available for purchase by mainland Chinese citizens; accordingly, they were not included in major international equity indices. However, the relevant rules have evolved, and, since 2003, many non-Chinese institutional investors are permitted to purchase these securities through China’s “Qualified Foreign Institutional Investor” (“QFII”) system.
In contrast, B shares are shares of these companies that trade in currencies such as the U.S. dollar. These securities may be purchased by both Chinese and non-Chinese investors; however, many Chinese investors have difficulty purchasing them due to currency exchange limitations. Some Chinese companies have equity securities that are listed as both A Shares and B Shares; however, since many Chinese investors can only purchase the B Shares with difficultly, the A Shares at times trade at higher valuations than the B Shares.
While the MSCI indices currently include Chinese stocks, the relevant stocks are those that are listed outside of China, in markets such as Hong Kong, where the “H Shares” of Chinese companies are listed. Accordingly, while these indices do provide exposure to Chinese stocks, these stocks are not necessarily representative of the Chinese market as a whole.
As of May 2017, Chinese companies constituted approximately 27.66% of the MSCI Emerging Markets Index. The new change will, slightly at first, further increase the concentration of the index in Chinese stocks. Some investors, who are critical of China’s domestic securities markets, may be displeased by the fact that the index change indirectly “forces” them into investing in China as a result of the multitude of instruments that track the MSCI Emerging Markets Index; for example, some analysts believe that the Chinese stock markets are characterized by significant amounts of insider trading and price manipulation, and the potential for governmental intervention. However, the move is an important step in the integration of the Chinese capital markets into the international economic system, and it may be a precursor of similar steps in the future.