China-MSCI stalemate: who’ll blink first?
Much of the debate around MSCI’s decision to not add A-shares has focused on China’s need to reduce its capital controls. But with Beijing unlikely to let go of the reins anytime soon and MSCI strident in its need for reform, the two sides have reached an impossible impasse unless a compromise can be made.
By now anybody interested in the index provider’s verdict knows that the non-inclusion of A-shares was down to two main reasons — repatriation of capital issues and anti-competitive clauses on index products.
Restrictions on moving capital in and out of China are the main bugbear of most investors, but China’s ironclad grip on capital controls is unlikely to be relaxed as long the renminbi is under pressure from outflows.
And giving a free hand to asset managers to launch products that could allow investors to short Chinese stocks is also not high on Beijing’s to-do list following the 2015 equities market crash and the circuit breaker fiasco at the start of 2016.
So while China has shown some willingness to undertake reforms to make A-share inclusion a reality such as clarifications to beneficial ownership and stock suspension rules, most market participants think that relaxing controls that affect the market stability is likely to be a step too far for the country’s authorities. This is especially when Brexit, Fed rate hikes and the US presidential election are set to rear their volatility-inducing heads.
So if China is unwilling to change, the alternative would be for MSCI to soften its stance.
However, the index provider has proven to be fairly consistent in making countries adhere to its criteria, especially when it comes to capital mobility.
Just take the example of South Korea which is still classified as an emerging market even though based on any other criteria bar capital mobility, it is way ahead of its EM peers and even many developed market nations.
This stalemate is a problem for both sides as China is keen to get A-shares included and MSCI cannot keep A-shares out forever. Not when A-shares already have a market cap of Rmb44.6tr ($6.76tr).
Compromise seems the most practical solution and has precedents in the example of Korea and Taiwan.
Korea was only allowed to join the MSCI EM index 24 years ago when it started relaxing foreign ownership limits. Even then only 20% of Korea’s equity market was initially included, increasing to 50% (1996) and 100% (1998). Similarly, the initial inclusion of Taiwan stocks only came once the country started to dismantle investor quotas and then was 50% in 1996 before rising to 100% in 2005.
But for now, MSCI seems determined that China will need to meet its criteria before it considers a partial 5% inclusion.
China and MSCI are both big and used to getting their own way but neither can afford to be without the other over the long-term. The solution is either compromise or someone blinks first. Either way it will be fascinating to watch.