MSCI forces investors to rethink China

Asia also ended mostly lower, with Hong Kong's Hang Seng down 0.6 percent and Japan's Nikkei down 0.5 percent but China's Shanghai gained 0.5 percent on addition of China A shares in MSCI Emerging Markets Index.

MSCI has finally endorsed China's domestic A shares, after a three-year review period, for inclusion in the influential Emerging Markets Index.

"If reforms progress is faster than now anticipated, we are likely to see significant increase of inclusion factor in three to five years, similar to the case of Korea market".

Morgan Stanley suggested the inclusion may bring as much as US$1.5 billion from global index funds tracking MSCI's benchmarks, into the mainland markets.

Saudi Arabia, which opened its market to global investors in June 2015 through its Qualified Foreign Investor (QFI) program, has to date registered more than $ 5.48 billion worth of investable assets.

MSCI estimated the change, which does not happen until June next year, would drive inflows of between US$17 billion and US$18 billion. In previous years, it opted to delay the inclusion while keeping Chinese equities on the watch list.

MSCI will also start to calculate a number of its provisional indices as part of the ACWI index series that include China A-shares in order to help manage the implementation of the inclusion of these stocks in investors' portfolios.

MSCI first considered adding Chinese stocks to its indexes in 2014, since then China's market has been through a steady stream of initiatives to make local exchanges more accessible to the outside world.

"MSCI inclusion is a major step toward the internationalization of China's stock market".

Commenting on the impact of the decision, Moody's writes: "MSCI Emerging Markets indices will have representation from the world's second-largest domestic equity market by market capitalization". That figure could grow if China reforms its financial markets, with the MSCI saying it was "hopeful" the momentum would accelerate.

The development opens China up to worldwide investors by allowing them to access companies trading on Chinese stock exchanges, but it will take time to reap the full benefits of the move. Your traditional A-share is a company incorporated in mainland China, with shares listed on the exchanges in either Shanghai or Shenzhen. "The expansion of Stock Connect has been a game change for the market opening of China A-shares".

During the consultation, the vast majority of institutional investors approved the proposal to include large-cap shares that are not in trading suspension.

MSCI may revise the implementation road map to a single phase if the daily limit on Stock Connect trading were to be abolished or significantly expanded before the scheduled inclusion dates.

Upon inclusion, many MSCI clients will add securities tracked by the MSCI China A International Index to their portfolios in some shape or form.

One large institutional investor, who has had a long-term commitment to onshore Chinese assets, says that although the Chinese economy faces serious issues, it has achieved a scale that makes its eventual integration into global financial markets a foregone conclusion.

"We were looking at 4-5 percent weight increase for China but that has now come down to nearly 40-50 bps, so the net impact on India's weight at best be 10 bps which could eventually lead to United States dollars 200 million of outflows".