The debate over the inclusion of China A shares in the MSCI Emerging Markets Index reignited on Sunday, with a senior Chinese official saying that step is a "historical certainty."
"China's A share market is the world's second-largest market; it is also the largest emerging capital market and the fastest-growing one," Qi Bin, the head of the international-affairs department at China's securities regulator, said according to Bloomberg. "So, theoretically a global index without A shares is incomplete."
You can't wait too long to add them, he added.
The comments came at a financial conference in Shanghai. It ramps up the pressure on MSCI, which will decide on Tuesday whether or not to include those shares. Goldman Sachs reckons there's a 70% chance they'll win inclusion.
A shares are stocks that trade within China's borders and in yuan, on either the broad Shanghai exchange or the smaller, tech-focused Shenzhen exchange. The alphabet soup continues with B shares, also listed in China but traded in foreign currencies, mainly U.S. dollars.
Why does this matter? Chinese shares have been horrible. They have been the worst performers among the world's major markets for several years ¿ and lead the list of losers this year. But they're all over the place. Between July 2014 and June 2015 they soared 150%, only to crash 40% from that point to September 2015. MSCI inclusion would pump billions of dollars into Chinese shares, and doubtless cause another bull run.
How things have changed since I moved to Hong Kong in 2001 to work for CNN. Back then I was writing about how China was struggling simply to be admitted to the World Trade Organization. Now its previously off-limits domestic stocks may start to open up even to you and me. At the very least we would be able to get a taste of Chinese stocks in a broader emerging-markets index without having to buy a China-dedicated exchange traded fund -- basically the same as wandering into a Vegas casino and slapping down your portfolio on black.
Chinese shares are little better than futures. Chinese regulators give absolutely no warning about changes in policy. So if you buy, say, stock in China Mobile (CHL), confident in the number of mobile-phone licenses granted by the government, don't sleep too soundly. You could wake up the next day and find that the number of licenses has doubled.
Access to China's markets is highly restricted, with investment banks and other institutional players having to apply for quotas under the Qualified Foreign Institutional Investor scheme, and pretty much always getting a fraction of the allocation that they wanted. It's much easier to access Chinese shares via Hong Kong, where investors can freely trade H shares -- Chinese companies listed on the Hong Kong exchange -- and Red Chips, China-focused companies that are incorporated outside China. Of course there are also stocks like Alibaba (BABA), which runs Taobao, China's eBay, that are listed in the United States.
There's an arbitrage play since there are often wide discrepancies between H shares and A shares. The domestic Chinese market is dominated by flighty retail investors who leap in and out of the market when there's any sign of momentum. Until recently they assumed China shares would always go up, and the Chinese government would bail them out if they didn't. Now they're finding out the hard way that the government wants to let market forces rule.
Domestic investors bid up local shares. They have few options as to where to put their money other than shares or real estate. B shares on the Shanghai exchange trade at an average P/E ratio of 29x and the less-popular A shares trade at 14x. Hong Kong shares trade at 10x earnings, all data according to the Hong Kong exchange.
MSCI started its consultation on A shares in March 2014. It balked at including them last year, worried about how investors looking to duplicate MSCI indexes would access the shares. Expect A shares to jump closer to B share valuations if they secure inclusion.
Ultimately MSCI expects to include a 5% weighting towards A shares in the MSCI Emerging Markets Index. The challenge, since China's markets are heavily restricted in terms of foreign participation, is making sure foreign investors will be able to map any such change. The company says it is working with China's securities regulator, the China Securities Regulatory Commission, to make that happen.
Qi said the CSRC has been tackling those issues, expanding access and enacting clear rules on issues such as stock suspensions. MSCI has been worried about that issue since half the market shut down last May amid a $5 trillion selloff, sparked by the sudden introduction of tighter rules on margin trading.