MSCI, Major Bellwether of China’s Financial Sector Reform
As the country is shifting to a more open capital market, the index provider might appear to be central to its success.
Global index compilers have a special place in the financial industry. While they can’t influence fundamentals and have nothing to do with the so-called real economy, their decisions are often crucial for many public companies. For example, in November 2019, the Hong Kong bourse saw the shares of marble miner and producer ArtGo Holdings (3313:HK) collapsing by 98% right after MSCI (MSCI:NYSE) decided to stop considering the firm’s stock as a possible candidate for its MSCI China Index. On that day, ArtGo lost over USD 5 billion from its market cap in a wink.
Meanwhile, the indexing business is on an upswing, with a constantly growing market demand for related products. Last August, the combined assets of index funds operating in the United States surpassed those of the country’s actively managed funds for the first time, reaching USD 4.27 trillion. There is, indeed, a long-lasting conflict between the two. Even some of the world’s most prominent wealth managers are envious of the ease that index portfolios tend to acquire new clients with, sometimes also accusing their ‘all-equalizing’ counterparts of being a bubble.
The amount of power the likes of MSCI, S&P Dow Jones Indices and FTSE Russell hold is spectacular. This is one of the reasons why, for China, which has been rapidly liberalizing its financial sector, a peculiar ‘friendship’ with these organizations is essential. And this issue is way more critical when it comes to some brand-new flagship projects that the country relies upon heavily to push the bulk of its equity markets forward.
One such initiative – the Nasdaq-style board on the Shanghai Stock Exchange, known as the Star Market – has been in the global spotlight for a while. As of the end of the last year, 70 high-tech Chinese companies had launched trading on the new marketplace. (Read more about it in our quarterly outlook.)
At the moment, the total market cap of the new venue-listed stocks accounts for nearly 1% of the country’s entire stock market. Nonetheless, this proportion is increasing, with more enterprises finishing their journey through the IPO pipeline.
When things get bigger, they gain more attention. In the financial world, this is particularly true. In October 2019, EqualOcean reported on MSCI’s intention to include the Star Market-listed stocks into its indices, the MSCI China and MSCI China All Shares.
Besides, that wasn’t the first time the New York-based financial juggernaut expressed its interest to a nascent Asian board: MSCI made an announcement three days before the new trading platform started its operation, making clear that it is currently monitoring the situation.
Another noteworthy detail is that the index compiler, apparently, has a good nose for global financial landscape shifts. MSCI indicated that it would rebalance its China-related indices two months before the latest reform was announced by President Xi Jinping at China’s first import expo. In September 2018, the organization first initiated a significant boost of yuan-denominated stocks in some of its ‘portfolios.’ One year later, the quest was successfully completed, with over 200 new A-shares, most of which are mid-cap stocks, including the MSCI Emerging Markets and MSCI China indices.
“The weight of China A-shares in the MSCI ACWI and MSCI Emerging Markets Indices will reach 0.5% and 4%, respectively,” stated the press release. “The MSCI China Index, which includes China A-shares and offshore listed shares, will include 710 securities representing 4% and 34% of the MSCI ACWI and MSCI Emerging Markets Indices, respectively.”
Nevertheless, that crescendo was doomed to end. MSCI created a deadlock for still-not-that-open China, pointing out four problems that prevent yuan-denominated stocks from further expansion within the lists it is managing. Those are lack of access to hedging and derivatives instruments, short settlement cycle, stock market holiday schedule differences and the need for an omnibus mechanism.
While concerns over de facto financial openness are looming, China is relentless in the adjacent fields. One example is that it is trying to lure the greatest global money-managers into its ample market by truly radical measures, such as full foreign ownership for companies across various subindustries, including asset management, securities, insurance.
There is now a litany of giants queueing for fresh opportunities in the world’s second-biggest market. For instance, Goldman Sachs – which, over the past ten years, has become a laggard in the fierce global investment banking industry – kicked off an aggressive hiring campaign in China, seeking better value-allocation options.
It is quite conceivable that the current course of comprehensive reform will convince not only such massive ‘bounty hunters’ but also less flexible, big picture-focused high and mightiest that are index-makers like MSCI. As usual, it needs some time. No, it needs something more precise: a mixture of speed and dedication.