Expectations that China’s booming stock market will become increasingly open to foreign investment appear to be growing as authorities continue to reform its financial markets.
The country’s A-shares market consists of shares in onshore Chinese companies that trade on Chinese stock exchanges. Currently these shares can only be purchased by mainland citizens, in renminbi, and are mostly owned by retail investors. Foreign investors must gain exposure to A-shares through the Qualified Foreign Institutional Investor (QFII) system, which is tightly regulated and presently has an overall exposure limit of just $125bn.
The other main share class listed on Chinese exchanges, B-shares, is open to both domestic and foreign investment, however. B-shares are also quoted in foreign currencies – they trade in US dollars and Hong Kong dollars on the Shanghai and Shenzhen stock exchanges respectively. A mutual fund or exchange-traded fund that invests in China will typically hold B-shares. Some companies have their stocks listed in both share classes, although there is more demand from Chinese citizens for A-shares, thanks to reforms within the last decade. This has resulted in higher valuations and larger volumes for A-shares trading by companies than what is evidenced for their respective B-shares.
China is working to blend these two stock classes together to create a more uniform investment policy across the country. This will open the door for including Chinese stocks in global emerging market indices, which should consequently facilitate significant foreign direct investment in mainland companies. Most overseas institutional investors currently have little exposure to China, so a huge influx of foreign capital into the world’s largest emerging market is expected as global access is increasingly authorised.
Indeed, some progress appears to have been made recently. On May 26, the UK’s benchmark stock market, the Financial Times Stock Exchange (FTSE), revealed that institutional investors could gain incremental exposure to A-shares through the launch of two “transitional indexes.” The FTSE Emerging Markets China A Inclusion index will give institutional investors an opportunity to invest in large-cap stocks, while the FTSE Emerging Markets All-Cap China A Inclusion index will cover a much wider range of stocks. The A-shares weighting within these indices will be calculated in accordance with the total quota allowance available through the QFII schemes, currently equating to approximately 5% of all assets that are tied to FTSE’s emerging markets indices.
Going forward, all eyes will be on the global benchmark index for emerging market investment, the MSCI Emerging Markets Index. China’s A-shares are currently prohibited from MSCI because many investors believe that China’s $4tn mainland market is not sufficiently open, given the stringent limits placed on foreign investors. It is possible that A-shares will be added to the MSCI Emerging Markets Index, most likely in 2016 or later. On June 9, a decision will be made by MSCI on whether to include A-shares in its emerging market indices; if the green light is given, it is expected that investors will be allowed 12-24 months to compile their exposures.
In the meantime, it is probable that the MSCI index will include overseas-listed Chinese stocks later this year. Jan Dehn, head of research at $61bn emerging markets house Ashmore Investment Management, believes China’s inclusion in emerging market indices will be “the single most important financial event in the next decade.” FTSE’s chief executive, Mark Makepeace, told the Financial Times that China will dominate emerging markets and will very likely become “20% of global portfolios.” Mr Makepeace also believes that in the next three or four years all institutional investors will be holding A-shares.
The resulting investment opportunities could be sizeable. A-shares have rallied by 80% in the nine months through March 2015, outperforming other emerging markets. However, given that both of China’s main stock exchanges have more than doubled in the past year, sizeable additional investment in A-shares could further inflate what some investors believe is a growing equities bubble.