Which A-share index inclusion scheme is more comprehensive?

Ultimately, how this race to offer a more comprehensive index inclusion scheme for A-shares pans out will depend on the appetite of foreign investors for Chinese stocks

Jessie Pak
Jessie Pak

The race is on among the global index providers to outdo each other when it comes to the inclusion of Chinese A-shares into their global indices.

MSCI was the first to make the move when it added 234 large cap shares into its MSCI Emerging Markets Index last June. While this inclusion was quite significant, being the first of its kind, critics were quick to say that 234 large cap shares is still a relatively small size of the total global index universe.

On the other hand, MSCI's clients are mostly large cap investors and, hence, restricting the initial list of A-shares to 234 large cap stocks is justified.

S&P Dow Jones Indices, is still in the process of deciding how to do the A-share inclusion after issuing a consultation paper on the matter earlier this year.

FTSE Russell appears to be undertaking a more comprehensive approach to index inclusion with an ambitious plan to include 1,250 A-share stocks, including large caps, mid-caps and small caps into its FTSE Emerging Index, beginning June 2019.

But in order to avoid flooding its global index with A-shares, FTSE Russell plans to do the inclusion over three separate tranches through to March 2020.

"To assist index trackers in their ability to efficiently replicate the underlying benchmark change, FTSE Russell intends to implement the inclusion over three separate tranches. After each tranche, FTSE Russell will seek market feedback to evaluate the ability of the market to absorb the additional assets," says Jessie Pak, managing director, Asia at FTSE Russell.

Upon completion of the first phase, China A Shares are expected to constitute 5.5% of the total FTSE Emerging Index, representing net passive inflows of US$8-10 billion of assets under management.

This is much larger than the aggregate weight of 0.39% represented by the 234 large caps included in the MSCI Emerging Markets Index. Within the FTSE Global All Cap Index, China A Shares are projected to have a weight of 0.57%.

"The inclusion factor for FTSE Russell is about 25%, whereas the MSCI inclusion factor is 5%," Pak says.

Separately, FTSE Russell has consulted with market participants to establish a transparent and evidence-driven country classification framework for its global fixed income benchmarks.

The recently agreed process identifies objective criteria to calibrate "Market Accessibility Levels", which will be incorporated into the methodology of flagship FTSE government benchmarks including the investment grade FTSE World Government Bond Index (WGBI).

As within the equity framework, a watch list of countries on the cusp of reclassification will be published and maintained with status updates provided each March and September.

Inclusion of a market on the watch list signals FTSE Russell's intent to engage with governments, central banks and regulators to address specific feedback from investors on the fulfilment of the criteria for the proposed accessibility level.

China government bonds will be added to this watch list and assessed against the stated criteria of the framework for possible inclusion in FTSE WGBI.

How the race to offer a more comprehensive index inclusion scheme for A-shares pans out will depend on how much appetite foreign investors have for Chinese stocks.

Although Chinese stocks have performed poorly in 2018, the urgent need for diversification from global investors is likely to fuel demand in the medium to long term.