At the beginning of June, we covered in some depth the introduction of Chinese A-shares into mainstream financial markets. It has been possible to invest foreign capital into domestically-listed Chinese shares on the Shanghai and Shenzhen stock exchanges for some time via the Hong Kong Stock Connect link. However, this month’s inclusion of 234 China-listed companies into the MSCI Emerging Markets Index market the first time Chinese equities have been included into one of the major indices international institutional investors are heavily invested in.
The development is considered to be the beginning of China’s equity markets making the transition from ‘exotic’ minority holding for adventurous stock pickers to a more accurate reflection of the scale and influence the country’s economy now has on the global stage. MSCI will gradually add more Chinese companies to their developing markets index and full representation is expected to mean they account for 40% of the index when taken together with offshore-listed Chinese companies.
Not all institutional investors are keen on the idea of passively investing in Chinese A-shares due to concerns around corporate governance standards and debt levels. However, analysts also consider the relative lack of international capital in the domestic market means values are far below those of comparable companies elsewhere. It was thought an influx of capital could, all being well, mean a period of sustained growth for Chinese equity valuations.
That might still prove to be the case. However, the first few weeks of trading have certainly not seen A-shares make a positive contribution to the index. The Shanghai Composite Index is down over 5% so far in June. Another argument is that international capital is only interested in quality Chinese companies and the few considered to meet the criteria for ‘quality’ have already benefited from international capital flows and have high valuations compared to peers.
Beijing’s recent tightening of credit controls has slowed the economy and local investors have sold stock, softening values. This Wednesday China’s ruling Communist Party promised to “stabilise market expectations and maintain stable functioning of the financial market”. This was interpreted as meaning an imminent policy easing that will inject liquidity into markets. While this would indeed likely mean a short term recovery it won’t do much to ease longer term concerns the destiny of the Shanghai Stock Market is still overly tied to the state.
It appears that the process of China coming into the wider fold of international financial markets will be a longer, more complex process than many hoped as recently as a few weeks ago.