31 May 2018

China connected to global markets: MSCI includes China A-shares in its major global indices from 1 June 2018

This article was written by Richard Mazzochi, Minny Siu, David Mu and Millie Burnett.

It has been almost a year since MSCI Inc. (“MSCI”) announced its decision to include China A-shares in its major global indices (the “2017 decision”).

In this third alert of our MSCI inclusion of A-shares series (also see our first and second alerts), we recap the key components of the 2017 decision and summarise the steps that address issues highlighted in the 2017 decision, including the daily quota limit under Stock Connect, and CNH liquidity issues for foreign participants.

A recap of the 2017 decision

The 2017 decision was based on MSCI’s Global Investable Markets Indexes Methodology, which includes 18 measures across its market accessibility criteria.

MSCI decided to complete partial inclusion of China A-shares[1] in its global indices in two stages – the first stage to include A-shares with a 2.5% inclusion factor and the second stage to increase the inclusion factor to 5%. 222 China A-shares were expected to be included in batches, after which China A-shares could roughly account for a weighting from 0.37% to 0.73% in the MSCI Emerging Markets index.


The key features of the 2017 decision were:

  • Only stocks available to global investors via the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect programs (the “Stock Connect”) will be included.
  • Large Cap China A-shares in companies which have H-share constituents already included in the MSCI China Index will be included.
  • To address the impact of trading suspension practices in the China A-shares market:
    • China A-Shares that:
      • are suspended during index review; or
      • have been suspended for more than 50 days in the past 12 months,

    will not be eligible for inclusion.

    • Index constituents which have been suspended for more than 50 days (even if the shares have a pending corporate event, including restructuring) will be removed. Trading suspensions were one of MSCI’s key concerns prior to the 2017 decision.

For further details on the 2017 decision, please see our second alert.

Developments since the 2017 decision

Passive investors which track the MSCI indices in the China A-shares market will want to know what steps have been taken to address:

  1. the risk of exceeding daily quotas under Stock Connect; and
  2. a squeeze on CNH liquidity.

Thankfully, the news is good.

1. Potential hurdle resolved: Stock Connect daily trading quotas quadrupled as of 1 May 2018

Stock Connect has reshaped the landscape for investment in China A-shares and was considered a key contributor to the 2017 decision. Foreign investors using the Stock Connect are not required to apply for qualified foreign institutional investor (“QFII”) or RMB-qualified foreign institutional investor (“RQFII”) status, nor are they generally subject to individual investor quota limits that apply under the QFII and RQFII regimes.

Stock Connect: Launched in November 2014, Stock Connect is a joint initiative of the China Securities Regulatory Commission (“CSRC”) and Hong Kong’s Securities and Futures Commission (“SFC”). It allows mutual stock market access between the Shanghai Stock Exchange (“SSE”) or the Shenzhen Stock Exchange (“SZSE”) and The Stock Exchange of Hong Kong Limited (“SEHK”). For more information, please refer to KWM Connect: China Stock Connect and Mutual Recognition of Funds – Latest developments in cross-border investment.

There is a daily quota under Stock Connect which limits the maximum net buy value of all trades that can be executed by Stock Connect exchange participants on any trading day. If the daily quota is reached, investors may however continue to sell securities or cancel their buy orders.

A key issue for consultation after the 2017 decision was whether MSCI’s index review methodology should be amended to allow for the postponement of the index changes where Stock Connect is closed due to daily limit breaches. Otherwise, investors accessing China A-shares via Stock Connect are exposed to tracking error or replication risk.

MSCI concluded its consultation in October 2017, deciding that “it will not postpone the implementation of corporate events and/or index review changes due to daily limits being breached”.

In response to market concerns over Stock Connect’s daily limits, from 1 May 2018, the northbound daily quotas were quadrupled – an increase to RMB 52 billion (USD 8.13 billion), up from RMB 13 billion (USD 2.03 billion).


This reduces the risk of daily quotas being triggered and assists to address the surge of capital flows expected from the inclusion of China A-shares in the MSCI global indices. These measures will help address the tracking error and replication risk arising from investors accessing China A-shares via the Stock Connect.

In its press release following the Chinese regulator’s decision, MSCI commented:


2. Double win for foreign investors: RQFII quota increased for Hong Kong and Japan

Alongside the Stock Connect, RQFII and QFII remain important channels for foreign investors to access China A-shares.

RQFII: Launched in 2011, the Renminbi Qualified Foreign Institutional Investor (“RQFII”) scheme is a modified version of the Qualified Foreign Institutional Investor (“QFII”) scheme. The RQFII scheme facilitates the use of offshore RMB for investment in China’s onshore securities market. For more information, please refer to KWM Connect: QFII and RQFII – a practical insight to recent developments

Two recent wins for Hong Kong and Japan’s RQFIIs have been:

  • in July 2017, China increased Hong Kong’s total RQFII quota to RMB 500 billion (USD 78.2 billion) from RMB 270 billion (USD 42.2 billion). This highlights Hong Kong’s important role as an intermediary to facilitate overseas investors’ participation in China’s financial market; and
  • on 9 May 2018, China granted Japan a RMB 200 billion (USD 31.3 billion) investment quota for the first time to buy China A-shares, bonds and other onshore China assets through RQFIIs.

The following table provides a summary of the key existing channels available to investors to access China A-shares:

Eligible Shares
  Shanghai-HK Stock Connect (Northbound) Shenzhen-HK Stock Connect (Northbound) QFII RQFII
Eligible Shares
  • Constituent stocks of SZSE Component Index and SZSE Small/Mid Cap Innovation Index, and with RMB6 billion+ market cap
  • Other SZSE-listed A-shares with SEHK-listed H shares
  • Constituent stocks of SZSE Component Index and SZSE Small/Mid Cap Innovation Index, and with RMB6 billion+ market cap
  • Other SZSE-listed A-shares with SEHK-listed H shares
RMB-denominated financial products, including:
  • Stocks, bonds and warrants traded or transferred on the SSE or SZSE
  • Fixed income products traded in the inter-bank bond market
  • Securities investment funds
  • Stock index futures
  • Other financial instruments approved by CSRC from time to time
QFII/RQFII holders may also participate in new issuance of shares and convertible bonds, further issuance of shares and subscription of rights issue.
Eligible Investors
  • HK and overseas investors
  • HK and overseas investors
  • At initial stage, only institutional professional investors may trade ChiNext shares
QFII holders RQFII holders
Trading currency RMB USD RMB
Investment quota
  • No aggregate quota
  • Daily quota of RMB 52 billion (effective from 1 May 2018)
Each QFII should hold an investment quota Each RQFII should hold an investment quota
Lock-up period No Generally, 3 months
Repatriation restrictions No Subject to 20% monthly repatriation limit No

3. Addressing liquidity pressure on CNH

With the expected substantial surge in northbound trading starting on 1 June 2018, liquidity pressure on CNH is inevitable.

(a) Hong Kong initiatives

The Hong Kong Monetary Authority (“HKMA”) and the Hong Kong Exchange (“HKEX”) have stepped in, committing to respond to CNH liquidity pressure and rising short-term borrowing rates to help ensure there is sufficient CNH to meet northbound trading investment demand.

The HKMA has:

  • requested that market participants not pre-fund or hoard CNH;
  • encouraged market participants with Chinese operations to bring RMB to Hong Kong;
  • told the nine banks responsible for providing CNH liquidity to keep their credit lines with the HKMA clear on 1 June 2018; and
  • committed to support the market with its liquidity facility and currency swap arrangement of up to RMB 400 billion (USD 62.5 billion) with the People’s Bank of China (“PBOC”), if required.

Trading and settlement via the Stock Connect were previously conducted in RMB only. Starting from 14 May 2018[2], the Hong Kong Securities Clearing Company Limited[3] has accepted USD or HKD as collateral for the early release of securities-on-hold under the Stock Connect up to a daily limit of RMB 500 million equivalent per clearing participant. This further alleviates liquidity pressure on CNH available for A-share investment. The haircut rate for providing HKD or USD as collateral is 3.3%.

(b) Mainland initiatives to facilitate CNH liquidity

The momentum of approval for mutual recognition of funds (“MRF”) has also recently picked up. It is reported that applications for approval of northbound funds are being processed. There have been 3 MRF approvals since the beginning of 2018, after only 4 approvals were given in 2017.

MRF: Launched in July 2015, the MRF programme provides a channel for fund managers based in Hong Kong to offer retail funds to the mainland investors (northbound funds). For more information, please refer to our MRF alert and KWM Connect: China Stock Connect and Mutual Recognition of Funds – Latest developments in cross-border investment

RQDII was relaunched in early May 2018 after a suspension for more than two years. The RQDII regime allows RQDII holders to raise money onshore and invest in RMB-denominated products in the offshore market.

RQDII: The Renminbi Qualified Domestic Institutional Investor (“RQDII”) regime, launched in November 2014, permits qualified RQDIIs to invest in overseas RMB-denominated products using their own RMB funds or RMB funds raised from PRC institutional or individual investors. It is effectively an RMB version of the Qualified Domestic Institutional Investor regime (“QDII”, please refer to KWM Connect: QDII – An offshore perspective).

The re-launch of RQDII and MRF (Northbound) approvals evidences a trend that more RMB outflow is expected. In a recent RQDII circular, the PBOC said it will take into account offshore RMB liquidity when carrying out macro and prudent-management over the RQDII business, which indicates that, in theory, when there is liquidity pressure in the offshore market, the PBOC may intervene.

MSCI’s Semi-Annual Index Review 2018

The Semi-Annual Index Review 2018 published by MSCI on 14 May 2018 confirms that:

  • the first stage of partial inclusion of China A-shares in its major global indices is scheduled to start on 1 June 2018; and
  • instead of including 222 A-shares as originally expected, MSCI will include 234 China A-shares[4] in the MSCI China Index and the MSCI Emerging Markets Index, representing aggregate weights of 1.26% and 0.39% respectively.

Therefore, from 1 June 2018, investment funds and financial products tracking these global indices are mandated to invest in China A-shares. This first stage is expected to attract inflows of up to USD 2 billion[5].

The second stage will coincide with the August 2018 Quarterly Index Review, when the inclusion factor of China A-shares increases from 2.5% to 5%. Up to USD 20 billion is predicted to flow into the China A-shares market during the two-stage inclusion process[6].

What will 1 June 2018 and beyond bring?

The expectation is that the impact on China’s USD 8.6 trillion equity market will be gradual.

The 2017 decision liberalises the China A-shares market for investors globally and advances the integration of China’s equity market with global capital markets through stages. As one of the largest equity markets in the world, the inclusion of China A-shares in leading global equity indices is a critical development to complement the internationalisation of RMB.

Further refinements to the Stock Connect and other access channels for foreign participation in the China A-shares market, such as the lifting of daily quotas or removing the 10% daily limit in stock moves and caps on foreign ownership, as well as the recent blueprint for a London-Shanghai Stock Connect, are likely to pave the way for MSCI to further expand the constitution percentage of China A-shares in its global indices.

We have been advising market participants on a range of issues and initiatives involving China A-shares and other China market access programmes, such as Bond Connect.

Bond Connect: Bond Connect is a new mutual access scheme allowing offshore investors to access the mainland Chinese bond market (“Northbound Trading”) and for onshore investors to access Hong Kong’s bond market (“Southbound Trading”) through a market infrastructure linkage between mainland China and Hong Kong. The initial phase of Bond Connect only supports Northbound Trading. Southbound Trading will be explored at a later stage. For more information, please refer to From Stock Connect to Bond Connect – The first northbound trade under Bond Connect launches today.

Foreigners first participated in the China A-share market in 2002 (with the launch of the QFII scheme). The inclusion of China A-shares in leading global financial equity benchmarks is an exciting new era for China’s capital markets.

[1] China A-shares are included as a separate sector to the existing sector for “China” exposure.

[2] The HKEX announced on 11 May 2018 that it would accept both HKD and USD as collateral for trading and settlement for Stock Connect.

[3] A clearing participant of China Securities Depository and Clearing Corporation Limited that settles trading in China A-shares on behalf of all the clearing participants of SEHK.

[4] MSCI published a few announcements on 30 May 2018, further removing 7 China A-shares that are either suspended or yet to be eligible for Stock Connect from inclusion. For the announcements, please refer to Link 1 and Link 2.

[5] Bigger stock connect quotas will cater to capital flow surge when MSCI includes China, says HSBC

[6] Flood or dud? Inflows from China MSCI entry are anybody's guess

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