MSCI inclusion for China spurs sharp increase in foreign accounts

China's inclusion into the MSCI Emerging Markets Index has driven a dramatic increase in foreign institutions opening up special segregated accounts (SPSAs).

By Charles Gubert

The ultimate end goal driving China’s ambitious market liberalisation initiatives – whether it be Stock Connect, Bond Connect, and even mutual recognition – has always been the aspiration that one day its A-Shares would be incorporated onto the MSCI Emerging Market Index. In June 2017, that objective was finally met, when MSCI announced it would add 234 China A large cap stocks to its Emerging Markets Index, beginning in June 2018.

Flows as a result of the upgrade are expected to be in the region of anywhere between $15 billion and $20 billion across both rebalancing periods, as passive providers build up their exposures, a sum total which may even exceed $500 billion when A-Shares are fully included on the index.

James O’Sullivan, head of securities services for Hong Kong at Standard Chartered, said inclusion had resulted in a dramatic increase in institutions opening up special segregated accounts (SPSAs).

“There was a 70% increase in the number of SPSAs being opened at the CSD between January and May 2018. There are now approximately 5000 accounts presently open at the CSD,” he said.  There were initial concerns that the Hong Kong leg of Stock Connect would buckle under the sheer size of the trading volumes, as people questioned if there was sufficient offshore RMB liquidity to settle all of the transactions.

Ahead of the MSCI inclusion, the Hong Kong Monetary Authority (HKMA) was in active dialogue with members of the banking and securities industries to ensure there was sufficient liquidity in the offshore market.  The HKMA also announced measures to address potential CNH liquidity issues during the rebalancing period.

Furthermore, the People’s Bank of China (PBOC) announced new measures in mid-May to allow overseas investors to access the China onshore FX markets for conversion and hedging purposes arising from Stock Connect related activities.  O’Sullivan said this policy broadly mirrored what the PBOC had already implemented for Bond Connect, whereby users can access the onshore FX market for funds and hedging purposes. 

With the ratcheting up of trade tariffs between the US and China, many experts feel the infusion of liquidity as a result of the MSCI upgrade will be a useful counterbalance to any potential disruption. China is also pushing through with enhancements to Bond Connect, following confirmation from Bloomberg Barclays that it would start to gradually add RMB denominated bonds to its flagship index from March 2019.

“Reforms to Bond Connect are being introduced around block trading, the enablement of real delivery versus payment (DVP) and the announcement of more market makers. The PBOC has said that block trading will be made available at some point in July, and that real DVP is going to be fairly imminent too,” commented O’Sullivan.