China’s Stock Connect flows yet to impress MSCI

China and Hong-Kong flagsInvestment flows on the Shanghai-Hong Kong Stock Connect programme may need to increase before MSCI includes China A-shares in its Emerging Markets index.

The programme – which allows foreign investors to buy A-shares on the Shanghai exchange via Hong Kong, and Chinese investors to buy Hong Kong shares from Shanghai, is the latest in a series of schemes designed gradually to open China's capital markets to international investment.

But Chin Ping Chia, head of MSCI index research in Asia, says a decline in investment flows after the first day indicates investors are not yet comfortable with the mechanism.

"The quota was not fully taken up after the first day," he says in an interview with Funds Europe to be published in our China report in January. "That reflects hesitation in the markets."

Chia suggests investors are exercising caution over the new scheme because of concerns about the recognition of custody arrangements in China and a requirement to deliver shares a day prior to the trade date.

In addition, there remains an element of uncertainty over whether a temporary exemption from capital gains tax in China will become permanent, he says.

"We need to look at whether investors are actually taking advantage of the schemes," he says. "You do see investors continue to get QFII [qualified foreign institutional investor] quotas. That indicates there is a market demand. Obviously the Connect is providing some liquidity. But overall you need to get to a stage where the investor feels comfortable."

Despite the concerns over lagging investment flows, Chia says Stock Connect is the "most promising channel" yet established by the Chinese authorities for foreign investors. He says it is more promising than the QFII and RQFII schemes, because it is "more market driven and there is no distribution issue". RQFII is an inwards investment scheme for investors who hold renminbi offshore.

MSCI plans to reveal the results of its current review on index components by June 2015. Based on previous reviews, MSCI would probably give a year after the announcement before implementing an upgrade, meaning the earliest that Chinese A-shares could enter the MSCI Emerging Markets index would be mid-2016.

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