China’s financial system took another step towards integration with the rest of the world this week -- but not quite the way that was envisioned years ago.
Domestic Chinese stocks will be included in MSCI Inc.’s international equity indexes for the first time, the New York-based company said Wednesday. It’s another win for China after the International Monetary Fund in 2015 granted the yuan the status of an official reserve currency. Next up is the potential entry of Chinese bonds into three major global indexes.
Since negotiations in the 1990s over China joining the World Trade Organization, it has long been thought that by bringing the country into global forums and institutions the hand of pro-market reformers would be strengthened -- that China would adopt international norms when it comes to regulation and transparency.
Yet experience since the WTO and IMF nods suggests there’s still a long road ahead. MSCI’s decision to downsize its original ambition for domestic Chinese stocks suggests the rest of the world is coming round to recognizing it must accept China on different terms, given its size.
“China is too big to be left behind,” said Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis SA in Hong Kong. “Anybody who has tried has seen a parallel institution being created of a very similar nature,” she said, noting the establishment of the Asian Infrastructure Investment Bank following years of Chinese frustration at lack of reform at the Washington-based IMF and World Bank.
When China emerged from its post-Tiananmen isolation in the 1990s, western negotiators bet that bringing it into the WTO would enhance the rule of law and promote reforms that gave opportunities to overseas companies.
Years later, U.S. and European business lobbies say the playing field is far from even. More recently, adding the yuan to the IMF special drawing rights basket was supposed to be accompanied by making it more flexible. Yet since the 2015 decision, capital controls have been tightened and the exchange rate became more closely managed.
In all such cases, the challenge has been to reconcile institutions generally associated with free markets with the Communist Party’s instinct toward intervention.
“China really cares about adopting all the forms of international institutions without actually adopting the substantive behaviors,” said Anne Stevenson-Yang, co-founder of J Capital Research, who has a quarter century of experience in China and previously worked at the U.S.-China Business Council. “These things are like trophies,” she said of China winning entry into bodies while undertaking only limited change.
Compared with some other emerging markets, China has been more reluctant to make the changes needed to meet MSCI’s market-access demands for A shares, as domestically-listed stocks are referred to. In the end, the index compiler decided to phase in a selection of Chinese shares next year, which will make up 0.7 percent of its global emerging-markets gauge.
Talks will continue between China and MSCI on expanding inclusion -- read more here.
“Ultimately, the U.S. is such a leader because it has deep and broad financial markets where everyone can trade; China is not doing that,” said Fraser Howie, co-author of the book “Red Capitalism” who has two decades of experience in China’s financial markets. “Many foreigners accept that,” but the cost is they will be “certainly very conservative about how much they put in to work at Chinese companies,” he said.
Tom Orlik, chief Asia economist at Bloomberg Intelligence, highlighted that China did take steps to increase its openness to win this marginal MSCI inclusion -- for example by setting up Stock Connect programs that allow investors to buy A-shares in the Hong Kong market.
“MSCI still has some negotiating capital with China, and China’s reformers still have some capital” going forward to press the case for opening, given that talks will continue about broadening China’s inclusion, Orlik said. Henry Fernandez, MSCI’s chief executive officer, says mid-cap stocks are one area of focus for the future.
When it comes to observing global norms, China isn’t the only one with challenges. Some Western governments have lost sway when it comes to moralizing on an ideal global order. U.S. President Donald Trump’s promise to exit the Paris Climate Accord and decision to pull out of a planned Asia-Pacific trade pact mark steps back from global consensus. And China has taken up the torch of globalization rhetoric.
Meantime, don’t expect the MSCI index inclusion move to improve Chinese accounting transparency. MSCI’s Sebastien Lieblich noted in a conference call that corporate governance isn’t a consideration for index inclusions. Nor are there any stops for the so-called national team to keep intervening in China’s domestic market.
Read more here about the idiosyncrasies of China’s A-share market.
At the end of the day, when it came to MSCI inclusion, Andy Xie, an independent analyst and a former chief Asia economist at Morgan Stanley, said it boiled down to this: “Money talks.”
To contact the reporters on this story: Enda Curran in Hong Kong at ecurran8@bloomberg.net, Christopher Anstey in Tokyo at canstey@bloomberg.net.
To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Christopher Anstey at canstey@bloomberg.net, Emma O'Brien
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