“China is just too big to ignore,” is one refrain nearly impossible to avoid in conversations about China. The logic is straightforward: the country is home to the second largest stock market and the third largest bond market in the world, and has lots of potential to grow further. Gaining exposure to China should be a no-brainer, conclude some.
Index providers seem to follow the same train of thought.
FTSE Russell is on track to become the latest index provider to put Chinese bonds in its benchmark, after saying last week that it will start a consultation on including Chinese government bonds (CGBs) in its World Government Bond Index (WGBI) later this year, as GlobalRMB revealed in June. In March, Bloomberg Barclays decided to add govvies and policy bank bonds to its benchmark. That inclusion will go live in March 2019.
Before FTSE Russell makes its big call on China, however, it should take a look at MSCI’s inclusion of 226 A-shares into its Emerging Markets indices, a $1.9tr benchmark, and what investors actually think about that.
Shielded by anonymity, 48% of buy-side managers surveyed by the Asian Corporate Governance Association said they disagreed with MSCI’s decision. Even 12% of executives at Chinese listed-companies opposed the move, according to the survey, the results of which were published last week.
Investors complained that it is too difficult to access information as well as senior executives at listed companies, hampering their ability to value these stocks. About 90% of foreign investors said they undertake significant additional analysis on corporate governance before buying A-shares.
Not that issues of governance were unknown to MSCI. The index provider put conditions on any further increase in the weighting given to A-shares in the index, with only 5% of eligible market capitalisation included at this stage. One of these conditions is that Chinese regulators sort through the country’s large pile of suspended stocks, MSCI said last year. The Chinese securities watchdog has responded positively, saying that it will make improvements — on suspensions and other areas — to push that figure to 15%.
But MSCI seems to have willfully ignored bigger issues. One is a clear tendency by Chinese authorities to meddle during downturns in onshore stock valuations. An example came this month when the mainland stock exchanges overrode their Hong Kong counterpart to stop Xiaomi — the first company with a weighted-voting right structure — to trade on Stock Connect. That prevented the stock from becoming accessible to Mainland investors, who seemed all too keen to shift money out of the onshore market and into Hong Kong during the second A-share bear market in three years.
The authorities’ hand is not only visible in the making — or remaking — of the rules. Its presence is also felt daily in the market by traders. In their coverage, Chinese media, including state-backed outlets such as Securities Times, openly refer to the ‘national team’, which is the cohort of government investment entities, such as Central Huijin Investment, that come in and buy stocks when the market goes south.
Kowtow
None of this is news. But what is new is index providers’ willingness to accept these shortcomings.
Last year, instead of stuffing Chinese bonds down the throats of sceptical investors, Bloomberg Barclays pulled off a balancing act, creating a separate Global Aggregate + China Index to cater for those enthusiastic about the market.
This year, despite having concerns over some aspects of Bond Connect, such as the lack of delivery-versus-payment (DVP), block trading and clarity over tax collection, the same index provider said it would fully add China to the global index. But again it offered a compromise, creating ‘ex-China’ versions of the Global Aggregate Index for those still unconvinced by changes in China.
And, to be fair to Bloomberg Barclays, it does make clear that it will only move ahead with the inclusion if the People’s Bank of China resolves the three main concerns. The central bank has promised to do just that.
But as the MSCI case shows, there seems to be a willingness to settle for a grey area when it comes to including Chinese securities, something that could end up hurting unaware global investors in the long run.
Index providers justify their moves by saying that they are only including a small number of Chinese securities and that they are starting from relatively safe government and policy bank bonds only.
But, with China struggling to move forward with its deleveraging campaign, and with an eye to the global financial crisis of 10 years ago, the market would be well advised to proceed with caution.
The real test will come when index providers expand their scope beyond the safe bets of government securities.