With a total market capitalization of USD $3.9 trillion, China's A-share market ranks only behind the New York Stock Exchange, Nasdaq, and Japanese Stock Exchange. Despite its size, the A-share market remains largely off limits to foreign investors. But change is coming and the introduction of a Mutual Market Access (MMA) program is an important step in opening up China to global investors.
Earlier this year, the Hong Kong Exchange and the Shanghai Stock Exchange proposed a solution that would allow foreign investors to invest more freely in China’s A-share market through the MMA program. This program was implemented on November 17, 2014.We have been following these developments closely, recognizing the importance of these changes and ensuring that Signature would be in a position to take advantage of the developments before the year has run its course.
Accessing China's locally listed companies
Before the introduction of the MMA program, investing in the domestic A-share market by foreign investors was limited to a few registered investors. Foreign investors could only invest in A-share stocks through either the Qualified Foreign Institutional Investor (QFII) or the Renminbi Qualified Foreign Institutional Investor (RQFII) programs. The first program (QFII) has numerous restrictions while the second program (RQFII) is only available to investors in approved countries. Canada was awarded an RQFII quota a week ago which opens another avenue for registered investors to access China’s A-share market. Looking at the more widely accessible QFII program, monthly net repatriation cannot exceed 20% of the total investment at the end of the preceding year and investors have to deploy the approved investment quota within six months of the approval, or the Chinese government will take the quota back. We have decided not to participate in these programs due to these restrictions even though it meant not having access to China's A-share market.
Thankfully, ever since the new Chinese leadership took office in March 2013, the government has demonstrated a strong desire to reshape the investment-led economy through economic and financial reforms, including Renminbi internationalization and the opening up of China’s capital market. In April 2014, they took a major step forward and provided an answer to the limited accessibility issue – the MMA program.
The MMA program allows foreign investors to invest directly in the Shanghai stock market (A-shares) with virtually no restrictions other than the annual and daily trade quotas. The program includes 568 A-share stocks, adding to the 266 H-share stocks (Chinese companies already listed on the Hong Kong stock exchange) that were already available to foreign investors. The A-share stocks represent 90% of the market capitalization on the Shanghai stock exchange. There are also talks that the biggest and most liquid A-share market, the Shenzhen Stock Exchange, may be included in the MMA program.
Emerging market indices not yet participating
Although the MSCI had tried to include a small portion of the A-share market in the MSCI Emerging Market (EM) Index earlier this year, investors blocked the move due to the limited accessibility to the A-share market. However, following the MMA program, it is quite conceivable that MSCI might try to include A-share again. This time, investors might be much more open to the idea. If the inclusion is fast-tracked, China A-share could make it into the MSCI EM index by mid-2015.
China is undergoing a series of changes under the new leadership with a renewed focus on the rule of law, anti-corruption, economic and fiscal reforms, and the government’s efforts on containing local government debt and clamping down the off-balance sheet lending. These reforms, if successful, should reduce the risk of a systemic crisis in China and, as such, lower the country’s risk premium over time. We acknowledge that this will be a long process with numerous false starts and disappointments along the way, but remain confident that China should be able to ultimately navigate the reform process successfully.
Deepening our understanding of China's domestic market
Like many local emerging markets, China’s stock market has its own complexities and, in some cases, even surpassing the complexities found in other markets. Conducting proper due diligence and building relationships with companies and the local investment community are critical for investing in China. To add to Signature's understanding of these complexities, we will be opening a Hong Kong office in January 2015. This office will focus exclusively on the Chinese and Hong Kong markets, adding another layer of understanding of the investment environment in Asia.