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Preparing for China’s inclusion in global benchmarks - A flexible approach to managing the transition

  • Following further increases in R/QFII allocations and improvements in the R/QFII application process, on May 26, 2015 FTSE Russell announced the start of its transition to include China A Shares in its widely followed global benchmarks, with the launch of new FTSE China A Inclusion Indexes.
  • China is opening its market to foreign investors at a significant pace. It is increasingly likely that within two to three years China A-shares will become eligible for inclusion in FTSE’s global indexes. To facilitate this growth in access, the FTSE China A Inclusion Indexes will give market participants a range of index choices to help them prepare for the inclusion of China A-shares in global benchmarks.
  • There will be no change to the standard FTSE Global Equity Index Series. Based on FTSE’s Annual Country Classification announcement, dated September 2014, China A-shares are not yet eligible for FTSE’s standard global benchmarks. For inclusion further progress is required as part of FTSE’s country classification process in areas such as market accessibility and quota allocation, as well as capital repatriation.
  • FTSE Russell will continue to consult and engage with market participants and the Chinese authorities to monitor developments and gauge progress in these key areas. A formal review of the status and eligibility of A-shares will be held every September. The next review is due in September 2015.
  • The FTSE China A Inclusion Indexes have been created to prepare market participants for the inclusion of China A-shares in FTSE’s standard indexes. It will provide market participants with the following benchmark options:
    • Global benchmarks with China A-shares included and weighted by the aggregate approved quota(including QFII/RQFII)
    • Global benchmarks with China A-shares included and weighted by free float and foreign ownership adjusted market value as if there were no quota restriction
    • Customized indexes based on an investor’s own QFII/RQFII allocation
  • Market participants who do not wish to have A-shares in their global benchmarks can continue to use the FTSE Global Equity Index Series.
  • The index series provides a range of benchmark choices reflecting alternative ways for market participants to access the mainland China market. It has been created for clients:
    • Who would prefer to increase their China exposure over a period of time;
    • Who have no quota constraint and would prefer a higher allocation to China A-shares;
    • Who prefer having an allocation to China A-shares based on their own quota size.
  • With over 14 years of experience developing China market indexes, FTSE’s China benchmarks have become widely recognized by investors and ETF issuers globally as the leading measure of the China equity market and the natural choice for creating China-themed investment products.

Introduction

China has shown strong indications that it is willing to open its market to international investors. The approval of QFII/RQFII licenses and quota has been increasing at a tremendous pace since 2011. The launch of the Shanghai-Hong Kong Stock Connect programme last year and the recent confirmation of a stocktrading link between Shenzhen and Hong Kong by the China’s State Council, has shown clear evidence that the Chinese regulators and stock exchanges are making significant efforts to improve the regulatory environment and trading mechanisms. An increasing number of investors are asking questions such as: When will China be included in global benchmarks? What can investors do to prepare for a possible inclusion? This paper aims to answer these questions and is intended for market participants as they prepare for China inclusion in FTSE’s global benchmarks. Section 1 and 2 describe the development of the China A-shares market and the milestones towards its globalization. The FTSE country classification system and the assessment results on China are discussed in Section 3. Section 4 outlines FTSE Russell’s solution to the China A-shares market changes. Conclusions can be found in Section 5.

1. China’s development and its importance to global investors

Following the implementation of market reforms in late 1970s, China has become one of the world’s fastest-growing economies. Over the past few decades, it has evolved to become the largest manufacturer and the second-largest economy by GDP.

Since the establishment of the Shanghai and Shenzhen Stock Exchange in the early 1990s, the Chinese equity market has been developing at a significant pace. The first public trading commenced on December 19, 1990, with eight companies listing on the Shanghai Stock Exchange. Shortly afterwards, the Shenzhen Stock Exchange opened. There are now over 2600 companies listed on the two exchanges with a combined market capitalization that exceeds USD 6 trillion. This makes China the second largest equity market by market value. China’s role in the global equity market has become increasingly important and attracted significant investor attention.

Although the Chinese equity market represents a significant portion of the global equity investment landscape, there are still some restrictions in market accessibility for the China A-share market. As the China A-shares market gradually opens, it is important for investors to understand the potential impact that an easing of such restrictions would have on their global benchmarks.

FTSE Russell, as the leading international index provider of Chinese indexes, has been a part of this remarkable evolution since the beginning of this century. Since then it has provided Chinese domestic and international indexes to global and domestic investors. Its two flagship China indexes – the FTSE China 50 Index and FTSE China A50 Index, were designed to provide tools to investors with and without access to the domestic Chinese market. As of March 31, 2015, ETFs and funds tracking the FTSE China A50 Index and FTSE China 50 Index had assets under management of USD 14.1 billion and USD 7.8 billion, respectively.

2. Milestones towards globalization

The size of the China A-shares market is significant. However, it is only relatively recently that the idea of the possible inclusion of China A-shares into global benchmarks has started to emerge. This emergence can be attributed to three major developments in China; the expansion of the stock market, regulatory improvements and easier market accessibility for international investors. These three developments have led FTSE Russell to consider the inclusion of China A-shares into its global benchmarks.

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