By Sandrine Soubeyran, director, research and analytics
One development that emerging market equity investors will be watching with interest this year will be the inclusion of China A Shares in FTSE Global and emerging market indexes.
During 2018, we evaluated the China A Share equity market against our Country Classification process and announced in September that China A Shares available via the Northbound Stock Connect program—the mainstream equity class in that country—would be included in our Global and Emerging Market Index.
As with all our country classification changes, we made this announcement well in advance of implementation to give market participants time to adjust. We will begin including China A Shares securities into FTSE GEIS from June 2019. To assist index trackers in their ability to efficiently replicate the underlying benchmark change, we will implement the inclusion over three separate tranches (Phase 1) through to March 2020. After each tranche, FTSE Russell will seek market feedback on the efficiency of the implementation and to evaluate the ability of the market to absorb the additional assets before proceeding with the next tranche.
Stock inclusion will be calculated using 25% of investable market capitalization of the eligible large, mid and small cap designated securities from the FTSE China A Stock Connect All Cap Index (currently around 1,250 stocks). As the chart below shows, upon completion of the Phase 1, China A Shares are expected to constitute c. 5.5% of the total FTSE Emerging Index, representing initial net passive inflows of $10 billion of assets under management.
Source: FTSE Russell as of August 2018. Future weights based on market assumptions that may ultimately be incorrect. Please see the end for important legal disclosures.
It’s vital to recognize that FTSE Russell formally reviews country classifications within its FTSE Global Equity Index Series (FTSE GEIS) using a comprehensive, transparent and consistent methodology, which verifies that important criteria for market efficiency and quality are met. Ensuring that those investor conditions are achieved lies at the foundation of our country classification evaluation process. China A Shares classification as Secondary Emerging Market was a result of constructive engagement with Chinese regulators, stock market officials and international investors/custodians.
So considerations for further inclusion of further China A Shares after Phase 1 will take place within that framework: specific questions could include whether the size of the next phase should be based on any increase to the quota sizes, whether phase 1 should be repeated (i.e., taking the total inclusion factor to 50%); and whether stocks outside of Stock Connect routes should be included.
But this is unlikely to be the end of the process: in time, China's listed equity markets are likely to dwarf the rest of the emerging markets. According to our research, China shares could in time form half of all stocks in FTSE Emerging Markets, with A Shares, and ex A Shares (B, H, N, P, Red and S Chips) providing a quarter each. But whatever happens will be determined using an agreed, transparent process, and asset owners and managers will be made aware of changes a long time in advance.
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