By Emerald Yau, Head of Equity Index Product Management, Asia
FTSE China A50 Index – FTSE Russell’s China flagship index consists of the largest 50 A Shares companies – is getting some highly anticipated changes this year via a two-step upgrade: (1) constituents subject to foreign ownership limit (“FOL”), and (2) constituents subject to Northbound Stock Connect eligibility. These upgrades represent the first wave of enhancements planned for the FTSE China A50 Index ecosystem.
A positive step post consultation
FTSE China A50 Index made its debut more than 18 years ago and has become a widely used benchmark for investors to access China opportunities through A-Shares – securities of companies incorporated in mainland China and traded on China’s stock exchanges.
But 18 years is a long time, particular in emerging market where things can change quickly. China is of no exception. The country has transformed and has been moving towards a more stabilized, consumption-driven growth model in recent years.
In light of the development of China, FTSE Russell conducted a consultation on its China A Share index offering last October to ensure that our China A products continue to meet the requirements of index users. Based on market feedback, a decision was made to enhance the methodology of FTSE China A50 Index, including this year’s two-step improvements in March and June 2022 reviews.
March 2022: applying 28% FOL instantly improve investibility and diversification
As more international investors pay attention to China, the user base of this popular FTSE Russell flagship has gradually and substantially shifted towards international investors over the years from the original intent of serving China domestic clients at launch in 2003.
To improve the index’s investibility and tradability by an international investor, it became apparent of a need to bake in the foreign ownership limit into the index design. The decision of updating the FTSE China A50 Index and having its constituents to be subject to foreign ownership at 28% starting from the March 2022 review was a significant move for market participants.
The application of FOL also led to an important benefit in terms of industry diversification in the FTSE China A50 Index.
Given the nature of the China A-Share market – where large banks and financial services companies dominate – the Financials industry has always held the heaviest weight. However, the Financials industry weight has actually been falling over the past years, as China's economy develops and the non-financials types of companies gain in size. Consumers, Health Care, and Technology industries particularly gained exposure.
However, given there are only 50 constituents in the FTSE China A50 Index, even though the index industry exposure evolves similarly to the broader A Share market, the exposure in Financials especially stands out.
Additionally, the shares of large banks and financial services companies in China are liquid and typically process higher investability vs. the 28% foreign ownership limit. As a result these large financials companies together contribute to a heavyweight in the Financials industry.
By placing the 28% foreign ownership limit, Financials weight immediately dropped to 27% from 38% – representing a whole 11% weight reduction!
This 11% weight drop in financials was then spread to other industries, making the FTSE China A50 Index more diversified. Particularly, the weights in industrials, health care, and consumer discretionary, saw a meaningful increase post review – which is in line with where China is focusing to propel its growth. Noteworthy is that the Financials industry is now at a comparable weight to the consumer staples industry.
June 2022: screening with Northbound Stock Connect eligibility
The QFII, RQFII and Stock Connect schemes that provide international investors with much needed access to China's domestic assets have gone through a range of enhancements since their debuts. It is not unreasonable to believe the now-unified QFII/RQFII (the “QFIs”) and Stock Connect may eventually converge, making the accessibility fungible between the two schemes. But for now, we see Stock Connect continues to be the preferred route by international investors.
The FTSE China A50 Index currently consists of A Shares that are available to domestic investors as well as international investors via the QFIs and Stock Connect programs. Considering the popularity of the benchmark and the inability of smaller international investors to access via the QFIs, it was decided that all FTSE China A50 constituents shall be subject to Northbound Stock Connect eligibility starting from June 2022 index review.
This move essentially will transform FTSE China A50 Index to an important tradable subset of the FTSE Global Equity Index Series. It is our hope that the evolution could further boost adaptation by international investors, by opening doors to smaller international investors without access to QFIs, as well as by improving an investment manager’s trading process by removing pre-funding operational hurdles in the QFIs scheme.
Evolution while maintaining a transparent methodology and an established ecosystem
While the FTSE China A50 is evolving for the better, the index continues to be based upon a transparent, well-understood free-float market cap adjusted index methodology, which continues to lead to a highly predictable index composition.
Meanwhile, China A Share investors can easily gain to the market and manage risk via the rich financial ecosystem consisting of widely used index-linked financial products and index derivatives based on the FTSE China A50 Index.
Pairing with the evolutions happening this year (and more to come), the FTSE China A50 Index will only transform to be more attractive and user-friendly for today’s investor.
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