How China Pressured MSCI to Add Its Market to Major Benchmark


The move raises questions about the independence of MSCI as the index giant wields increasing market power.

Last summer, the world’s largest index provider added stocks in China to one of its most prominent global benchmarks, leading billions of dollars to flow into Chinese shares and advancing China’s plans to draw more foreign investors to its markets.

The move by MSCI Inc. MSCI 1.52% came after it came under heavy pressure from the Chinese government, which tried to curtail the company’s business in the country, according to people familiar with the matter.

MSCI’s decision to include domestic Chinese stocks in its widely followed Emerging Markets Index was received unfavorably by some investors who were concerned about robustness and transparency of markets in the world’s second-largest economy.

Since the addition, Chinese stocks have stumbled, as has the global index. Yet business has boomed in China for MSCI and large global asset managers who supported its move. Regulators last year approved nine Chinese exchange-traded funds designed to track the performance of MSCI indexes, when just one existed previously.

The firm is now considering quadrupling China’s weighting in the emerging-markets index, which is tracked by close to $2 trillion in assets, and a decision is expected this month. Such an increase could bring another wave of foreign money to China’s $7 trillion stock market, which was one of the world’s worst performing last year.

The episode raises questions about the independence of MSCI at a time when the firm wields increasing market power, thanks in part to the rise of the “passive investing” phenomenon.

In 2018, more than $13.9 trillion in investment funds had stock portfolios that mimic the composition of MSCI indexes or used them as performance yardsticks, and nearly all investments by U.S. pension funds in global stocks are benchmarked against MSCI indexes.

MSCI, which has headquarters in New York, plays the role of a gatekeeper by influencing how investors around the world deploy their funds. It is also a for-profit company that collects fees from asset managers who use its indexes. MSCI’s own shares rose 11% over the past year, compared with a 5% decline in the S&P 500.

MSCI said all of its index decisions are made after consultations and feedback from a wide range of global market participants, including asset owners and managers, brokers, local authorities, regulators, stock exchanges and others. The consultation process is “transparent and objective to ensure MSCI indexes remain relevant and accurate investment decision support tools for its clients,” the firm said in a statement to the Journal.

The company cited safeguards including the fact that its index-inclusion process is handled by its editorial division, which is separate from its commercial operations, and based on criteria that it has made public.

“MSCI acts as a conduit between local policy decision makers and international institutional investors to constructively communicate market feedback; it takes this responsibility very seriously,” it said.

MSCI has long sought a larger role in China’s nascent asset-management industry. It first started operating in the country in 2005, but for years had a minuscule presence in the world’s most populous nation.

In 2013, MSCI started consulting market participants and regulators on whether stocks in China should be added to its emerging-markets index. At the time, China was starting to open up its financial sector to foreign firms, creating opportunities for global asset managers to gain a foothold in its economy.

There were many hurdles for China, mostly regarding foreign investors’ accessibility to Chinese stocks and limits on their ability to move money out of the market during downturns. Many Chinese companies have poor corporate governance, and investors also found problematic the capricious nature of trading suspensions in Chinese stocks that could last weeks or months.

MSCI’s discussions with several Chinese asset managers were abruptly curtailed in 2015 and 2016 after the firm didn’t add Chinese-listed stocks to the emerging-markets index following its midyear reviews, according to people close to or directly involved in the discussions. The Chinese firms communicated that they had been instructed by authorities to cut off negotiations with MSCI, the people said.

China’s two national stock exchanges also threatened to withdraw MSCI’s access to market pricing data, which the company provided to its customers all over the world, the people added. It was akin to “business blackmail,” said a person familiar with MSCI’s negotiations with Chinese regulatory authorities.

The Shanghai Stock Exchange declined to comment, and the Shenzhen Exchange and China’s securities regulator didn’t respond to requests for comment.

MSCI grades markets across 18 metrics that include capital-flow restrictions, short selling and the rights of foreign investors. Each is placed in one of three categories, ranging from “no issues” to “improvements needed.” China mostly scored in the last category, and between 2016 and 2017, none of the 18 metrics moved into a better category.

When MSCI decided in June 2017 to include more than 200 domestic Chinese stocks in the emerging-markets index, it said the number of suspended stocks in the market had declined. A three-year-old stock-trading link between Hong Kong and China had also made it easier for foreigners to access China’s markets.

In its statement to the Journal, MSCI said that its “ultimate decision” to include stocks in China “was only following positive feedback from the investment community about the market accessibility reforms.”

Many foreign investors still oppose the move. Of 155 international investors polled last year by the Asian Corporate Governance Association, nearly half felt MSCI was wrong to include domestic Chinese shares in the emerging-markets index, while only 27% said it was right to do so, the survey found.

Tim Atwill, head of investment strategy at Seattle-based asset-management firm Parametric, said the ability of investors to get money in and out of China’s stock market is still very uncertain during periods of extreme turmoil. “There’s an arms race going on with the index providers,” he said, referring to competition among index companies to increase their presence in China. “That can lead to all sorts of business pressures.”

By Mike Bird


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