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As widely anticipated, MSCI (MSCI - Free Report) announced yesterday that it will include China A shares in the MSCI Emerging Markets Index and the MSCI ACWI Index, beginning June 2018. The MSCI indexes currently include Chinese stocks listed offshore but not those trading on the Shanghai and Shenzhen exchanges—known as A shares.

Well known Chinese tech giants like Tencent (TCEHY - Free Report) , Alibaba (BABA - Free Report) and Baidu (BIDU - Free Report) are listed in the US or Hong Kong and already included in the MSCI Emerging Markets Index, which has more than 27% exposure to such Chinese equities. (Read: Move Over FAANGs--China Tech Stocks and ETFs are the Hottest)

The move signifies China’s acceptance as a major investment destination in the world. While China has slowly opened its stock market—second largest in the world with about $ 7 trillion market capitalization---to foreign investors, big asset managers have mainly been concerned about lack of investor protection laws and capital controls. MSCI had rejected the proposal in the past three years mainly due to these concerns.

This year, MSCI had broad support from large institutional investors, thanks mainly to improved access to A-shares via the Stock Connect program. This program provides foreign investors access to stocks trading on the Shanghai and Shenzhen stock markets through Hong Kong.

Of total 3,162 companies listed in China, only 1,477 can be traded through the trading link.  MSCI currently plans to include 222 Large Cap stocks from these, representing approximately 0.73% of the MSCI Emerging Markets Index. Weighting of A shares in MSCI indexes would be increased gradually.

“When further alignment with international market accessibility standards occurs, sustained accessibility is proven within Stock Connect and international institutional investors gain further experience in the market, MSCI will reflect a higher representation of China A shares in the MSCI Emerging Markets Index.” (Read: Blue Chips to Soar Ahead? Buy These 5 ETFs)

Asset managers like pension funds and insurers that track MSCI indexes would have to include domestically traded Chinese stocks to their portfolios but inflows would be minor initially. It is estimated that the inclusion could lead global funds to buy about $17 to $18 billion of these stocks.

Over longer-term however, the impact would be much greater provided China further revamps its capital markets and improves corporate governance practices. HSBC estimates that if MSCI as well as FTSE fully include A-shares, approximately $500 billion could flow into these shares over the next five to 10 years.

As expected, China A shares ETFs were higher after the decision.  Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR - Free Report) , KraneShares Bosera MSCI China A ETF (KBA - Free Report) , VanEck Vectors ChinaAMC CSI 300 ETF (PEK - Free Report) and iShares MSCI China A ETF (CNYA) were up more than 1% today.

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