MSCI to add mainland China shares to key benchmark

By Dion Rabouin

NEW YORK (Reuters) - U.S. index provider MSCI said on Tuesday it will add mainland Chinese stocks to one of its key benchmarks, but shocked many emerging market investors by failing to upgrade Argentina from the frontier market category where it has languished in recent years.

MSCI also said it would consult on adding Saudi Arabia to the benchmark and that Nigeria will remain a frontier market, awaiting further review on a possible downgrade to "standalone" status.

The full inclusion of domestic Chinese stocks in the widely tracked MSCI Emerging Markets Index <.MSCIEF> could pull more than $400 billion of funds from asset managers, pension funds and insurers into mainland China's equity markets over the next decade, according to analysts.

"Inclusion in the MSCI index family is a strong signal of greater market openness, and it will undoubtedly help the A-Share market to attract broader attention and participation of international investors," said Yannan Chenye, head of china equities research and portfolio manager at Harvest Global Investments in Hong Kong.

"This sharp increase in international market participants will substantially change fundamental features of the market."

The decision not to reclassify Argentina to an emerging market came as a surprise to investors. The country's shares will remain in the smaller frontier markets index, where it has been since 2009.

"We think Argentina could be initially hit, because the expectation for the inclusion was pretty high," said Lucy Qiu, emerging market analyst at UBS Wealth Management in New York. "We still think this could be a long term positive story but hold tight for temporary weakness."

Saudi Arabia in April moved to a more favourable settlement cycle for institutional investors, which had been identified as the last major impediment for official watch-list inclusion.

If it were added to the emerging markets index in 2018, Acadian Asset Management estimates the country could end up with a 2 percent to 3 percent weighting or up to 5 percent if it moves forward with plans to float state oil giant Saudi Aramco.

"In our view this is an endorsement of the positive Saudi Arabian stock market reforms," said Emily Fletcher, director and portfolio manager at BlackRock Inc in London.

MSCI's decision to give so-called Chinese "A" share the green light - after having rejected them for three years - represents a symbolic victory for the Chinese government, which has been working steadily over the past few years to open up its capital markets.

"This decision has broad support from international institutional investors with whom MSCI consulted, primarily as a result of the positive impact on the accessibility of the China A market," MSCI said in a statement.

The company has been in discussions with Chinese regulators and global investors for nearly four years on whether to add yuan-denominated shares listed in Shanghai and Shenzhen to the benchmark. It had left them out because of concerns over restricted access to China's equity markets.

In March, however, MSCI moved to relax its investment criteria by cutting the number of stocks to 169 from 448 in a bid to address curbs on repatriating capital from China and concerns over the country's high number of suspended stocks.

The revised proposal helped address these issues because the 169 stocks can be easily accessed by foreigners through the "Stock Connect" link launched in 2014 and significantly expanded in December.

MSCI said it planned to add the 222 stocks - which will have an initial weighting in the index of just 0.73 percent - and will begin a review of the "A" shares and include them in provisional indexes beginning in August.

"Over the long term, assuming further liberalisation and regulatory reform of the mainland stock markets, the depth of China's A-share market could mean China gains substantial weight within those broader indices," said Nick Beecroft, portfolio specialist of Asian equity at T. Rowe Price in Hong Kong.

Nigeria's shares will remain in the frontier index until at least November 2017, when MSCI will again address the country's access to markets.

(Reporting by Dion Rabouin and Richard Leong in New York, Additional reporting by Michelle Price in Hong Kong, Saqib Ahmed in New York and Sujata Rao in London; Editing by Dan Grebler)