By Dion Rabouin
NEW YORK (Reuters) - U.S. index provider MSCI said on Tuesday it would 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 investors about adding Saudi Arabia to the benchmark and that Nigeria would remain a frontier market, with the possibility of being downgraded 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.
BlackRock Inc
"We believe our clients will benefit from today's decision to bring Chinese equities into mainstream investment," said Ryan Stork, BlackRock's chairman for Asia-Pacific in Hong Kong and one of the company's most senior executives, in an emailed statement.
"BlackRock has continued to support all opening of investment in China's onshore capital markets for a number of years."
The decision not to reclassify Argentina as an emerging market surprised 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 estimated that the country could end up with a 2 to 3 percent weighting or up to 5 percent if it moves forward with plans to float state oil company 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 in London.
Nigeria's shares will remain in the frontier index until at least November, when MSCI will again address the country's access to markets.
MSCI's decision to give so-called Chinese "A" shares the green light - after having rejected them for three years - marks 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 relaxed 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 would have an initial weighting in the index of just 0.73 percent - and would begin a review of the "A" shares and include them in provisional indexes beginning in August.
Investors believe China could grow to account for as much as 40 percent of MSCI's emerging market index in the future. The A-share market, including shares from Shanghai and Shenzhen markets, is worth roughly $7.5 trillion, the world's largest after the New York Stock Exchange and Nasdaq.
"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.
Chinese regulators have been working in recent years to meet MSCI's demands that they free up repatriation of foreign capital, reduce the number and length of share suspensions and loosen other rules. But the country's reform agenda has stalled lately as the authorities have battled to prop up the flagging yuan through capital controls.
Futures for China's blue chip CSI300 index, the major Chinese mainland stock benchmark,
(Reporting by Dion Rabouin in New York, Additional reporting by Michelle Price in Hong Kong, Saqib Ahmed and Richard Leong in New York and Sujata Rao in London; Editing by Dan Grebler and Richard Chang)
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