China A-shares and Global Indices. Adapting the Benchmark for International Market Participants

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1 China A-shares and Global Indices Adapting the Benchmark for International Market Participants Page 1

2 Overview China equities represent an important part of the global equity investment landscape Based on mainly HK-listed equities is currently the 9th largest equity market Whilst China A-shares represent a significant proportion of the Chinese equity market, foreign investment is restricted to those with QFII allocation There are a number of key challenges that need to be overcome before China A shares can be included in FTSE global benchmark indices Page 2

3 ETFs & China share classes Historically investors have turned to ETFs for liquidity and market access Initial China ETFs focused on HK-listed large cap equities Current FTSE China All Cap index equity market representation consist of: H-shares: 56%, Hong Kong listed, incorporated in China Red Chips: 24%, incorporated outside of mainland China, substantially owned by government related entities P Chips: 17% incorporated outside of mainland China; listed in Hong Kong, controlled by mainland Chinese individuals with an establishment and origin in mainland China B-shares: 3%, incorporated in mainland China, listed on either the Shanghai or Shenzhen stock exchanges. China A-shares accessible through ETFs have been popular, despite not being part of any current global benchmarks Page 3

4 Growth of the A-share market A-shares, companies incorporated in mainland China, with listings on either the Shanghai or Shenzhen stock exchange The current A-share market comprises over 2,100 companies Number of A-share listings has grown by 74%, over the past ten years Main growth in Shenzhen Stock Exchange, new listings more than doubled from 492 to 1171 Over the same period, Shanghai Stock Exchange listings have grown by 31% Total trading activity has risen from less than $400bn to $4.6trn Total full market capitalisation of A-shares of $3.6trn Page 4

5 QFII Status, changes and recent trends Foreign access to the A-share market remains tightly controlled under the Qualified Foreign Institutional Investor (QFII) scheme Initially put in place in 2002, regulated through the China Securities Regulatory Commission (CSRC), which allocated licenses based on specific criteria Quota allocation controlled by State Administration of Foreign Exchange (SAFE) Market participation expanded through Renminbi QFII scheme (RQFII) Allows institutional investors with offshore Renminbi to invest back in the domestic market Typically this has been used to create offshore A-share and bond funds Page 5

6 QFII Status, changes and recent trends cont Foreign ownership restrictions lifted from 20% to 30% Current QFII; 150 of the 229 firms asset managers In 2012 of the 71 new firms awarded QFII, 60 were asset managers Page 6

7 Trends in ETF assets and A-share derivatives QFII allocations at the end of July 2013 close to $50bn RQFII allocations similarly sized at RMB 270bn ($43.5bn) Singapore listed FTSE China A50 futures, following CFTC approval, volumes picked up; end of 2012 open interest over $2bn Three fold jump in open interest in options on the isharesa50 ETF All the trends in these access products are interesting given the current lack of A-share representation in benchmark indices China A-shares need to pass the FTSE Country Classification Quality of Markets tests Page 7

8 FTSE Country Classification Framework Any change to the status of China A shares and subsequent inclusion in FTSE s Global Benchmarks will be dependent on Country Classification Four main areas: Market and Regulatory Environment covering investor protection, regulatory bodies, treatment of minority shareholders, free flow of capital Custody and Settlement assesses services and efficiency investors are like to experience and trading, stock lending, settlement and clearing Dealing Landscape considers depth of broker services, liquidity, transaction costs and market transparency Derivatives Market checks for an efficient derivatives market (only required for developed markets) Page 8

9 FTSE Country Classification Framework cont Key focus is on what criteria would need to change for China A to be classified as either an Advanced or Secondary Emerging market Notable progress in many aspects Key area preventing a change in classification is the restriction on capital flows Limitations in terms of timing remains a critical issue for international investors Page 9

10 The impact of China A shares on FTSE China FTSE has considered four scenarios for the FTSE China All Cap Index From a global benchmark perspective China A shares would change the nature of the region FTSE Asia Pacific ex Japan Potentially reconsider the review process with China on a stand alone basis Dedicated All China indices Page 10

11 The Impact of adding China A-shares Page 11

12 The impact of China A shares on Global Indices All analysis is dependent on China A being classified as eligible for the FTSE All- World Index The four scenarios naturally yield significantly different results Adding the current QFII quota of $50bn would have only a limited impact on the weight of China in global indices An expansion to $500bn would be more meaningful with the weight in the FTSE Emerging Index rising from just under 20% to close to 31% In the FTSE All-World Index China s weight would rise from 2.1% to 3.7% China would move from its current status of 9th largest market to 5th largest Page 12

13 The A-share market and China s position in global equity markets Source: FTSE Page 13

14 Solutions for current QFII holders These potential weights of China in global indices suggests that any change will be substantial FTSE will consider provisional indices to help investors manage the change For investors with a current QFII quota FTSE can provide custom indices based on the desired QFII allocation in a representative benchmark One example shown is based on having a 2% allocation to the FTSE China A50 index in the context of the FTSE Asia Pacific index Other pro-forma custom indices can be built based on individual QFII allocations, which may be variable over time As the leading international provider of equity indices focussed on the Chinese market FTSE is well placed to deliver appropriate benchmark indices Page 14

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