A share market after MSCI inclusion

A share market after MSCI inclusion Mar. 2018 Li Chen +86 10 66538641 chenli@csfounder.com Mar 2018 1

1: A-share Inclusion in MSCI indexes MSCI will include 231 China large cap A shares in the MSCI Emerging Markets Index using a twostep inclusion process beginning June 2018. An Index Inclusion Factor (IIF) of 2.5% and 5% will be applied to the FIF-adjusted market capitalisation of China A shares in the pro-forma MSCI China Index in June and August, respectively. Current Aug 2018 (Inclusion factor=5%) Weight # of Securities Weight # of securities MSCI China 152 383 A shares - 0 2.61% 231 MSCI EM 846 1,077 A shares - 0 0.82% 231 MSCI Asia ex-japan 646 877 A shares - 0 0.96% 231 2

2.1: Fund inflow into the A-share market We estimate $14.8 bn fund flow into the A-share market by August inclusion The most heavily weighted stocks in the provisional index Moutai, Ping An, China Merchant Bank, Industrial Bank, ICBC, etc. will receive the largest fund flows Table: Top 20 stocks receiving the largest fund flows Security Ticker Security Name Index weight Fund flow into the stock (bn RMB) 6M average daily turnover (bn RMB) Days to trade 600519 CH Equity KWEICHOW MOUTAI A 0.04% 5.38 3.04 1.8 601318 CH Equity PING AN INS A 0.03% 4.84 6.36 0.8 600036 CH Equity CHINA MERCH BK 0.03% 4.19 1.78 2.4 601166 CH Equity INDUSTRIAL BANK A 0.02% 2.48 2.13 1.2 601398 CH Equity ICBC A 0.02% 2.41 1.62 1.5 600000 CH Equity SHANGHAI PUDONG 0.02% 2.37 0.78 3.0 000333 CH Equity MIDEA GROUP CO A 0.01% 2.16 1.73 1.2 002415 CH Equity HANGZHOU HIKVIS A 0.01% 2.10 1.36 1.6 000002 CH Equity CHINA VANKE CO A 0.01% 2.01 1.59 1.3 601668 CH Equity CHINA STATE CON A 0.01% 1.87 2.29 0.8 601328 CH Equity BANK OF COMMU A 0.01% 1.76 0.90 2.0 601766 CH Equity CRRC CORP A 0.01% 1.73 1.42 1.2 000858 CH Equity WULIANGYE YIBIN A 0.01% 1.69 2.15 0.8 601601 CH Equity CHINA PACIFIC A 0.01% 1.68 1.06 1.6 600016 CH Equity CHINA MINSHENG A 0.01% 1.67 0.93 1.8 600104 CH Equity SAIC MOTOR CORP A 0.01% 1.66 0.86 1.9 601288 CH Equity AGRI BANK OF CN A 0.01% 1.64 1.45 1.1 600900 CH Equity CHINA YANGTZE 0.01% 1.49 0.36 4.1 601988 CH Equity BANK OF CHINA A 0.01% 1.41 0.92 1.5 000001 CH Equity PING AN BANK CO A 0.01% 1.39 1.84 0.8 3

2.2: Some stocks could benefit in the short term The stocks with a higher ratio of potential fund flow to average daily turnover may be shortterm beneficiaries, especially those stocks in which foreign investors hold very small number of positions. Table: Top 20 stocks with the highest fund flow/daily turnover Security Ticker Security Name Index weight Fund flow into the stock (bn RMB) 6M average daily turnover (bn RMB) Days to trade 000046 CH Equity OCEANWIDE HLDGS 0.00% 0.21 0.03 8.1 603288 CH Equity FOSHAN HAITIAN 0.00% 0.73 0.14 5.3 600900 CH Equity CHINA YANGTZE 0.01% 1.49 0.36 4.1 000166 CH Equity SHENWAN HONGY 0.00% 0.61 0.19 3.3 600027 CH Equity HUADIAN POWER 0.00% 0.19 0.06 3.2 000027 CH Equity SHENZHEN ENERGY 0.00% 0.12 0.04 3.1 600023 CH Equity ZHEJIANG ZHENENG 0.00% 0.34 0.11 3.1 600000 CH Equity SHANGHAI PUDONG 0.02% 2.37 0.78 3.0 002411 CH Equity JIANGSU BICON 0.00% 0.16 0.06 3.0 000883 CH Equity HUBEI ENERGY 0.00% 0.13 0.04 2.9 600998 CH Equity JOINTOWN PHARMA 0.00% 0.19 0.07 2.8 601169 CH Equity BANK OF BEIJING 0.01% 1.00 0.39 2.6 600642 CH Equity SHENERGY CO 0.00% 0.17 0.07 2.5 601390 CH Equity CHINA RAIL GRP 0.01% 1.02 0.41 2.5 600221 CH Equity HAINAN AIRLINES 0.00% 0.33 0.14 2.4 600663 CH Equity SHANGHAI LUJIAZ 0.00% 0.20 0.08 2.4 601985 CH Equity CHINA NATL NUCL 0.00% 0.61 0.25 2.4 600011 CH Equity HUANENG POWER 0.00% 0.19 0.08 2.4 600036 CH Equity CHINA MERCH BK 0.03% 4.19 1.78 2.4 600637 CH Equity ORIENTAL PEARL 0.00% 0.26 0.11 2.3 4

3.1: Overseas investments through QFII, RQFII and stock connect keep rising Stock connect, QFIIs and RQFIIs are three channels for foreign investors to buy A-share stocks Overseas investment in the A-share market was approximately Rmb448 bn as of 3Q 2017, constituting 1% of A-share s floating market cap 1.1% 500 1.0% 450 0.9% 400 0.8% 0.7% 0.6% 0.5% 0.4% 350 300 250 200 150 100 0.3% 50 0.2% Q1 2013 Q2 2013 Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015 Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017 - Overseas Investment (bn RMB) Overseas holdings % of A-share floating market cap 5

3.2: QFII and RQFII are open to licensed investors QFIIs and RQFIIs are open to licensed investors, allowing investors to invest in all the A-share stocks and participate in IPO subscriptions Ticker Name Ranked by market cap held by QFII (Rmb mn) 002008.SZ Han's Laser Technology Co., Ltd 1,219.7 81.0 313.1 300180.SZ Huafon Microfibr 5.3 1.6 3.7 Data as of 07-Feb-2018 600779.SS SCSF 1,218.6 553.6 468.4 000613.SZ Dadonghai 4.9-4.9 Ticker Name Ranked by as % of total free-float stocks 3Q17 Changes 2Q17 3Q17 Changes 2Q17 601169.SS BJ Bank 18,571.9 (452.3) 19,024.1 603233.SS Dashenlin 34.1 600519.SS Kweichow Moutai Co., Ltd 13,546.0 224.8 11,184.4 601009.SS Bank of Nanjing 15.7 (0.2) 15.9 002142.SZ Bank of Ningbo 10,891.0 644.5 10,246.4 002142.SZ Bank of Ningbo 15.3 (0.0) 15.4 601009.SS Bank of Nanjing 10,028.7 (272.2) 10,300.9 601169.SS BJ Bank 13.6 (0.0) 13.6 000333.SZ Midea Group Co Ltd 8,235.2 352.6 7,882.6 002173.SZ Innovation Medic 8.4 1.5 6.9 000858.SZ Wuliangye Yibin Co., Ltd 4,654.3 (74.9) 3,888.2 002439.SZ Venustech 8.2 0.0 8.2 002415.SZ 000651.SZ 600276.SS 600009.SS 002304.SZ Hangzhou Hikvision Digital Technology Co., Ltd. Gree Electric Appliances Inc of Zhuhai Jiangsu Hengrui Medicine Co. Ltd Shanghai International Airport Co Jiangsu Yanghe Brewery Jointstock Co., Ltd 3,556.8 (470.4) 4,027.3 603866.SS Toly Bread 7.6 2.1 5.5 3,472.3 (165.0) 2,077.3 600533.SS Chixia Dev 7.3 1.6 3.3 2,692.5 1,018.6 1,673.9 002032.SZ Supor 7.1 0.1 7.0 2,592.3 19.9 2,136.4 000089.SZ Shenzhen Airport Co. 6.8 1.9 3.3 2,493.1 194.0 1,180.6 300676.SZ BGI Genomics 6.6 600104.SS SAIC Motor Corp Ltd 2,168.3 67.6 2,100.7 600009.SS Shanghai International Airport 6.2 (0.0) 5.2 600585.SS Anhui Conch Cement Co. Ltd. 1,905.1 234.0 1,671.0 002186.SZ QUANJUDE 6.2 (0.0) 0.3 601888.SS China Intl Travel Service 1,498.7 147.7 951.5 600779.SS SCSF 6.0 1.1 3.9 002032.SZ Supor 1,468.0 (104.0) 1,572.0 002831.SZ Yuto Packaging 5.9 002508.SZ Hangzhou Robam Appliances Co Ltd 1,238.8 169.9 1,068.9 000796.SZ Hna-Caissa 5.4 000089.SZ Shenzhen Airport Co. 1,208.7 290.8 634.4 300166.SZ BONC 4.6 0.2 2.2 600690.SS Qingdao Haier Co., Ltd. 1,164.8 1.4 1,163.4 002120.SZ YUNDA Corp. 4.4 (0.0) 4.4 6

3.3: Stock connect, a more flexible channel Compared with the traditional channels such as QFIIs and RQFIIs, stock connect is more flexible in that it allows all foreign investors to trade A-shares on a daily basis without a pre-approved quota. The capital mobility is higher through the Connect, because it sets no lock-in period or other restrictions, other than a daily quota limit. Currently, the investment made through the Connect has reached Rmb315 bn cumulatively. Table: Northbound investors' top 20 largest holdings Ticker Security Name Market Cap Held by northbound investors (bn RMB) As of floating market cap (%) 600519.SS Kweichow Moutai 50 5.6 002415.SZ Hikvision 38 10.7 000333.SZ Midea 35 9.8 601318.SS Ping An (A) 27 3.7 000651.SZ Gree 26 8.6 600276.SS Hengrui Medicine 25 13.0 600887.SS Yili 18 9.5 600900.SS Yangtze Power 18 9.5 600009.SS SHIA 16 32.0 600036.SS CMB (A) 10 1.6 600104.SS SAIC 10 2.6 601888.SS CITS 9 9.8 600690.SS QingDao Haier 9 7.7 000858.SZ Wuliangye 9 3.3 601901.SS FOUNDER SECURITI ORD A 8 14.6 002304.SZ Yanghe Brewery 8 4.0 600660.SS Fuyao Glass (A) 7 Data as of 07-Feb-2018 13.0 603288.SS Haitian Flavouring 7 4.8 000538.SZ YNBY 6 6.6 600066.SS Yutong Bus 6 14.2 7

2013-01 2013-04 2013-07 2013-10 2014-01 2014-04 2014-07 2014-10 2015-01 2015-04 2015-07 2015-10 2016-01 2016-04 2016-07 2016-10 2017-01 2017-04 2017-07 2017-10 2011-12 2012-04 2012-08 2012-12 2013-04 2013-08 2013-12 2014-04 2014-08 2014-12 2015-04 2015-08 2015-12 2016-04 2016-08 2016-12 2017-04 2017-08 2017-12 4.1: It may 5-7 years for full inclusion of A-shares According to the inclusion history of Taiwan and Korea, it takes several years from initial inclusion to full inclusion: six years for Taiwan and nine years for South Korea, respectively. The timeline may be faster for A-share due to: (1) Capital market has made a progress of opening up; SAFE-approved QFII, RQFII quota keeps expanding at a steady pace Obstacles need to be addressed before full-inclusion Changes or improvement progress (1) 20% monthly repatriation limit for QFIIs Unchanged. (2) Trading suspension treatment (3) Pre-approval requirements by the local exchanges on launching financial products (i) The implementation of new trading suspension policies by local exchanges has brought the number of voluntary trading suspensions back to pre-crisis level. However, the number of trading suspensions in the China A-shares market remains by far the highest in the world. (ii) The CSRC has guided that suspension period for individual stocks should be less than 3 months. MSCI is in discussions with China exchanges in an effort to reach a resolution on the removal of pre-approval requirements on new and pre-existing financial products linked to China A shares. Table: SAFE-approved QFII quota Table: SAFE-approved RQFII quota 120 3.0 620 605 40.0 100 97 2.5 520 35.0 80 60 40 20 0 2.0 1.5 1.0 0.5 0.0-0.5 420 320 220 120 20-80 30.0 25.0 20.0 15.0 10.0 5.0 0.0 MoM Chg (RHS, US $bn) QFII quota (US $bn) MoM Chg (RHS, US $bn) RQFII quota (US $bn) 8

4.2: Full inclusion in A-share might be faster than in Korea, Taiwan (2) RMB stabilisation enhanced investor interest in the A-share market 7.2 7 6.8 6.6 6.4 6.2 6 5.8 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 USD/CNY 9

4.3: Forecasted A-share inclusion timeline Table: Taiwan, Korea inclusion timeline Jan-92 Sep-96 Aug-98 Korea 20% 50% 100% Sep-96 May-00 Nov-00 Dec-01 Taiwan 50% 65% 80% 100% Table: Estimated A-share inclusion timeline 2018 2019 2020 2022 2023 2024 China 5% 20% 30% 50% 80% 100% Weight in EM index 0.8% 3.2% 4.8% 8.0% 12.8% 16.0% Estimated fund flow (bn USD) 15 60 90 150 240 300 10

4.4: Larger fund flow into A-share expected after full inclusion Although MSCI inclusion may have a limited funds flow impact initially, after using a 100% inclusion factor, the weight of A-share stocks in the MSCI EM index will become 16%, which implies US$300 bn funds inflow to A-shares. Figure: Approximate weight in each index after future full inclusion 11

5: Sectors in A-share with lower valuation, higher ROE, and more large-cap quality stocks There are more quality companies of over 5bn market cap in consumers, TMT and healthcare in the A-share market than Hong Kong market. In the longer term, as the A-share market becomes more open and investible, international investors' allocation will keep growing. Active investors may seek growth and performance in these sectors. It has been proven that in these three sectors have been favourites of overseas investors (by way of QFII/RQFII and Connect) over the past years. Many of the quality stocks are very competitive compared with their global peers. Table: Sectors with lower P/E in A than H Sectors with lower PE A share PE H share PE Restaurants & tourism 33 54 Household appliances 21 36 Textile & garments 25 28 Food & beverages 33 35 Agriculture & fishing 27 40 Banks 8 9 Information technology 43 58 Table: Sectors with higher ROE in A than H Sectors with higher ROE A share ROE H share ROE Non-ferrous metal 3.0 2.6 Steel 3.9 3.6 Basic chemical 9.3-6.4 Construction 4.4 4.3 Power equipment 3.4 3.4 National defense 1.7 1.5 Home appliance 8.6 5.3 Food & beverages 9.4 5.1 Banking 7.6 7.0 Transporation 4.7 4.3 Media 5.0 3.2 12

5.1 Crowded or not? Table: Top ten companies held by northbound investors Security Ticker Security Name Market cap held by northbound investors (bn RMB) As of floating A Share market cap (%) 600519.SS Kweichow Moutai Co., Ltd 56 5.9 002415.SZ Hangzhou Hikvision Digital Technology Co., Ltd. 43 10.9 000333.SZ Midea Group Co Ltd 38 9.8 600276.SS Jiangsu Hengrui Medicine Co. Ltd 33 13.6 601318.SS Ping An 32 3.9 000651.SS Gree Electric Appliances Inc of Zhuhai 27 8.3 600900.SS China Yangtze Power Co Ltd 19 9.9 600009.SS Shanghai International Airport Co 18 32.7 600887.SS Inner Mongolia Yili Industrial Group 17 9.0 600104.SS SAIC Motor Corp Ltd 11 2.6 Source: Wind, data as of 20-Mar 2018 13

5.2 Crowded or not? Consumer Table: China saving growth vs China income growth 40% 30% 20% 10% 0% Big four banks personal savings growth YoY Residents' disposable income growth YoY Table: Tier 3 cities housing prices vs consumer sectors revenue growth 25 20 15 10 5 0-5 -10 Department stores revenue growth YoY (% LHS) Dairy revenue growth YoY (% LHS) Tourism revenue growth YoY (% LHS) Tier 3 cities housing price YoY (% RHS) 8 6 4 2 0-2 -4-6 Source: Wind, data as of 20-Mar 2018 14

5.3 Crowded or not? Consumer Table: No. of trains run during New Year 9000 8000 7000 6000 5000 4912 5907 6801 7366 7814 4000 3000 2000 1000 0 2014 2015 2016 2017 2018 No. of trains during New Year Table: No. of passengers peak day (million person) Year 2014 2015 2016 2017 2018 Date 7th day of CNY 6th day of CNY 7th day of CNY 7th day of CNY 17th day of CNY No. of passenger (mn) 8.4 9.5 10.3 11.0 12.8 Source: Wind, data as of 20-Mar 2018 15

5.4 Crowded or not? Healthcare Table: Hengrui PE band 90 80 70 60 50 40 30 20 10 0 Hengrui TTM PE Hengrui TTM PE three years' average Source: Wind, data as of 20-Mar 2018 16