* MSCI has slimmed down proposal to include 169 Connect
* Investors, sources see greater likelihood of inclusion in
* BlackRock says "supportive of" general benchmark inclusion
* Some investors still spooked by capital outflow curbs
HONG KONG, April 24 (Reuters) - The chances of MSCI Inc
adding China-listed shares to its global index have risen
significantly since it proposed to cut the number of companies
to include, investors say, but capital controls and market
access snags may still pose a hurdle.
New York-based index provider MSCI will announce in
June if it will add yuan-denominated Chinese shares, or A
shares, to its Emerging Markets Index, a move that could draw up
to $400 billion into China stocks over the next decade.
MSCI last year declined for the third time to include
mainland-traded shares to the benchmark, tracked by around $1.5
trillion in assets, saying more had to be done to open up the
country's tightly-controlled market.
The index provider has now narrowed the gap between China
and global asset managers by proposing a smaller slate of stocks
and confining them to large-cap companies accessible to foreign
investors via a trading link with Hong Kong.
"Certainly, in terms of the challenges China poses with
respect to equity market access, this proposal does go some way
to addressing those concerns," said David MacKenzie, head of
Asian Equity Management at Schroders. "I'd be very surprised if
they didn't push it through this year."
BlackRock - MSCI's largest client - said in a statement it
was "supportive of" China A-share inclusion in global benchmarks
but did not comment on the timeline or MSCI's new proposal.
MSCI said last June China needed to allow foreign investors
to freely repatriate capital under its cross-border Qualified
Foreign Institutional Investor (QFII) investment scheme.
It also wanted the country to scrap a rule requiring
foreigners seek regulatory approval before launching investment
products that include A shares, and said it wanted to see fewer
long-term share suspensions.
Chinese regulators and benchmark providers have been in
discussions for several years to smooth out market access
issues, but have reached a deadlock over the last remaining
hurdles, said two people briefed on the matter.
QUALITY OVER QUANTITY
One of the people said MSCI was working around these last
issues by reducing the proposed selection of 448 stocks to 169.
"This is a bit of negotiation with the investors on one side
telling MSCI what they want to see, and the Chinese regulators
on the other side saying this is what they can offer," said
Daniel Morris, senior investment strategist at BNP Paribas
"This latest proposal suggests MSCI is taking a quality over
quantity approach. This seems like a good start."
The China Securities Regulatory Commission did not respond
to a request for comment, while MSCI declined to comment.
MSCI will hold consultations with investors in the next few
weeks and may still struggle to convince many who remain wary of
Beijing's restrictions on capital outflows, some investors said.
"There is still a lot of pushback from investors due to
capital outflow restrictions, so I would say the chances of
global benchmark inclusion this year are still only around
50-50," one person closely involved in the discussions on
benchmark inclusion said.
Others pointed out that the Connect scheme continues to have
operational snags that prevent some investors from using it.
The smaller proposed number of stocks means the weighting of
A shares in the index would be just 0.5 percent if MSCI proceeds
in June, meaning around $12 billion would flow into Chinese
shares, Nomura analysts said. China's equities market is valued
at nearly $8 trillion.
"I do think this time round there is a greater likelihood of
inclusion but it is a small selection of stocks and the actual
investment amount is very small," said Yannan Chenye, portfolio
manager and head of China research at Chinese asset management
giant Harvest Global Investments.
"But inclusion would be very symbolic, meaning global
investors would have to look at the China market more closely."
(Editing by Jacqueline Wong)