Hopes rise for China share inclusion as MSCI pitches compromise

Michelle Price

* MSCI has slimmed down proposal to include 169 Connect

stocks

* Investors, sources see greater likelihood of inclusion in

2017

* 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

Investment Partners.

"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)