MSCI Inc.’s decision to exclude China’s A shares from its global indices shows the nation must reduce trading restrictions to lure international investors to the biggest emerging economy.

    China’s quota system for overseas money managers, which limits holdings to less than 3 percent of the country’s US$3.3 trillion market capitalization, is the biggest hurdle for including China’s A shares in global funds, MSCI said yesterday after a yearlong consultation with investors. China’s rules against same-day trading, controls on using multiple brokers and uncertain tax laws also deter funds, MSCI said.

    The exclusion is a setback for Chinese policymakers seeking to boost inflows into one of the world’s worst-performing stock markets in the past five years, promote the yuan’s use in international trade and turn Shanghai into a global financial center.

    While the value of Chinese stocks has surged in the past decade as State-owned companies listed shares, efforts to modernize the market failed to keep pace, said Fraser Howie, a director at Newedge Singapore who wrote a book on the history of Chinese finance.

    “This is probably the last big, big market which is still remarkably restrictive and limited,” Howie, the co-author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise,” said before the MSCI decision. “There’s a lot of things that can be fixed. Whether or not it will happen I am not entirely sure.”

    China will expand programs that allow foreign investors to buy local shares and will scrap quotas when conditions allow, China’s central bank said in an annual report for 2013 posted on its website yesterday.

    Instead of including China’s A shares in the MSCI China Index and MSCI Emerging Markets Index from next year, the index provider will introduce by June 27 a China A International Index as a standalone benchmark gauge. MSCI will keep the shares under review over the next 12 months for potential inclusion.

    MSCI’s China proposal faced opposition from international money managers including Fidelity Worldwide Investment and Templeton Emerging Markets Group, who said in April that the plan is unworkable unless China removes the capital controls that limit access to local securities.

    “With quota constraints, investors still can’t freely buy and sell stocks,” said Ryan Tsai, an Asia equity strategist at Standard Chartered Plc.

    Under China’s existing rules, only overseas institutions that have been awarded licenses and quotas can invest in local securities. The combined approved quota is about US$94 billion.

    International money managers gave positive feedback on China’s plan to link exchanges in Shanghai and Hong Kong, according to MSCI, which said earlier it would contact between 2,000 and 3,000 global investors on its China proposal.

    The bourses agreed in April to allow as much as 23.5 billion yuan (US$3.8 billion) in daily trading, opening up the mainland market further to foreign investors while giving wealthy mainland investors a route to buy Hong Kong stocks. The pilot program is due to start around October.

    “Shanghai-Hong Kong connect will be a very important development,” Chia Chin-ping, a Hong Kong-based managing director at MSCI, said yesterday. “This scheme will lead fresh element into the discussion and at this stage it is on the positive side.”

    On top of barriers to accessing the Chinese stocks, MSCI highlighted investor concerns over the nation’s market structure and tax system. (SD-Agencies)