HONG KONG (Reuters) - MSCI’s decision to add China-listed stocks to a key benchmark will give investors a stake in China’s growth, but the cost of such access will be exposure to persistently weak corporate governance in the country, investor activists and analysts said.
The U.S. index provider said on Wednesday it would add 222 China-listed large cap stocks to its Emerging Markets Index, tracked by around $1.6 trillion (1.26 trillion pounds) in assets.
The decision was hailed as a major endorsement of China’s reform agenda, but it also comes at a time of renewed concerns following a flurry of corporate scandals and a surge in public campaigns by activist investors alleging problems with fraud, financial engineering and market manipulation.
Given that the Beijing government is also stepping up its interference in corporate affairs by insisting that Communist Party committees be established at state firms, some governance activists are questioning MSCI’s decision.
“Is this the right time for global investors to have to be exposed to China? It’s hard to argue that the level of investor protection, regulatory consistency, and overall corporate governance in China is high enough,” said Jamie Allen, secretary general of the Asian Corporate Governance Association (ACGA).
China ranks ninth out of 11 Asian economies for corporate governance, according to the ACGA. Its overall scores have declined since 2014.
This stems largely from the authorities’ heavy-handed intervention during the 2015 market crash, when the government put a cap on share sales and allowed more than 50 percent of companies to suspend their shares. The ACGA also highlighted slow progress on reform of state firms, poor audits and disclosure, and low levels of management accountability.
“We continue to encounter managements of large A-share companies who have yet to appoint an investor relations officer and who see no reason for senior management to meet shareholders,” Gary Greenberg, head of emerging markets at Hermes Investment Management, said in a note to clients and media.
“Governance is often a challenge, as management may owe primary allegiance to municipal, provincial or national administrations,” said Greenberg, adding many of these issues should have been fixed by now.
Government interference at listed companies has grown after Beijing began imposing Communist Party committees at state firms. These committees have the power to overrule the board of directors, marking a “step backwards” for China corporate governance, said Allen.
Several such companies feature in MSCI’s selection after the index compiler added a surprise 53 extra stocks to its original list, many of them “old economy” companies in the troubled financial and industrials sector such as China Construction Bank and PetroChina.
Benchmark providers take into consideration the quality of regulation and supervision when deciding how to classify a country, but they do not screen individual companies for corporate governance issues when adding them to global benchmarks.
“These are purely quantitative indexes, where we take into consideration the size and liquidity of the stock, but not governance aspects,” Sebastien Lieblich, global head of index management research at MSCI, told reporters on Wednesday.
To be sure, the China Securities Regulation Commission (CSRC), the country’s markets regulator, has increased enforcement in the financial sector. The government is expected to update its 15-year-old corporate governance code this year.
CSRC vice-chairman Fang Xinghai also seemed to confirm a widely-held view that inclusion should promote better governance over the long-term when he pledged on Wednesday to continue with reforms and ensure “good” companies come to the market.
In the meantime, active investors that measure their performance against the EM index said the challenges of investing in China created ripe opportunities for those prepared to do their homework.
“It works both ways. All the problems that people complain about, including a lack of transparency and corporate governance, all create investment opportunities,” said Qi Wang, a former MSCI executive director and currently chief executive for asset manager MegaTrust Investments.
“Governance in Chinese companies is so varied, it creates alpha opportunities for those who can see through these issues.”
Reporting by Michelle Price; Editing by Sonya Hepinstall