MSCI rejects A-shares on capital repatriation and ETF pre-approval restrictions.

　　At 5am HKT today, MSCI Inc. decided to delay its inclusion of China A-shares but didnot "rule out a potential off-cycle announcement" ahead of June 2017. According toMSCI Inc., the outstanding hurdles are the "20% monthly repatriation limit" and "localexchanges' pre-approval restrictions on launching financial products" (referring mainlyto A-share-linked ETFs). MSCI will host a webinar at 2pm HKT today to reveal moredetails.

　　Near-term market responses to be negative as event-driven trades unwind.

　　We notice that many investors have already positioned themselves for the MSCIinclusion event in previous weeks (Figures 1-3) via the Stock Connect (US$2.7bnnorthbound trade), offshore A-share ETFs (US$0.8bn net subscription) and A-shareindex futures (US$4.1bn open interest by contract value). We believe the unwinding ofthese trades could add pressure to A-share performance in the short term.

　　Mid/long-term strategy to play on China's increasing presence in global market.

　　In the next two to three years, we still believe global investors will add their positions inChinese equities. We believe the delay of MSCI inclusion to some extent reflects theirlack of confidence on the policy transparency and implementation efficiency in China.

　　We think such concerns should gradually ease along with China's continuousliberalisation of its capital account. We believe global investors have already felt thegravitational importance of China A-shares of US$7tr market cap, and they will cherrypick primarily non-SOE stocks in the new economy sectors at this stage. Traceablegrowth, cash-generating capability, quality corporate governance and reasonablevaluations will be their key stock selection criteria, in our view.

　　Defensive names to return to centre stage.

　　Given the disappointment over the MSCI's decision and recent weakness inmacroeconomic indicators, we think investors' focus will return to H-share names ofdefensive nature - those with strong balance sheets, inexpensive valuations and highdividend yields. In the A-share market, we also prefer the relatively defensive sectorssuch as F&B, healthcare and home electrical appliances.