US stock index provider MSCI has agreed to include China's mainland domestic shares in its emerging markets index for the first time.

Image copyright Reuters

The move is a step forward for Beijing as it attempts to open up its financial markets and attract foreign capital.

China's inclusion had been rejected for the past three years, amid worries about regulation and accessibility for global investors.

MSCI is world's biggest stock index provider.

The shares of 222 Chinese companies, known as A-shares, will be added to the Emerging Markets Index, though they will make up barely 0.7% of the index's value.

Karishma Vaswani: China's MSCI inclusion is a game changer

How big a deal is this?

The MSCI Emerging Market Index currently has about $1.6 trillion tracking it.

This means those investors (mainly investment funds) will be obliged to have part of their investment in the A-shares of selected Chinese firms.

China's inclusion will have needed to support of many of these key investors.

The fact they've given the nod indicates they now feel the way Chinese markets are run and regulated has sufficiently improved.

"We view this announcement as an important milestone in the integration of China's equity markets with the rest of the world," said Jonathan Garner, chief Asia and emerging-market strategist at Morgan Stanley.

Is this the first time foreign investors will be able to trade in Chinese companies?

Far from it. There are already several ways to invest directly in Chinese firms.

Image copyright Getty Images

Many Chinese companies have a dual listing, meaning they appear on both the Shanghai and Hong Kong markets. The Bank of China is one high-profile example.

And you find Chinese firms listed on some foreign markets. US-traded Chinese businesses include the e-commerce giant Alibaba.

And since late last year, foreign investors in Hong Kong have been able to trade shares in about 900 firms in companies on the Shenzhen Stock Exchange and vice-versa following the official launch of the Shenzhen-Hong Kong trading link.

That link followed the launch of the Shanghai-Hong Kong Stock Connect in November 2014, which allowed international investors to trade in hundreds of Shanghai-listed A-shares as well as Hong Kong stocks.

How much foreign money is in China's markets?

China has the world's second biggest stock market and third biggest bond market.

However, less than 2% of Chinese shares and bonds are held by foreigners.

The Shanghai and Shenzhen initiatives mentioned above are one way Beijing has tried to make its markets more accessible to foreign money and, crucially, to build trust.

The schemes had been "a pivotal part " in the MSCI inclusion said HSBC's head of Asia Pacific equities, Rakesh Patel.

What has been holding Chinese markets back?

There are confidence issues China has had to overcome - and there is still a long way to go.

The boom-and-bust nature of the markets over the past few years, with some high-profile crashes, has not helped the market's image.

Nor has the ad hoc, and often heavy handed, government intervention.

Image copyright AFP

And there has also been the issue of individual stocks being suspended, often for long periods of time - though the frequency of this has been reduced said HSBCs Mr Patel.

"China has been given a big tick in the box from the international investment community and the MSCI," according to Sean Taylor, Asia Pacific chief investment officer at Deutsche Asset Management.

"And it might mean that over the next few years, they will accelerate reforms. It gives them the confidence to know that they are doing the right thing.

Ken Jarrett, president of the American Chamber of Commerce in Shanghai, said Tuesday's decision must be a catalyst for more change.

"We hope that the MSCI decision will spur domestic regulators to bring China's stock markets in line with global norms and make the regulatory environment more predictable, improve transparency in the stock market listing process, and bring stronger rule of law to the wider securities industry.

"This would mean not banning major stockholders from selling shares during periods of market turbulence, not suspending the trading of stocks outside the use of predetermined circuit breakers, and therefore not creating the conditions that lead to moral hazard."

Can we expect Chinese shares to rally?

Probably not for now.

China's stock market is worth about $6.9 trillion dollars.

And given Chinese shares will make up such a small part of the MSCI Emerging Market index there's a limit to how much foreign money will be attracted in.

Also, while the go-ahead has been given, its inclusion will not begin until May 2018.

"There is unlikely to be a significantly positive impact on A share index performance near term," said Morgan Stanley's Mr Garner.