Will Egypt's new short-selling platform boost trading volume?

Short selling, by which investors borrow and sell shares to seek a margin on declining prices, has been on the development agenda of the Egyptian Exchange (EGX) for some time. The ability to short a stock brings a number of advantages for investors, which exchanges seeking to increase trading volumes are usually eager to highlight. Investors and portfolio managers frequently use the tool as a hedge to balance the risk associated with their long positions, either by shorting the same security or a related one. Investors may also use a short purely for purposes of speculation if they believe that a stock will decline in price.

Regulators across the MENA region, however, have taken a cautious approach to the concept. Short selling is considered an advanced strategy for experienced investors, and losses on a badly judged transaction are theoretically unlimited. Regional regulators have also shown a desire to protect retail investors from the increased costs and risk associated with the concept: as short selling is carried out using borrowed money, investors are exposed to interest rate charges and are liable for dividend payments on shorted stocks to be paid to the broker, as well as charges related to possible share splits, spin-offs and bonus share issues.

Careful Implementation

Efforts to establish a sustainable short-selling framework began in August 2017, with the announcement by the EGX and Misr for Central Clearing, Depository and Registry that the two planned to upgrade the bourse’s trading system to allow for more advanced trading processes, including short selling and derivatives trading. In May 2018 the Financial Regulatory Authority (FRA) approved a number of amendments to the Capital Markets Act to allow brokerages and securities firms to offer short selling.

Short selling was fully implemented in December 2019 and the initial framework was a conservative one. The EGX started with an approved list of 30 stocks, which it is to review every six months. To be included shares must be frequently traded, with at least 10% of registered brokerage firms trading the assets. Stocks may not be shorted unless they have at least 300m issued shares that account for a regulator-defined percentage of the market’s free float. Investors are also required to make a cash deposit equivalent to at least 50% of the value of the securities borrowed, while brokerages must deposit 20% of the value in fixed-income instruments while the position is open. Beltone Financial and HC Securities & Investment were the first brokerages to carry out short selling, but around 50 other firms have also been granted approval.

Slow Start

The initial uptake of the new short-selling function has been modest, with analysts telling local media in April 2020 that only a handful of short transactions were made during the first four months after its roll out. One explanation is that many investors and brokerages are unfamiliar with the new shorting system. Price may also be a factor: some brokers voiced concerns regarding the proposed LE153,000 ($9430) fee for use of the electronic platform that supports short selling. While EGX officials voiced willingness to find ways to reduce the cost of the software, the pricing issue may have disincentivised early uptake.

In recent months the authorities have moved to make the short-selling process more attractive to market participants. In February 2020 the FRA agreed to a proposal by the EGX to extend the period during which custodians can short shares from two to six months. The regulator also agreed to extend to six months the limit for traders to resolve their margin positions.

In the meantime, the short-selling framework continues to operate, with the EGX making its first revision to the approved list in February 2020. The new list contained an additional 25 securities that met the requirements for short selling, and among them were some of the country’s most prominent brands: EzzSteel, Palm Hills Developments, Telecom Egypt, Emaar Misr, Orascom Development Holding, Oriental Weavers, CI Capital and the EGX20 Index exchange-traded fund.