The country’s financial markets are poised to recover lost ground

After the downturn it suffered in the wake of Egypt’s 2011 revolution, the Egyptian Exchange (EGX) has staged an impressive recovery. Beginning in 2012, a run of positive growth extended into 2014 and the year saw the main index finally overtake the high point reached prior to the economic crisis. Having dealt effectively with the fallout from the broader economic uncertainty, the management of the EGX has now turned its attention to deepening the market and widening its investor base – two important objectives in the context of increasing competition for capital as the management of exchanges across the region endeavour to attract new investors.

Long Legacy

The origins of Egypt’s exchange lie in Alexandria, where during the second half of the 19th century the Café de l’Europe acted as an informal location for trading in cotton – the crop which at that time accounted for much of the nation’s wealth. By 1885 this activity had coalesced into the Alexandria Futures Market, while in Cairo a new centre of trading opened up, with 228 listed companies by 1907. A period of rapid growth followed, and by the outbreak the Second World War the combined Cairo and Alexandria Stock Exchange (CASE) was the fifth largest in the world. Under then-President Gamal Abdel Nasser’s policy, CASE’s development slowed down and it was not until the promulgation of the Capital Market Law of 1992, implemented during the Hosni Mubarak presidency, that the exchange began its second major phase of growth.

By 2000 over 1000 companies had listed on CASE’s main board, a rapid expansion that, although welcomed by the investment community, also gave rise to market volatility, insider trading and frequent violations of disclosure requirements. Reforms were clearly necessary, and over the following years the exchange focused on establishing a smaller number of high-quality listings and more sustainable growth of market capitalisation. In 2009 the CASE was rebranded as the EGX, and in April 2012 it moved the bulk of its operations to Smart Village, an information technology park located west of the capital, while retaining its building in the city centre. Today the EGX stands as one of the largest and most sophisticated capital markets in the MENA region and is a crucial engine of growth for Egypt’s economy.

Main Market

One legacy of the early rivalry of the Cairo and Alexandria markets is that today’s EGX is a multi-location platform with floors in both cities, which operate on a standard primary (new issue) and secondary (trading) basis. Both locations share the same trading, clearing and settlement mechanisms that have been operated by the private company Misr for Central Clearing Depository and Registry (MCDR) since the bourse moved away from physical stocks in 1996. The main shareholders of MCDR are the companies that have listed on it as well as a number of domestic banks. As of June 2014, 214 companies were listed on the exchange, which had a total market capitalisation of LE478bn ($67.4bn). Among these are regionally and internationally active firms that have assisted the EGX in attracting capital from the Gulf Cooperation Council (GCC) region and beyond, with the most actively traded stocks as of the first half of 2014 being Orascom Telecom Media and Technology Holding, Amer Group Holding, Egyptian for Tourism Resorts, Arabia Investments and the Palm Hills Development Company.

The relatively broad base of Egypt’s economy compared to some of its regional peers makes for a diverse exchange, with capital well distributed across its listings sectors. The largest of these is construction and materials, the companies listed within which accounted for 21.37% of total market capitalisation as of the close of 2013, followed by telecoms (15.7%), banking (14.3%) and financial services, excluding banking, (7.29%). Other significant sectors include real estate (7.09%), chemicals (6.38%), basic resources (5.93%), industrial goods, services and automobiles (5.06%), travel and leisure (4.81%), and food and beverage (4.67%). The smaller sectors that make up the rest of the market are health care and pharmaceuticals, oil and gas, personal and household products, retail, media, technology and utilities.

The NILEX

Since 2010 investors have also had the option to direct their capital to a range of small- and mid-cap firms that are listed on a separate board, the Nile Stock Exchange (NILEX). This sub-market is subject to the same trading rules and principles as the main market, although it differs in terms of the primary listing requirements, which have been adapted to suit the profiles of small and medium-sized enterprises (SMEs). The NILEX is open to companies from any country or industry sector with issued capital of less than LE50m ($7.1m), while the financial history requirement is limited to financial statements for one fiscal year preceding the listing application. As well as the lighter disclosure requirements, companies listing on the NILEX also benefit from lower annual listing fees, which stand at 0.5 per thousand of the capital with a minimum of LE500 ($71) and a maximum of LE30,000 ($4260) as of 2014.

As of August 2014, some 24 companies had listed on the new board, five of which had joined it in 2013. Building on this momentum and establishing the NILEX as a route to funding for Egypt’s large SME sector is on of the EGX’s main priorities (see analysis). For now, however, it accounts for only a small portion of total market capitalisation at around LE1bn ($142m) of LE478bn ($67.4bn) in June 2014.

Tracking The Markets

Market observers are able to track the performance of the EGX through a range of indices. The EGX 30 is the primary index, and since 2009 it has been formulated both in Egyptian pounds and US dollars to better facilitate comparison with other markets. The same year saw the creation of the EGX 70, which tracks the most active stocks outside of the EXG 30 in terms of market capitalisation and liquidity.

Other major indices include: the EGX 100; the EGX 20 Capped, in which the weighting of any single company is capped at 10%; the S&P/EGX ESG Index, which is a partnership with Standard & Poor’s (S&P) that tracks firms committed to environmental best practice and corporate governance; and the Dow Jones EGX Egypt Titans 20 Index, which is a partnership with Dow Jones that tracks the leading 20 stocks ranked by free-float market capitalisation, revenue and net income. In early 2014 the EGX introduced the Nile Index to boost interest in the NILEX. The new index follows similar a similar methodology to the EGX 30, with some small but significant differences.

The Debt Market

Operating alongside the sizeable equity market are the EGX’s primary and secondary debt markets. However, activity on the bond market is limited in scope and, despite the exchange’s technical platform for secondary trading, activity is presently confined to the Primary Dealers System (PDS). The PDS is linked electronically to all primary dealers, comprising 15 banks, as well as custodians and MCDR, and follows an internationally standard pricing system using the clean price. Treasury bonds account for the vast majority of activity on the PDS: in 2013 some 27.4m government bonds worth LE28.8bn ($4.09bn) were traded on the system, compared to just over 183,000 worth LE18.6m ($2.64m) in corporate offerings.

Beyond the Treasury offerings, as of August 2014 some 19 government-issued housing bonds were listed on the exchange, as well as 49 development bonds. Domestic debt continues to be a useful source of funding for the government at a time when Egypt is effectively frozen out of international debt markets, although the profusion of it has led to some concern that it is crowding out lending to the private sector as banks have directed capital towards the easy yields offered by government paper (see Banking chapter). Stimulating the EGX’s relatively dormant bond market is one of the main pillars of an ambitious development strategy designed to increase the depth of the market (see analysis).

Sukuk

The EGX’s development strategy for its debt markets also includes the activation of new rules for sukuk, or sharia-compliant bonds, the basis of which has already been established by a sukuk law promulgated in May 2013. The recently passed law is a relatively flexible instrument, allowing for both asset-based and asset-backed sharia-compliant debt instruments, and extends the right to issue them to the government and Egyptian private companies. While the assets must be located within Egypt, the issuance can occur in the domestic or international market through offshore special purpose vehicles. The law also establishes a central sharia board to oversee compliance, while corporate issuers are required to maintain their own sharia boards to oversee the development of their debt instruments.

Disputes regarding sukuks, according to the new legislation, may be referred to the Egyptian commercial court or, when all parties are in agreement, an arbitration process. When promulgated, the law was widely welcomed by the financial services community as a measure that would increase Egypt’s ability to secure foreign investment, particularly from the GCC, where Islamic finance is rapidly becoming ubiquitous. Mohamed Younes, chairman at Concord International Investments Groups, told OBG, “Although Islamic banking is yet to reach a market penetration comparable to other countries in the region, the fact is that it is slowly growing.”

In early 2014 the market regulator announced its intention to replace the sukuk law with a new chapter in the securities law and some amendments. While the usefulness of sukuks as an instrument means that they will likely play a part in the debt market of the future, the finer details of the implementation process have yet to be revealed.

Performance

Since the 2011 revolution, which saw the EGX temporarily close and the main index plummet, the prevailing trend of the country’s stock exchange has been one of sustained recovery. Upward momentum started in 2012 when all of the indices showed significant gains, with the EGX 30 rising 51% year-on-year (y-o-y) and the EGX 70 and EGX 100 climbing by 15% and 24% y-o-y, respectively. The performance over 2013 was also a strong one, despite the challenges of a tumultuous backdrop and regional unrest, with the EGX 30 rising by 24%. Similarly, both the EGX 70 and the EGX 100 indices were up by 14%. Much of the growth came in the second part of the year, during which time the market at last overtook its pre-crisis high set in January 2011. This expansion took place across the market, with the exception of financial services, excluding banking, with food and beverage listings showing the greatest gain of the year with an 87% increase, followed by basic resources (45%), banking (33%) and chemicals (26%).

A mark of the upturn in market sentiment is the fact that the travel and leisure sector, the constituent companies of which were particularly affected by Egypt’s difficult political transition, recorded a gain of 14% for 2013. In terms of the market capitalisation of the main market, listed stocks posted a 14% increase in 2013, to finish the year at LE427bn ($60.63bn), compared to the LE376bn ($53.39bn) at the close of 2012. Also noteworthy is the performance of Egypt’s exchange in relation to its peers. For the second year in a row the EGX ranked second (after Greece) among all other developed and emerging markets in terms of percentage change, according to Morgan Stanley’s MSCI Price Index.

Looking Up

On a regional basis, the Reuters survey of Arab indices in 2013 shows Egypt shared in what was a good year for Middle Eastern exchanges, with its 24% gain comparable to that of Saudi Arabia (27%) and Kuwait (27%), and comfortably ahead of other regional peers such as Qatar (20%), Muscat (19%), Bahrain (17%) and Amman (6%).

The NILEX showed a strong performance for a second consecutive year in 2013. Trading value rose significantly on a y-o-y basis from LE247m ($35.07m) to LE748m ($106.22m), while trading volume rose from 81m securities in 2012 to 254m securities over the same period. Much of this expansion can be attributed to an increase the trading hours on the secondary board to match the main board, as well as the efforts of the EGX’s management to promote its new market domestically and internationally.

Importantly, the gains that were made in 2013 have been consolidated in 2014. In the first six months of the year, the EGX 30 posted an increase of 20.34%, while the EGX 70 and EGX 100 grew by 9.03% and 12.04%, respectively. Financial services, excluding the banking segment, was the only sector to show a contraction in 2013, but it then rebounded to become the strongest performer in the first half of 2014, with growth of 54%. The next in terms of sector gains was real estate (43.03%), followed by personal and household products (32.45%), and construction and materials (29.15%).

Investor Profile

In 2012 the amount of new investors registering on the exchange fell to 22,000, compared to 36,000 the previous year, though the number of newly coded institutions over the same period remained almost the same at 1458. While the EGX succeeded in attracting 16,000 new investors in 2013, this still fell short of the previous year’s total. This negative trend, the result of “economic uncertainty and misconception about the stock market”, according to the EGX, clearly runs counter to the bourse’s ambition to expand the investor base, and therefore represents a significant challenge. Currently, retail investors have a marginal majority when it comes to exchange activity, with individuals accounting for 51% of the volume traded in 2013, with institutions making up the remainder. The share of market activity claimed by individuals, which was as low as 41% in 2012, has risen in recent years. This shift towards a retail-dominated exchange brings with it concerns regarding market volatility.

International Partners

There has been an equally significant shift in the ratio of foreign to domestic investors, a useful indicator of market conditions, although in this case a more complex one. In the wake of the 2011 revolution, non-Arab foreign investors generated net outflows of LE4.2bn ($596.4m) in 2011, which only slowed marginally in 2012 to LE3.6bn ($511.2m).

Arab investors, meanwhile, followed a more positive trend, adding LE188m ($26.69m) to the value of the exchange in 2011 and LE1.6bn ($227.2m) in 2012. In 2013 non-Arab foreign investors continued to withdraw capital from the exchange, generating net outflows of LE2bn ($284m), while Arab investment remained almost static.

However, by 2014 signs of a welcome return of foreign interest in the exchange, both regional and global, began to emerge. According to data released by the EGX, in the first six months of the year Egyptians made up around 85.69% of the value traded on the exchange, while foreigners claimed the remaining 14.31%. Of these, non-Arab foreign investors were net buyers, adding LE328.37m ($46.63m) to the market, while Arab investors also bought heavily, adding LE2.5bn ($355m) to total capitalisation. In terms of geography, European investment has played a useful role in this positive turn, accounting for 43% of total foreign investment in 2013. Arab investments accounted for 30% of the foreign investment total, while 20% was derived from American and Canadian interests. At the national level, the UK is the single largest foreign investor, with around 32% of the total in 2013, followed by the US and Saudi Arabia with 19% and 14%, respectively.

Regulation

Attracting more institutional and foreign investors is a priority for both the exchange and its regulator. While the disruption of 2011 has made attaining this objective more challenging, the EGX is starting from a relatively strong position thanks to an ongoing process of regulatory reform.

Since 2009, the non-banking financial services sector has been overseen by the Egyptian Financial Supervisory Authority (EFSA), which has assumed the duties of the now rescinded Capital Markets Authority. Since its inception, the EFSA has continued to manage the process of market reform started by its predecessor, most notably in cooperating with the exchange on issues of corporate governance, disclosure and transparency.

The most visible effects of this process have been the reduction of listed companies on the exchange from 803 in 2004 to 212 in 2013 and a rise in the market’s value over the same period from LE172.86bn ($24.55bn) to LE427bn ($60.63bn) – a trend which illustrates the regulator’s emphasis on quality over quantity.

The outbreak of political unrest in 2011 diverted the EFSA’s attention away from long-term reforms to tackling short-term challenges. Much of its work in 2011 was directed to the alteration of market operations in order to safeguard the exchange, such as the temporary suspension of T+0 settlement. However, by the middle of 2012 the regulatory judged the macro-economic scenario sufficiently stabilised for it to gradually rescind these measures, which has allowed the EGX to return its attention to continuing to develop the exchange’s long-term ambitions.

Exchange Expansion

As soon as the EGX reopened for business after its closure in 2011, the bourse set about ensuring a fast recovery and establishing a platform from which this important component of the economy could expand. In the short term, it sought to enhance its global links by placing the EGX on important indices, such as the 2012 inclusion on the S&P/OIC COMCEC 40 Sharia Index, a joint index of the Organisation of Islamic Cooperation member states’ exchanges and S&P indices, as well as the FTSE ASEA Pan Africa Index, which tracks securities domiciled in 19 African countries.

The management of the EGX has also sought to raise the global profile of the exchange through technological innovation, such as its installation of the FIX HUB, which connects the EGX to 175 international markets via the Fidessa international linking network. Meanwhile, in the domestic market, the exchange continued to meet with local investor associations to strengthen cooperation and discuss ways in which the problems facing the market might be overcome. Of most interest to market observers, however, was the publication of a policy document that maps out the future development of the exchange. The “Egyptian Exchange Proposed Strategy 2013-2017” identifies several weaknesses, such as legislative rigidity, a dearth of market instruments, modest liquidity and a weak secondary bond market. The document envisages the tackling of these challenges across six major axes: developing the legislative infrastructure; enhancing the trading environment; reinforcing the EGX’s role in economic and social development; investing in technological infrastructure; raising social awareness; and reinforcing the EGX’s international position.

Crucially, this plan has been advanced beyond the drawing board and into implementation: 2013 has seen a number of steps taken towards the realisation of its objectives, including the drafting of a new capital markets law, eased regulations governing issues such as share splitting and the country’s first conference to focus on initial public offerings. This process of reform is ongoing and is central to the EGX’s efforts to widen the investor base and develop a more liquid market (see analysis).

Outlook

Despite the weaknesses identified in the exchange by the EGX as it went about formulating its development strategy, Egypt’s market is well positioned for growth. It is the only exchange licensed to practise securities trading in the most populous Arab country, it boasts a wide variety of sectors that reflect the underlying diversity of the national economy, and it possesses high-quality market infrastructure and a generally liberal trading regime. Moreover, its management and the regulator have demonstrated a willingness to identify problematic market issues and confront them. The EGX does face competition from surrounding markets and remains vulnerable to exogenous pressures, such as controls on the exchange rate or the free movement of capital. In terms of index growth, these external factors are likely to play the larger part in determining direction in the medium term. While ratings agencies take a more favourable view of the nation’s economic prospects, significant structural reforms are still necessary to stabilise Egypt’s economy in the longer term.

The EGX’s four-year development strategy might be ambitious, but the first year of its implementation shows that the bourse has the capacity to act with determination where it is required to do so. This capacity may be increased in the future should even just one of its stated goals be achieved. Buried in the strategy document is a statement of its desire to transform itself into a self-regulatory organisation. This model, by which an external regulator retains ultimate authority but the exchange regulates itself to a large extent, has been adopted in other jurisdictions, but would represent a major shift in Egypt. The EGX has proffered the idea as a means by which market efficiency and competitiveness might be enhanced. Should the idea be taken up, the EGX will have a much greater degree of independence in the future and the speed of its reforms will likely increase.