New reforms set to bolster Egyptian Exchange

The year 2016 was a difficult one for exchanges across the MENA region, thanks in large part to stubbornly low oil prices and political unrest. Egypt’s main index reflected the regional malaise for the first half of 2016, with a currency crisis and seemingly intractable fiscal deficit doing little to boost investor confidence. By the second half of the year, however, the index was climbing once again as negotiations regarding an IMF lending programme were nearing a successful conclusion. Moreover, beneath the headline index movements, the exchange authorities have had much to enthuse about over recent years, including the maintenance of a strong initial public offering (IPO) pipeline and a healthy growth in market capitalisation. While challenges abound, not least the direction of Egypt’s troubled economy over the coming years, the Egyptian Exchange (EGX) and its regulator continue to develop one of the region’s most important exchanges.

History

The exchange has a history of durability, having weathered many an economic storm. While the Great Depression did hamper some growth for Egyptian markets, by the outbreak the Second World War the combined Cairo and Alexandria Stock Exchange (CASE) was the fifth-largest in the world. By the year 2000 more than 1000 firms had listed on CASE’s main board, although that also led to a jump in volatility and poor governance, which prompted several years of clean-up. A process of market reform greatly reduced the number of listings and established a basis for a more sustainable growth of market capitalisation. In 2009 the CASE was rebranded as the EGX, and in April 2012 it moved its operations to Smart Village, a technology park located west of the capital, while retaining its landmark city centre building. Today, the EGX stands as one of the premier capital markets in the MENA region, and a crucial engine of growth for Egypt’s economy.

Bucking The Trend

While the country’s economy remains in a state of transition, as the government strives to address a stubborn fiscal deficit and implement an ambitious strategy of economic reform, the EGX has succeeded in retaining the interest of investors. By the end of the fourth quarter of 2016 market capitalisation reached LE601.49bn (equivalent to $31.9bn as of December 2016), a rise of LE110bn ($5.8bn) since mid-2013, when the current government took office. According to the most recent full-year figures for 2015 from the EGX, the bourse has played an important role in economic development, as more than 50 companies increased their capital by LE14bn ($742m) in 2015, 50% higher than the figure recorded in 2014 and more than the total capital increases recorded in 2014 and 2013 combined.

Main Market

Today, the EGX is a multi-location platform with floors in both Cairo and Alexandria, which operate on a standard primary (new issue) and secondary (trading) basis. Both locations also share the same trading, clearing and settlement mechanisms, which have been operated by the private company Misr for Central Clearing, Depository and Registry (MCDR) since the bourse moved from physical stocks in 1996. As of January 2017 some 223 companies were listed on the exchange, compared to 222 in 2016 and 214 in 2014, with a combined market capitalisation of LE612.8bn ($32.5bn) as of the start of 2017.

The market sectors of the EGX reflect the broad base of the Egyptian economy, with activities spread across banking, basic resources, chemicals, construction and materials, financial services, excluding banks, food and beverage, health care and pharmaceuticals, industrial goods, services and automobiles, oil and gas, personal and household products, real estate, retail, media, technology, telecommunications, travel and leisure, and utilities. Of these, the banking sector is the largest, accounting for 20% of total market capitalisation in 2015, followed by construction and materials (19%), and real estate (12%), according to EGX’s most recent annual report. The main board of the EGX is home to numerous regionally and internationally active firms that have succeeded in attracting capital from the Gulf and beyond, with the most actively traded stocks in the fourth quarter of 2016 being Orascom Telecom Media and Technology Holding, Amer Group Holding, Porto Group, Citadel Capital, Palm Hills Development Company and Global Telecom Holding.

The Nilex

One of the most significant infrastructural changes to the exchange over the past decade has been the introduction of a secondary board, the Nilex, for small- and mid-cap firms. Established in 2010, the Nilex shares the same basic trading rules and principles as the main market, but attempts to attract smaller businesses through less-demanding listing requirements. For example, companies listing on the Nilex are only required to produce financial statements for one fiscal year before the listing request and do not have exceed a minimum net profit level. Nilex listings also enjoy lighter disclosure rules with regard to their quarterly and semi-annual financials, which do not need to be submitted to the regulator and the exchange for approval before submission. Fees have also been reduced in a bid to attract more listings, and as of 2016 annual listing fees levied on small and medium-sized enterprises (SMEs) stood at LE0.5 per thousand of capital with a minimum of LE500 ($26.50).

As is often the case with new secondary boards, the first years of Nilex’s operations were characterised by low trading volumes and muted interest on the part of investors. However, the authorities at the EGX have worked hard to promote the Nilex as a useful capital-raising platform for SMEs, and by January 2017 a total of 32 firms had listed on it, for a total market capitalisation of LE1.4bn ($74.2bn), which makes it one of the best performing SME exchanges on the continent.

Debt Market

As with other markets in the region, the EGX is primarily an equities platform. While the technical infrastructure for both a primary and secondary debt market is in place, the bond arena remains at an early phase of development. At a superficial level, the debt market is showing encouraging growth, and bond trading witnessed its best performance in history in 2015, recording a value of about LE89bn ($4.7bn), compared to LE67bn ($3.6bn) the previous year. Similarly, the volume of bonds traded in 2015 hit a high of 86m, versus 65m in 2014. While this is a positive development, the challenge facing the exchange is to broaden the sources of issuance. The bulk of debt market activity is confined to Treasury bonds issued through the Primary Dealers System, which links the exchange to 15 banks that are the principal recipients of the government’s debt offerings.

In the first half of 2016 government bonds accounted for almost the entirety of the value of bonds traded with LE46.649bn ($2.472bn) out of a total of LE46.652bn ($2.473bn), a trend that is likely to continue for as long as the government is compelled to turn to the nation’s banking sector for funding to bridge its stubborn fiscal deficit. This domination of the debt arena by government offerings is high, even by emerging market standards. A 2015 study by the International Organisation of Securities Commissions showed that on average government bonds accounted for 72% of bond issuance in emerging markets, and it ranked Egypt 28th out of 40 emerging economies for the size of its bond market.

While this means that Egypt’s corporate bond arena is larger than that some of its African equivalents, such as Morocco and Nigeria, it falls short of those found elsewhere in the Arab world, such as Saudi Arabia and the UAE. While market sentiment is a key factor in the growth of corporate bonds, the regulator has identified areas of its framework that might be fine-tuned in order to encourage their development. Moving Egypt up the ranks of emerging market corporate bond issuance has therefore become a key priority for both the financial regulator and the EGX authorities.

Tracking The Exchange

A developing market demands an expansion of tracking tools, and in 2015 the EGX’s indices committee responded to investor demand by approving the new EGX 50 EWI. This tracks the top-50 companies listed on the exchange by their liquidity and activity, allowing investors prioritising price movement to more readily ascertain opportunities. The introduction of the EGX 50 EWI is only the latest in a number of index innovations that have taken place since the 2011 revolution – among the most notable was the 2014 addition of an index for Nilex.

The market’s primary index is the EGX 30, which since 2009 has been formulated both in Egyptian pounds and US dollars to 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 that tracks firms showing commitment to environmental best practise and corporate governance; and the Dow Jones EGX Egypt Titans 20 Index, a partnership with Dow Jones that tracks the leading 20 stocks ranked by free float market capitalisation, sales/revenue and net income. In 2015 the indices committee approved an amendment for the EGX 30 regulation, by which companies with a free float less than 15% are eligible to be included in the EGX 30 index, provided that their market capitalisation is equal to or more than LE100m ($5.3m).

Performance

The turbulence of the last half-decade has presented the exchange with formidable challenges. The 2011 revolution saw the temporary closure of the exchange and a significant fall in the main index when it reopened, but since 2012 it has showed a sustained recovery. The EGX 30 climbed by 51% in 2012, and followed this rebound with a further rise of 24% in 2013, according to the bourse’s annual reports for those years. In 2014 the trend continued, as the EGX 30 realised a 32% gain for the year, which represented a 100% growth over the previous three years, cementing the exchange’s position as a key component of the Egyptian economy. In 2015 the EGX, like emerging markets across the globe, was adversely affected by low oil prices and slow growth in traditionally strong export markets such as China and Europe. The market showed a 25% decline for 2015, in line with an emerging market trend which saw Greece fall by as much as 62% and Qatar dip by 23%. In terms of market activity, however, 2015 was the second-best year for the EGX since the 2011 revolution. The main market value traded, after excluding deals and bonds, registered LE117bn ($6.2bn), the highest record since 2010, with the exception of 2014 when it recorded LE189bn ($10bn). During the first half of 2016, the EGX 30 reached a level of around 7500 and traded sideways for much of the period, before closing for a minor decrease of 0.91%. Most sectors saw modest growth or declines, with the exception of the telecoms, and health care and pharmaceuticals sectors, which showed gains of 27.2% and 9.2%, respectively.

Concerns regarding slow regional growth due to low oil prices and a currency challenge (see Economy chapter) did much to mute investor sentiment during this period. The second half of 2016, however, began with a surge in the EGX 30 on the back of news regarding a $12bn package from the IMF. The conclusion of the agreement is expected to greatly ease the nation’s fiscal position and do much to act as a green light to foreign investors. By mid-August 2016 the market’s main index was showing a year-to-date gain of over 19%. Looking to the Nilex, the index of the secondary board showed a modest decline in 2015, although liquidity in the market remained strong. Trading figures surged by 45% over the course of 2016, with the turnover ratio reaching 60%, considerably higher than the main market’s turnover ratio of 27% for the same period. In 2016 the index climbed steadily for the first half of the year, by mid-August showing a year-to-date gain of 11.7%.

Regulation & Reform

The vagaries of the domestic investment climate, regional unrest and global growth trends mean that for the exchange authorities and the regulator, the long-term sustainability of the EGX, as opposed to short-term performance, is a more important concern. Since 2009, the non-banking financial services sector has been regulated by the Egyptian Financial Supervisory Authority (EFSA), which since its inception has overseen a process of market reform focused on key issues such as corporate governance, disclosure and transparency. While EFSA provides crucial oversight, the EGX is the more proactive body in terms of generating new regulations and marketing the exchange as an investment platform.

One of the most significant regulatory changes carried out by the exchange authorities in recent years was the creation of new listing rules, which went into effect in February 2014. These laid the basis for a growth in IPO activity, which saw Egypt emerge, alongside Saudi Arabia, as principal generator of public offerings in 2015 in the MENA region – a position it also maintained in the first quarter of 2016 (see analysis). According to the EGX, the total capital of newly listed companies in 2015 reached LE6bn ($318m), which is three times higher than 2014 and equivalent to what was achieved in the years between 2010 and 2014 collectively.

Transparency Measures

The exchange has also worked hard to boost transparency, most notably with the introduction of the Electronic Disclosure System in 2015, which allows companies to send their disclosures to the EGX electronically. Firms have also been asked to provide a wider range of financial and operational information as part of the bourse’s drive to provide investors with a clear and objective overview of the market. Meanwhile, the listing rules have been subject to 36 amendments to ensure a greater degree of corporate governance and investor protection, such as a new requirement that founders, managers and directors of companies applying to be listed do not have previous court judgments issued against them.

The debt market has also been targeted for regulatory reform. In January 2016 EFSA announced that it had amended the Capital Market Law to allow for the introduction of covered bonds and non-rated bonds. Covered bonds are supported by cash flows from mortgages or public sector loans with an underlying asset pool that the bond purchaser can lay claim to. This is a more secure form of investment that is likely to appeal to cautious foreign investors. Non-rated bonds are securities that have not received a credit rating, and their introduction will allow SMEs to issue debt instruments as a means to raise funding. To protect retail investors from the elevated risk of non-rated bonds, they will only be made available through financial institutions and investment funds capable of carrying out the necessary risk assessment.

Outlook

The EGX is an important component of the Egyptian economy, and, thanks to an ongoing process of market development, is likely to continue to act as a useful platform for both corporates and SMEs wishing to raise capital. According to the EGX Strategy 2013-17, the authorities aim to further reinforce the exchange’s position regionally and internationally: through continuous development of the legislation and regulatory framework to ensure investor protection, the introduction of new technologies, continued investment in human infrastructure, and enhanced corporate governance. While the ability of the EGX to attract both new listings and investors is tied to the wider question of Egypt’s macroeconomic performance and the vicissitudes of global politics, the exchange is well positioned to grow should circumstances allow. 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 Egypt’s economy, and possesses high-quality market infrastructure and a generally liberal trading regime.

The wider capital markets arena may also be enriched by another exchange in the near future. The proposed EGYCOMEX will initially handle spot and futures transactions in a range of agricultural commodities, before including precious metals and energy commodities such as oil and gold. While a commodities exchange of this sort has been a topic of discussion for some years, a memorandum of understanding signed between the Ministry of Supply and Internal Trade and Sigma Investment, the Jordan-based conglomerate, has considerably boosted its chances of implementation (see analysis).