Path to recovery: Long-term market strategies will be key during a time of political transition

Since the start of the nation’s difficult political transition in 2011, Egypt’s capital markets have faced a number of challenges. An economy that was growing at a rate of 7% has given way to a more modest GDP expansion of 2.2% in the 2011/12 fiscal year, while foreign direct investment fell from a net of LE6.76bn ($971.96m) in 2009/10 to just LE2.19bn ($311.64m) in 2010/11 and is likely to remain subdued until Egypt’s political situation has stabilised. Both of these factors have exacerbated a growing state budget deficit and the decline in the nation’s international reserves, which has left the nation with a less than promising economic outlook in the short term. Nevertheless, 2012 saw Egypt’s exchange recover the ground it lost in 2011, growing by 51% year-on-year to become one of the fastest expanding in the world. Its path to recovery has been a volatile one, which has demonstrated the influence of political events on market sentiment, but just as importantly, the return to form displayed the bourse’s ability to attract capital when circumstances allow.

HISTORY: Egypt’s capital markets have a venerable history, extending as far back as the latter part of the 19th century when Alexandria’s Café de l’Europe became an informal location for cotton trading. By the start of the 20th century the Mediterranean city had its own exchange, while in Cairo a newly incorporated bourse had been temporarily established in an old branch of the Ottoman Bank on Maghraby Street. At the time of the financial crisis of 1907 the Cairo bourse alone had 228 listed companies, and in 1909 it moved into new, purpose-built premises with a viewing gallery and trading floor on what was renamed New Bourse Street. In 1928, a year before the Wall Street stock market crash, the Cairo exchange moved to its present location on Sherifein Street, an Art Nouveau building that has become one of the city centre’s more notable landmarks.

GROWTH SPURT: By the outbreak of the Second World War the combined Cairo and Alexandria Stock Exchange (CASE) was the fifth-largest in the world, but in 1961 it closed as then-President Gamal Abdel Nasser’s tilting of the economy towards socialism took effect. While his successor, Anwar Sadat, began to dismantle the command economy of his predecessor and return Egypt to a path of market liberalisation, it was not until passage of the Capital Market Law of 1992, implemented during the Hosni Mubarak presidency, that the exchange began its second major phase of growth.

By the year 2000 over 1000 companies had listed on CASE’s main board, an expansion that, although welcomed by the investment community, was also marked by market volatility, insider trading and a culture of poor disclosure. A period of reform over recent years aimed at establishing a smaller number of highquality listings, more sustainable growth of capital and increased interest from foreign investors has resulted in a more durable bourse. In 2009 the CASE was rebranded as the Egyptian Exchange (EGX), and in April 2012, while retaining its city centre building, its headquarters moved to Smart Village, an information technology park located west of the capital. Today, despite the challenges the sector has faced during Egypt’s ongoing political transition, the EGX remains a regional giant that stands ready to benefit from the return to economic stability that the financial community hopes for.

MAIN MARKETS: The EGX is a multi-location platform, with floors in Cairo and Alexandria, that utilises a standard primary (new issue) and secondary (trading) system. Both locations share the same trading, clearing and settlement mechanisms that have been undertaken by a private company, Misr for Central Clearing, Depository and Registry (MCDR) since the bourse moved from physical stocks in 1996, with the EGX, banks and member firms as the main shareholders. As of June 2012, 212 companies were listed on the exchange, with a nominal capital of LE150.1bn ($21.4bn) and market value capital of LE339.8bn ($48.4bn). Among these are regionally and internationally active firms that have assisted the EGX in attracting capital from the Gulf Cooperation Council (GCC) and beyond, including Mobinil, Telecom Egypt, Commercial International Bank, Orascom Construction Industries, Talaat Moustafa Group Holding and EFG-Hermes.

The breadth of the exchange’s listings by sector reflects the diversity of Egypt’s economy, with the largest by capitalisation being construction and materials, with 22% of total market capitalisation (mcap) in 2012, telecommunications (16%), banks (14%) and financial services excluding banks (8%). The remaining sectors comprise real estate (7%), chemicals (6%), basic resources (5%), travel and leisure (5%), and industrial goods and services (5%).

The exchange is tracked by several indices. The EGX 30 is the primary index, and since 2009 it 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 mcap 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 (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 which tracks the leading 20 stocks ranked by free-float mcap, sales/revenue and net income).

NILEX: In January 2010 Egypt’s main board was supplemented by a new sub-market, the Nile Stock Exchange (NILEX), designed for small-cap firms that wish to access activity through the exchange. While it is subject to the same trading rules and principles as the main market, 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), and the financial history requirement is limited to financial statements for one fiscal year preceding the listing application. Listing fees have also been set at an attractive level in a bid to entice smaller firms to the market, standing at 0.5 per thousand of the capital with a minimum of LE500 ($71.20) and a maximum of LE30,000 ($4269). As of June 2013 there were 17 listed companies trading under the NILEX regime, while a further six companies had listed but had yet to allow their stock to be traded. Despite commencing operations at an inauspicious time in Egypt’s economic history, the EGX’s new platform has demonstrated steady growth and, in terms of new listings, has outperformed the main board.

“In the last couple of years we have attracted eight new listings to it, compared to only two on the main board. That is a good performance, given the turbulence of the time. If we had spent as much effort on this in the days prior to the revolution we would have been able to attract 20 to 30 companies,” Mohamed Omran, the former chairman of the EGX, told OBG.

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 (composed of 15 banks as of 2013), as well as custodians and the MCDR, and follows an internationally standard pricing system using the Clean Price.

BONDS: In 2012 Treasury bonds issued through the PDS accounted for 99.8% of total bond trading value and 98% of trading volume, a result of the government’s reliance since 2011 on the domestic banking sector to fund its budget (see Banking chapter). Beyond the Treasury issuances, as of June 2013 there were 19 government-issued housing bonds listed on the exchange via the PDS as well as 56 development bonds. The preponderance of Treasury issuances, delivering yields in the range of 14% or 15%, combined with the challenging economic circumstances, has had a limiting effect on private sector debt issuance. On the corporate side, 20 securitised, four fixed-rate and one floating-rate bond are currently listed on the bourse. No new issuances emerged in 2012, and total value traded on existing bonds fell to LE68m ($9.7m) from LE227m ($32.3m) in 2011. Prior to the uprising of 2011, the creation of a vibrant debt market had been established by the government as a strategic priority.

In 2010, for example, the Ministry of Finance announced that utilities and other quasi-government agencies would be allowed to issue bonds, and later indicated that it would examine ways to boost secondary trading of debt instruments. While the onset of political unrest forestalled the government’s plans, the promulgation of Egypt’s first sukuk (Islamic bond) law in May 2013 revived hopes that the EGX might play host to a deeper debt market, although the subsequent upheaval in summer will likely forestall that happening.

SUKUK: Egypt’s new sukuk law allows for both assetbased and asset-backed debt instruments that are compliant with sharia law and extends the right to issue them to the state and Egyptian private companies. While the assets from which the sukuk is derived must be located within Egypt, the legislation allows issuance to occur in the domestic or international market through offshore special purpose vehicles.

The law also establishes a central sharia board to oversee compliance, which represents the ultimate authority regarding issuance, while corporate issuers are also required to maintain their own sharia boards to oversee the development of their debt instruments. Disputes regarding sukuk, according to the legislation, may be referred to the Egyptian Economic Courts or, when all parties are in agreement, an arbitration process.

While the executive regulations of the law had yet to be published as of July 2013, the potential of sukuk to attract foreign investment, particularly from the GCC, drew a cautious welcome from the financial community. However, as long as political uncertainty continues, the fate of Egypt’s new sukuk law remains in doubt; even before the removal of President Mohammed Morsi from office, it was opposed by a number of groups, including nationalists fearful of ceding control of Egyptian interests to foreign parties. With the prospect of a new or amended constitution and fresh Parliamentary elections, the schedule for the publication of the law’s executive regulations and its eventual implementation remains uncertain.

PERFORMANCE: After a difficult year in 2011, the EGX’s main board showed a high degree of resilience in the face of continued economic and political turbulence. All of the indices showed significant gains, with the EGX 30 rising 51% over the year and the EGX 70 and EGX 100 climbing by 15% and 24%, respectively. In terms of sectoral performance, all showed strong growth, with basic resources leading the recovery with an increase of 146%, followed by banks (82%) and the real estate sector (78%). The sectors showing the smallest gains, meanwhile, were industrial goods and services (11%) and chemicals (7%).

To put the EGX’s performance in context, its 44% growth in 2012 as per Morgan Stanley’s MSCI Price Index, placed it second after Turkey compared to all other developed and emerging markets, while, according to Reuters’survey of Arab indices’ performance in 2012, Egypt’s bourse outperformed all other exchanges in the region, including Dubai, Abu Dhabi, Saudi Arabia and Kuwait. The main board of the EGX also exhibits attractive valuations in comparison to its regional peers, with a price-earnings ratio of 12.8 as of September 2012, compared to an average of 14.4 for the Middle East and North (MENA) region, according to the S&P/IFCI composite index for emerging markets, as well as a high dividend yield of 8.34% compared to MENA’s 3.16%.

The NILEX also displayed a strong performance over 2012, with total trading volumes growing from 31m securities in 2011 to reach 81m traded securities, while the value traded expanded from LE191m ($27.2m) to LE247m ($35.1m) over the same period. However, it should be noted that the recovery of the EGX in 2012 came after a 49% drop in value on the EGX 30 in 2011, with the basic resources, real estate and tourism sectors particularly negatively affected by Egypt’s ongoing political transition. Moreover, the results of 2012 demonstrate that the performance of the EGX is unduly influenced by political events; while the successful Parliamentary elections at the start of the year saw the market follow a positive trend, the political tension in the run-up to the presidential elections in June 2012 saw these gains wiped out.

The market climbed again in August and September 2012, until more tension between the presidency, the judiciary and the armed forces saw the market dip significantly again in November 2012. Similarly, while the market began a recovery in December 2012, February and March 2013 saw declines as political tension between the government and opposition increased. Meanwhile, the ouster of the president in early July 2013 saw Egyptian stocks show a 7.3% rise – the largest since the previous summer. This volatility is likely to remain an attribute of the market until Egypt’s political and economic arenas have stabilised.

INVESTOR PROFILE: The turbulent environment in which the EGX now operates has affected its investor base. In 2012 the number of registered new investors dropped to 22,000, compared to 36,000 the previous year, while the number of newly coded institutions over the same period remained almost the same, at 1458. In terms of trading activity, the split between institutions and individuals shifted in favour of the latter over the year, with the value traded by individuals rising from 41% to 50%, a trend which is often characteristic of a volatile market. The role of foreigners in the market, however, is more complex. Foreign individuals and institutions constituted 21% of the total value traded in 2012, but the pattern of foreign participation has changed greatly from previous years. Reacting to the political unrest, non-Arab foreign investors generated net outflows of LE4.2bn ($597.7m) in 2011, which only slowed marginally in 2012 to result in an outflow of LE3.6bn ($512.3m). Arab investors followed a more positive trend, adding LE188m ($26.8m) to the value of the exchange in 2011 and LE1.6bn ($227.7m) in 2012.

FOREIGN INVESTORS: However, despite the decrease in non-Arab investment and continued inflows from Arab nations, the former remain the largest foreign investment bloc on the exchange, with European investments representing the single biggest share, at 41% of the total. Among the European investors, the UK accounted for around 32% of total foreign investment on the exchange in 2012, followed by the US and Saudi Arabia, with 23% and 15%, respectively. The EGX has taken a number of steps to counter the negative impact of Egypt’s political uncertainty on its investor base. In 2012 it succeeded in being included in the S&P/OIC COMCEC 50 Sharia Index, a joint index of the Organisation of the Islamic Conference 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 EGX management has also sought to attract investment through technological connections. In 2012 the EGX launched the FIX HUB, which links the exchange to 175 international markets via the Fidessa international linking network, and as of mid-2013 it was in the process of finalising a linkage with Borsa Istanbul, one of the largest stock markets in the region. And 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.

REGULATION: The EGX has been aided in its efforts to attract institutional and foreign investors by a regulatory regime that has followed a path of consistent reform. Since 2009 the non-banking financial services sector has been regulated by the Egyptian Financial Supervisory Authority (EFSA), which has assumed the duties of the Capital Markets Authority. Since its inception, the EFSA has overseen the process of market reform instigated by its predecessor, most notably by 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 LE172.7bn ($24.6bn) to LE339.8bn ($48.4bn) – a trend that illustrates the regulators’ emphasis on quality over quantity. The outbreak of political unrest in 2011 diverted the EFSA’s attention from long-term reform to short-term challenges, and much of its work in 2011 was directed to the alteration of market operations to safeguard the exchange; T+0 settlement was suspended, which brought intra-day trading to an end; the pre-trading mechanism used to quote stocks’ guide prices was halted; and price fluctuation caps were introduced, acting as dampers to volatility by temporarily shutting down the exchange when they were exceeded.

In the second half of 2012, the EFSA began to rescind some of these measures and return its attention to the longer-term issues facing the exchange (see analysis). The EFSA’s 2012 decision to address the long-standing challenge of closing-price manipulation represents a return to the regulator’s original agenda of improving market governance.

Mohamed S Younes, chairman of Concord International Investment, agreed that a long-term approach was of high priority. “We need to promote and encourage investments to create value and not short-term market speculation that would destabilise the financial sectors,” Younes told OBG. “In regards to derivatives products, it is much too soon to consider such products.”

OUTLOOK: Egypt’s ongoing political transition is the single biggest factor affecting the bourse’s performance, and until the prevailing unsettled economic backdrop has stabilised, it is unlikely that the EGX will show the type of sustained growth that its management and regulator have been working assiduously to engender. In the shorter term, steps can be taken to ameliorate the threats of economic and political shocks. According to a report published in 2013, the EGX is planning to launch a separate trading system for the execution of large deals, aimed at encouraging trading by institutions by increasing execution speed and reducing trading costs. With this in mind, the investment community will be paying close attention to the political process that will determine the fate of the nation’s economy. Given the right conditions, the presently undervalued EGX has significant potential to grow.