Product expansion, rule simplification and wait reductions support Egyptian capital markets

The year of 2018 was challenging across the board for many emerging markets, and changing trends in global capital movements have brought turbulence to the Egyptian Exchange (EGX) as well. After rising significantly in the first four months of 2018, the exchange’s main index, the EGX30, showed a sustained retrenchment to end the year at a level not seen since early 2017. Throughout this period, however, the authorities implemented a series of reforms that are establishing the bourse as a safer and more transparent destination for domestic and international investors. With forecasts for the country’s economy broadly positive, Egypt’s capital markets are well positioned to serve their purpose as facilitators of growth and development over the coming year.

History

Egypt is home to one of the oldest exchanges in the region, with formal market activity dating back to the 19th century. Trading during this early period was divided between the Alexandria Futures Market and a new market located in a branch of the Ottoman Bank on Cairo’s Maghraby Street. In the early 20th century the bourse moved to its current location on Sherifein Street and was almost immediately rocked by the effects of the 1929 Wall Street crash. However, by the outbreak the Second World War, the combined Cairo and Alexandria Stock Exchange (CASE) had expanded to become the fifth largest in the world.

When Egypt achieved its independence in the 1950s, activity was reduced significantly by the socialist restrictions on private enterprise introduced by President Gamal Abdel Nasser. The exchange began a process of recovery under the liberalising policies of Nasser’s successor, President Anwar Sadat, who held office from 1970 until his death in 1981. However, it was not until the promulgation of the Capital Market Law No. 95 of 1992, introduced during the Hosni Mubarak presidency, that the bourse finally returned to the level of growth it had enjoyed earlier in the century. By the year 2000 the CASE’s main board was home to more than 1000 companies. However, rapid expansion brought with it instability and bad practise, particularly in the area of company disclosure. Therefore, over the following decade the regulator oversaw a period of reform which reduced the number of listed companies and established the market on a more sustainable growth trajectory. In 2009 the CASE was rebranded as the EGX, and in April 2012 it moved the bulk of its operations to Smart Village, an IT park located west of the capital. While the EGX retains its landmark city centre building, the final transfer of the exchange’s data centres to its new location was completed in 2016.

Main Market

The EGX continues to operate trading floors in Cairo and Alexandria. Both locations share trading, clearing and settlement infrastructure that has been operated by the private company Misr for Central Clearing, Depository and Registry since the bourse moved from physical stocks in 1996. As of early April 2019 there were 225 listings on the EGX, with a combined market capitalisation of LE818.34bn ($46bn).

The main board of the EGX is home to domestic giants as well as regional and international players. The range of sectors by which listed companies are allocated on the exchange reflects the broad base of the economy, and categories include banks; 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; telecoms; travel and leisure; and utilities. At the end of 2018 banking was the largest sector, accounting for around 23.4% of total market capitalisation, followed by financial services excluding banks, with 11%. Industrial services and products and real estate were close behind, each with around 10% of the total.

The Nilex

Since 2010 the EGX has included a secondary board for small and medium-sized enterprises (SMEs). Companies on the Nile Stock Exchange (Nilex) are subject to the same basic trading rules as the main market but enjoy lower fees, and less onerous listing and disclosure requirements. There were 32 companies listed on the Nilex as of November 2018, operating in sectors as diverse as plastics, education and food production. Like many secondary boards, the Nilex has faced a challenge in attracting capital. In 2017 the value traded on the SME market declined to LE677m ($38m), against the previous year’s LE894m ($50.2m), a reduction of approximately 24%. Moreover, the Nilex’s market capitalisation declined by 15% over the year, at a time when the main board was setting new records. More encouragingly, the smaller board has displayed a high level of liquidity, showing a turnover ratio of 56% in 2017, compared to the 31% recorded by the main market. While the EGX did not cite detailed statistics for the smaller board in its 2018 annual report, total trading volume for the year was recorded at LE380m ($21.4m), and it was expected to see five new firms listed in the near future. The exchange authorities have taken steps to both encourage new Nilex listings and help existing Nilex companies to develop their businesses, introducing them to international financial donors such as the European Bank for Reconstruction and Development, and Germany’s GIZ.

Debt Market

As is the case with most markets in the MENA region, the EGX is primarily an equities platform, with trading in stocks accounting for nearly 80.1% of total traded value in the fourth quarter of 2018, and bonds accounting for the remaining 19%. The fixedincome segment of the exchange may, however, see an increase in activity as a result of a government policy innovation. In July 2018 it was reported by local media that the Ministry of Finance wished to start selling government bonds on the EGX in FY 2018/19. A mechanism revealed in August 2018 would see a number of approved banks and financial institutions take part in government bond auctions, reselling the instruments to both institutional and private investors on the exchange. The move is part of a broader reform effort that aims to establish a central securities depositary that will include auction systems for the primary and secondary debt market, as well as other functionalities, such as a yield pricing monitor. Any government bond sales on the exchange, according to Mohamed Maait, deputy minister of finance, would come with long tenors, in keeping with the government’s desire to shift the nation’s debt profile to the longer term.

Looking to the wider fixed-income arena, Egypt continues to raise debt in global markets despite low sovereign ratings. The country raised $4bn in US dollar-denominated bonds in February 2018 in a bid to mitigate its budget deficit and increase its dollar holdings, and followed up the deal with a €2bn euro-denominated bond in April 2018. In October 2018 the government revealed plans to issue up to $20bn in Samurai and Panda, meaning Japanese and Chinese, bonds before 2022. The pivot to Asian markets was widely interpreted as a response to declining appetite for its regular issuances of Treasury bills, which compelled it to cancel four offerings over the year.

Performance

IMF support for the economic policies of President Abdel Fattah El Sisi and a devaluation of the currency in November 2016 have underwritten a sustained expansion of the market in recent years. In 2017 the EGX30 reached its highest ever level, passing the 15,000 mark for the first time and showing a 22% gain for the year. The EGX70 and EGX100 indices, meanwhile, rose by 79% and 80%, respectively. The positive trend extended across all sectors; personal and household products topped the market, with 116% gains, followed by chemicals, which rose by 84% over the year. The lowest gain in 2017 was realised by telecoms, which posted an increase of 3%.

The EGX showed a gain of approximately 12% over the period on the MSCI Emerging Markets Index, which is measured in US dollars. This was the strongest performance in the region and enabled the country to retain its position of top-performing market in the world since 2013. However, in 2018 investors were reminded of Egypt’s exposure to global economic trends, as the US Federal Reserve began to hike interest rates, resulting in cash outflows from exchanges around the world. The EGX30 declined by 13% over the year, while market capitalisation on December 31, 2018 stood at LE749.7bn ($42.1bn), compared to LE824.9bn ($46.4bn) a year earlier. Tourism and leisure; services, industrial products and automobiles; and financial services excluding banks were the only positive performers, recording gains of 26%, 15.3% and 3.6%, respectively. Comparatively, telecoms declined most significantly, by 38.8%, followed by construction and materials, down 35.7%, and personal and household products, which decreased by 25.5%. In 2018 total trading volume on the EGX increased by 7.92% to LE358.5bn ($20.1bn). At the same time, trading volume decreased by 22%, with the number of transactions falling to 6.3m from around 7m a year earlier.

Regulation

The challenging environment in 2018 serves as a reminder of the importance of an ongoing process of regulatory reform. Since 2009 the non-banking financial services sector has been regulated by the Financial Regulatory Authority (FRA) – previously known as the Egyptian Financial Services Authority – which since its inception has sought to overhaul the framework applied to key areas which include corporate governance, disclosure rules and transparency. The Capital Market Law introduced in 1992 remains the legislative backbone of the sector.

Over the years it has been amended numerous times, with its most substantial overhaul coming in 2018, when the House of Representatives gave final approval to a number of changes to the law. More than 45 of the act’s articles were altered as a result, with noteworthy innovations being the establishment of a framework for government and corporate sukuk (Islamic bond) issuance; a regulatory clearance for the trading of futures contracts; allowing for the creation of a commodities exchange, as well as privately owned stock exchanges; a reduction of listing fees to 0.002% of the value of the financial instrument; and the founding of a federation for non-banking financial institutions, similar in concept to the Federation of Egyptian Banks.

Liquid Environment

A central concern of the regulator more recently has been boosting liquidity. Legislative adjustments in 2017 and 2018 to this end include the reduction of trading suspension times from 30 minutes to 15 minutes, the scrapping of a rule which required companies to seek approval from the regulator and the EGX for stock splits, and a lengthening of the list of securities eligible for T+0 (same-day settlement) trading. In January 2019 the EGX issued regulations covering market making. Market makers are useful liquidity boosters in that they assume the risk of holding a certain number of shares in a particular stock, establish bid and ask prices for them, and then make transactions with their customers at these rates, taking the opposite side of the trade. The introduction of the regulations has extended T+0 trading and margin trading, previously restricted to the EGX’s category-A and -B securities, to all stocks, while a specialised committee has been established to determine which stocks are to be eligible for market making transactions.

New instruments also play a sizeable part in the bourse’s liquidity-boosting efforts. The nation’s first real estate fund began trading on the exchange in March 2018. The LE80m ($4.5m) fund, which is the result of collaboration between the Egyptians Abroad Investment and Development Company, Pioneers Holding and Misr Iran Development Bank, has revealed plans to invest in four real estate developments.

Some steps have also been taken to establish the market as a more investor-friendly platform. A March 2018 decision to raise the minimum free float requirement for newly listed companies from 10% to 25% of their shares has brought the exchange closer to the global norm, and made it a more attractive prospect for investors who desire more influence over companies. More such regulatory changes have come as a result of the FRA’s work to bring the listing and trading regulations in line with the recently amended Companies Act, such as the introduction of a weighted voting system that gives shareholders a vote on board members.

Going Short

The EGX has also established a model for short selling, and at the outset of 2019 was awaiting approval from the FRA for its introduction to the market. The regulator envisages full implementation of the system in 2019. The arrival of the facility on the EGX’s platform represents a significant technical advance for the bourse. Exchanges across the region have been more cautious in rolling out short-selling functionality in their respective markets, largely due to a desire to protect retail investors from the increased costs and risk associated with the process.

A central concern is that short selling is undertaken using borrowed money to which interest rate charges are applied, making the process more expensive than the ordinary purchase of stock. Short sellers are also liable for dividend payments on shorted stocks, to be paid to the broker, as well as being exposed to the possibility of charges related to share splits, spin-offs and bonus share issues. The exchange is therefore taking a cautious approach to the implementation of short selling on the bourse: only a select number of brokers will be authorised to offer the service, rules will establish limits on the number of shares a short-seller can borrow for a position and a cash deposit worth 50% of the borrowed shares will be required.

Strategy

The reform process, which the introduction of market makers and short selling are a central part of, is being guided by the FRA’s medium-term strategy. The regulator is currently implementing a strategic plan for the non-bank financial sector, first announced in April 2018. The new 2018-22 blueprint establishes a number of ambitious targets, including: raising the size of the capital market from the current LE1trn ($56.2bn) to LE3trn ($168.6bn), increasing its contribution to GDP from 25% to 50%, and growing the number companies listed on the EGX to 400. Achieving these targets will involve a combination of legislative and structural reform of the non-banking financial services sector, such as the introduction of new financial instruments, the simplification of EGX listing rules and procedures, and a reduction in the amount of time taken to make a determination on licences and stock issuance requests. Furthermore, an overhaul of the regulatory framework surrounding investment funds is also on the agenda, with a view to ensuring that their assets are sufficiently diverse and yielding the best returns to their shareholders.

Public Offerings

While the reform agenda advances, the ordinary business of the exchange continues. New issuances in the primary market are often turned to as a barometer of market sentiment, and the authorities have spent considerable efforts to increase the initial public offering (IPO) pipeline in recent years. In 2018 Mohamed Farid Saleh, chairman of the EGX, told local media that the exchange had reached out to business associations to encourage new listings and had received expressions of interest from 15 private companies. The market ultimately saw four IPOs during 2018, with a combined value of LE5.6bn ($314.7m), representing a 40% gain over 2017.

All of these originated in the financial sector: B Investments was the first to launch in March, offering 5m shares set at LE10.75 ($0.60) each that were oversubscribed 54 times; this was followed by CI Capital in April, with 411.45m shares at a value of LE1 ($0.06) each, oversubscribed 29.5 times; and Cairo Investment and Real Estate Development in October, putting up around 207m shares at LE6 ($0.34) each, bringing in approximately LE1.2bn ($67.4m). The final IPO of the year, by Sarwa Capital, saw setbacks in November, when it was suspended by the authorities due to cited procedural irregularities in the offering.

Privatisation

The country’s attempts to offload sizeable tranches of state assets date back to the 1990s, when more than 300 public sector companies were slated for divestment. Since then, the process has proven politically challenging, with mixed results. For instance, the 2006 sale of the state-owned retailer Omar Effendi resulted in job losses, while the government has also raised billions in revenue through other divestments, such as the $1.6bn sale of Bank of Alexandria to Italy’s Sanpaulo in the same year. However, the cancellation of the Banque de Caire sale in 2008, after the received bids were deemed too low, marked the end of the government’s privatisation programme. Instead, the minster of investment at the time stated that the remaining 149 state-owned companies would be reformed to make them more attractive to private investors. In August 2018 the government announced plans to privatise five state-owned firms by the end of the year: Alexandria Mineral Oils Company, Eastern Tobacco, the Heliopolis Company for Housing and Development, Alexandria Containers and Cargo Handling, and Abu Qir Fertilizers. However, in October 2018 these plans were delayed due to unfavourable market conditions. In early March 2019 the IPO of Eastern Tobacco, the first of the five, was held, giving a sign that plans may be back on track (see analysis).

Outlook

While some aspects of recent years have shown the vulnerability of the exchange’s main indices to global economic trends, some resilience has also been demonstrated. A slew of reforms undertaken by the authorities are helping to establish the EGX as one of the most interesting platforms in the region. In 2017 some 56% of participants in main IPOs were from abroad, while in the fourth quarter of 2018, after a lacklustre year for the market, more than a third of transactions on the exchange were carried out by non-Egyptians. The breadth of the investor base, almost evenly split between individuals and institutions, also bodes well for exchange stability. The prospects of the domestic economy, meanwhile, support a positive outlook for exchange growth. In October 2018 the IMF forecast GDP would expand by 5.3% in 2018 and 5.5% in 2019, compared to 4.2% in 2017. In the meantime, the process of market reform is expected to continue, with the planned rollout of futures on the EGX marking a significant milestone in the bourse’s development.