Ups and downs: Despite ongoing uncertainty, historical strengths remain firmly in place

The capital markets, like the wider economy, have been subject to the effects of the historic political events that unfolded in Egypt during 2011. Uncertainty has bred volatility: a rapid decline in value over 2011 was followed by a record recovery in the first quarter of 2012. However, with parliamentary elections successfully concluded and signs that the heated political arena is incrementally cooling, the process of regulatory reform and market deepening that attracted greater amounts of liquidity to the exchange in recent years has once more resumed. Political uncertainty remains, and investor confidence has become a priority for the market’s management, but the stance of the Egyptian Exchange (EGX) remains an expansive one, with new regulations and instruments aimed at reclaiming lost liquidity playing a key part in its strategy for 2012.

HISTORY: The Cairo and Alexandria Stock Exchange (CASE), established in 1888, grew steadily under the monarchy and British protectorate. By the outbreak of the Second World War, CASE was the fifth-largest exchange globally. The post-war period brought independence and a turn towards socialism under Gamal Abdel Nasser, which ultimately stunted the exchange. Nasser’s successor, Anwar Sadat, reversed these policies in an economic liberalisation scheme in the 1970s, later maintained by his successor, Hosni Mubarak. With the Capital Market Law of 1992, CASE saw a second growth wave, and the number of listed companies surpassed 1000 by the year 2000. Rapid expansion, however, came at the expense of quality, and the early years of the new century were marked by volatility, insider trading and a culture of poor disclosure.

Recent years have seen a reform process focused on corporate governance and transparency and that led to the reduction of the number of listed firms on the exchange to 212 as of April 2012. CASE was re-branded as the EGX, and as the nation approached its most recent political milestone, the impact of these reforms were becoming apparent: a smaller number of high-quality listings, steadily growing market capitalisation, and increased interest from foreign investors. In April 2012 the EGX moved into its new headquarters in Smart Village, a state-of-the art business campus in an exurb west of Cairo, where fellow tenants include many of the high-cap companies listed on its main board. Today, despite the political and economic turbulence following the uprising of 2011, the EGX remains a market of depth and complexity, and a regional giant that stands ready to benefit from the anticipated resolution of Egypt’s political challenges.

MAIN MARKETS: Government-owned, the EGX is the only registered securities exchange in Egypt and operates a multi-location platform with floors in Cairo and Alexandria. Both locations, which utilise a standard primary (new issue) and secondary (trading) market models, share a board of directors and have access to the same trading, clearing and settlement systems. Since 1996, when the exchange began dematerialising (no longer using physical stocks), these operations have been undertaken by a private company, Misr for Central Clearing, Depository and Registry, the main shareholders of which are the EGX, banks and member firms.

Egypt has one of the most diverse economies in the region, as reflected by the listing sectors of its exchange. The largest listing sectors by market capitalisation measured have been banking, basic resources, chemicals, construction and materials, and financial services. Other sectors include food and beverage, industrial goods and services, health care and pharmaceuticals, oil and gas, personal household products, real estate, retail, media, technology, telecommunications, travel and leisure, and utilities. A number of regional giants that attract capital from the GCC and beyond form a cadre of blue chip companies on the exchange. These include Orascom Construction Industries, El Ezz Aldekhela Steel, Egyptian Iron and Steel, Commercial International Bank, TMG Holding, EFG Hermes, Telecom Egypt and Mobinil.

The primary tracking tool of Egypt’s exchange is the EGX 30, formulated in both Egyptian pounds and US dollars since 2009 to allow for easier comparison with other markets. The EGX 70, launched the same year, tracks the most active stocks in terms of market capitalisation and liquidity outside the top 30. Other significant indices include the EGX 100, and the S&P/EGX/ESG – a partnership with Standard & Poor’s to track the stock of firms displaying a commitment to environmental best practise and corporate governance. In 2011 the EGX launched the EGX 20 Capped to track the performance of the 20 most active companies in terms of market capitalisation and liquidity, with the weighting of any single company capped at 10%.

THE DEBT MARKET: Alongside its large equity market, the EGX operates a primary and secondary bond market, although activity on the latter is limited. By the end of December 2011, there were 19 listed housing bonds and 41 treasury bonds on the exchange. Government debt issuances continued throughout the year, despite four credit rating downgrades by Moody’s leaving them at B2 by the end of the December 2011. Six treasury bonds were issued via the primary dealers system valued at LE232bn ($38.8bn), and housing bonds were also listed, with a value of LE3.5m ($585,795) and a maturity date in December 2030.

The historic regularity of Egyptian treasury issues has made for a well-established yield curve. However, the political and economic turmoil since the start of 2011 has left Egypt’s debt market operating in exceptional conditions, and at a debt issue of nearly 15%, government debt has become expensive for the state. The currently distorted yield curves reflect the general unrest, but domestic banks are buying up the government bonds, taking advantage of the attractive rates.

On the corporate side, the unfavourable market conditions resulted in no listings or de-listings in 2011, leaving making for five fixed rate and one floating rate corporate listings on the exchange. However, there were two listings of securitised bonds in 2011, bringing the category total to 10 by the end of the year.

Increasing activity on Egypt’s debt market has been a government priority since 2010. Following a decision earlier in the year to allow utilities and other quasi-government institutions to issue bonds, the Ministry of Finance announced in the fourth quarter that it would examine ways to boost secondary trading. The onset of the revolution in January 2011 interrupted this reform, and the reliance of the ministry on local banks for funds during the economic turbulence that followed has starved the secondary market of liquidity. However, the 2012 announcements by the two largest parties in Egypt’s newly elected parliament that they are formulating regulations to allow for the nation’s first sovereign sukuk (Islamic bond) holds out the prospect of increased activity in Egypt’s debt market (see analysis).

THE NILEX: Since January 2010, the EGX has held a sub-market, the Nilex, to help small-cap firms access liquidity. It is subject to the same trading rules and principles as the main market, but differs in its primary qualifications for listing of small and medium-sized enterprises (SME). “Many SMEs have fared reasonably well in the post revolutionary economy. However, appetite for investing in SMEs is much slower because everyone is waiting to see a direction, regulatory framework and solutions to the many obstacles Egypt faces,” Marianne Ghali, chairman and managing director of private equity management firm Sphinx Egypt, told OBG. As a potential funder of Egypt’s SMEs – over 90% of the country’s active enterprises, according to the OECD – the Nilex is key to the EGX’s development strategy.

In 2011 the rules governing Nilex’s operation were modified to ensure the listing included promising companies with organised plans to increase capital. The EGX also signed a memorandum of understanding with the General Authority for Investment (GAFI), under which both organisations will cooperate to encourage new firms to raise capital on the Nilex. The revised arrangement grants the EGX access to GAFI’s sizeable SME database, which will help it target new companies it hopes will list. Despite the challenging political and economic backdrop, listings on the Nilex increased by five firms to reach a total of 20 by the end of 2011.

PERFORMANCE: The Nilex’s expansion ran counter to the contraction on the main market in 2011. All market indices declined over the year, with the EGX 30 falling by almost 49% and the EGX 70 and EGX 100 decreasing by 42% and 45%, respectively. The immediate 6.1% drop on the benchmark index following the beginning of the revolution on January 25, 2011 prompted the authorities to shut the exchange from January 27 through March 22, 2011.

A sharp decline followed the resumption of trading, and a brief mid-year rally was followed by a retreat in the third quarter as the trials of the former leaders began. External factors, like the European debt crisis, also exacerbated conditions.

The real estate and basic resources sector listings were particularly hard hit, retreating by 67% and 76%, respectively. Slower tourism resulted in a 66% decline in the travel and leisure sector, while the banking sector contracted by 59%. Financial services excluding banks declined 56%. Some sectors did show more resilience: health care and pharmaceuticals contracted by a relatively modest 16%, while personal and household goods saw a 25% decline. “There are some attractive values on the exchange. Certain sectors have survived and done well – we can call them defensive sectors,” Sherif Raafat, managing director at Concord Corporate Finance and Securities, told OBG. The attractive valuations on the EGX in 2011 meant that the exchange compared favourably to its regional peers. It recorded a dividend yield of 10.4%, compared to the Middle East and North Africa (MENA) average of 3.6%, according to the S&P/IFCI Composite, a leading emerging market index, and a low price to earnings ratio of 10.5 times against a MENA average of 15.9 times.

The good value to be found on the exchange, increasing political stability and a number of encouraging stock-specific developments underpinned a rally at the start of 2012 that held for much of the first quarter (see analysis). After reaching a low of around 3600 on December 29, 2011, the EGX 30 rose to 5452 by March 7, 2012. The 27% rise in January 2012 was its largest monthly gain in seven years and the biggest advance recorded by the 72 global indices tracked by Bloomberg. Following the presidential elections in June 2012, the second half of 2012 saw the exchange settle into subdued trading (both in volume and value), similar to those trends seen across the region and beyond.

REGULATION: The recovery of Egypt’s bourse is aided by a regulatory regime that has demonstrated its ability to react to the unique challenges of 2011 and its determination to continue the development of this important financial institution. Since 2009, the non-banking financial services sector has been regulated by the Egyptian Financial Services Authority (EFSA), which has taken on the duties of the now rescinded Capital Markets Authority (CMA). Since its inception, EFSA has continued the process of capital markets regulatory reform started by its predecessor, most notably in cooperating with the EGX on issues of corporate governance, disclosure and transparency. EFSA and the CMA’s guiding principle has been the prioritisation of quality over quantity. The gradual enhancement of the regulatory framework governing the EGX saw the number of companies listed on the exchange drop by nearly a thousand over an eight-year period, reaching 213 by 2011. However, market capitalisation over the same time frame rose from $26bn to $88bn as the strengthened EGX brand attracted more inward investment.

The political turmoil of early 2011 compelled the EFSA to shift focus from long-term reform to short-term measures aimed at protecting the market as it reopened after a period of suspended trading. Its first step was to amend price limits on listed shares whereby trading on a stock is suspended for half an hour after a 5% change. Intra-day trading was also suspended when the exchange re-opened for business, and EFSA paid particular attention to disclosures of companies’ operational, financial and administrative status during this volatile period. Intra-day trading was resumed towards the end of the year, and as the political and economic situation began to stabilise EFSA made several amendments to its specialised activities standards, covering issues such as margin trading and short selling to boost activity on the bourse.

Meanwhile, EFSA’s preliminary approval in 2011 of the rules governing the issuance and trading of sukuk on the EGX is a further attempt to develop new investment tools in order to attract more liquidity to the Egyptian capital market.

REACHING OUT: Having managed the challenges following the events of January 2011, the EGX has turned its attention to encouraging new companies to list. Public figures and representatives of financial institutions have been invited to open trading sessions in a bid to raise awareness of the exchange’s activities. Through an educational initiative, EGX staff have visited universities nationwide to help students better understand investment principles, and a stock market training module targeting secondary school students was brought to nearly 90 schools across the country.

The EGX has also sought to reassure global investors via promotional campaigns in the Gulf region, Europe and the US. It has planned a further round of road shows after the presidential election period in 2012, although at time of press, this had yet to be started.

Market analysis for 2011 suggests the EGX’s promotional campaigns were fruitful: despite unfavourable market conditions, the number of coded investors in the Egyptian market increased by 36,000, compared with the 35,000 new investors seen in 2010. Moreover, despite the efflux of foreign capital that followed the unrest, the EGX maintains a relatively robust foreign investment component: the outflow of LE4.3bn ($720m) in 2011 represents less than half of the net non-Arab foreign inflow of 2010, according to EGX data, and less than 12% of the net non-Arab foreign inflow over the past five years (around LE33bn, $5.5bn). “In the past, retail investors always represented a larger percentage of the market, by about 70:30, when compared to institutional investment,” Mohamed Younes, the chairman of Concord International Investments, told OBG.

DEVELOPING THE EXCHANGE: In 2012 the EGX signalled its intention to continue efforts aimed at deepening the market and attracting more liquidity. The measures it took in 2010 to enhance the debt market are expected to be expanded (although an exact strategy has yet to be determined), while a number of new instruments have been identified as useful additions to the main market. There have been plans since 2009 to introduce listed futures contracts to the EGX, to be followed by a second phase of development that will see options and swaps on the Egyptian market for the first time. The nation’s first exchange-traded funds are also expected to be rolled out in the short term. The regulations that will allow for them were at an advanced stage of development prior to the closure of the bourse in early 2011, and the low-cost and low-risk market access that they can offer to investors makes them a high priority for implementation in 2012.

OUTLOOK: The European debt crisis, regional unrest and the potential for further political turbulence are the biggest challenges to expanding the Egyptian exchange. Turning around a trend of declining trade volumes, from a daily average of LE1.3bn ($217.6m) in 2010 to LE716m ($119.8m) in 2011, will require political stability and the resolution of issues in the national economy that threaten wider growth, as well as the continued efforts of the EGX’s management.

However, despite the current uncertainty, there is room for optimism. Even with the adverse economic conditions, 79% of companies listed on the exchange attained profits in 2011, according to the EGX. On a value basis, the Egyptian market is now considered one of the more attractive in the region; and a strong rise in market indices during the parliamentary elections that saw the EGX 30 and EGX 70 climb by 19% and 15%, respectively, suggests that investor demand remains. The tuning of Egypt’s economy to compete globally has resulted in the country rising five places to 94th in the World Bank’s 2011 “Doing Business” report, making it well positioned for an economic recovery. Most importantly, the economic foundations that had made the EGX an attractive capital destination prior to 2011 – a large domestic market, an expanding private sector and a diversified services sector – remain in place.