New regulation: Reforms are bringing the stock exchange in line with international best practices

Even amidst the broader turbulence and upheaval in Egypt, the country’s financial markets have avoided worst-case scenarios in part thanks to a robust regulatory regime and careful intervention. The creation of the Egyptian Financial Supervisory Authority (EFSA) in July 2009 was widely welcomed by both the financial community in Egypt and interested parties in the international sphere. A year later, the Organisation for Economic Cooperation and Development (OECD) stated that its establishment “should further improve the regulatory environment and oversight”, support the development of a well-regulated capital market, and bring about new developments in the financial sector by creating a “more conducive regulatory framework”.

EFFECTIVENESS: In setting out a reform agenda for the Egyptian Exchange (EGX), the EFSA had a tough act to follow. The preceding years had seen the now-defunct Capital Markets Authority (CMA) implement a series of radical regulatory decisions aimed at bringing the nation’s bourse in line with international best practices. These moves included the 2008 merger of the Cairo and Alexandria stock exchanges into a single entity, a number of infrastructure upgrades, the introduction of a new trading platform and the creation of the Nile Stock Exchange – a trading board for small-cap companies.

Those observers who had expected further radical reforms following the EFSA’s establishment, such as the introduction of a regulatory framework to incorporate the more complex financial instruments, would, it seemed, have to wait. The EFSA’s early work brought no significant change of strategic direction, and might be described as a continuation of the CMA’s focus on corporate governance, disclosure and transparency. As early as 2010 the OECD raised a note of concern about what it saw as a tardy start-up process, stating that “one year after the formal merger of the CMA, the Mortgage Finance Authority (MFA) and the Insurance Authority, the EFSA is only now finalising its internal restructuring and still needs to come fully into its own as a regulator”. The OECD cited a limited number of staff, approximately 800 at the time, and their concern with internal issues as the principal causes for the regulator’s slow start, and called for more capacity to be added.

EXTERNAL FACTORS: However, the window for the EFSA to step up the pace of regulatory development for the EGX was closed by forces beyond its control when the popular uprising of early 2011 saw the bourse shut down for nearly eight weeks. Instead, its focus was shifted to short-term measures aimed at protecting the market as it reopened to an altered economic environment. The political turbulence that began in 2011 has persisted into 2013, and with investors’ priorities weighted towards capital preservation, there has been little appetite for the sort of structural reform that was being discussed in the years prior to the EFSA’s formation. Still, the internal reorganisation over which the OECD voiced its concern in 2010 has already borne fruit, and the EFSA has started to make its presence felt through a number of modest regulatory changes.

NEW STRUCTURE: In September 2012, state-owned Middle East News Agency (MENA) revealed that the EFSA had completed its internal re-structuring, which had involved combining the operations of the CMA, Mortgage Finance Authority and the Insurance Authority into a unified corporate body. The former chairman of the EFSA, Ashraf Al Sharkawy, told the news agency that the “new organisational structure of the supervisory body is up to international standards”, and he outlined its five main divisions: supervision and control; establishment and licensing; tools and financial reporting; information services; and administrative and financial affairs.

The completion of this piece of housekeeping will allow the staff of the EFSA to turn their attention from what has been a lengthy process of internal reform and reorganisation and concentrate instead on the organisation’s stated mandate, which is to both safeguard the stability and promote the development of Egypt’s non-banking financial markets.

REFORM: The EFSA has made a number of small, yet significant, regulatory changes over the past year. In September 2012 the regulator addressed the question of closing-price manipulation, which had been an issue on the bourse for some time. The new regulations stipulate that the number of shares traded should not be less than 0.5% of the stock’s average daily turnover for the previous three months if its closing price is to be altered.

Moreover, the value of the traded shares must be greater than LE10,000 ($1423), or the equivalent in foreign currency, and private transactions between investment companies are not to be taken into consideration in determining the closing price. Speaking to local press after the announcement of the new measures, Hany Mahmoud, the managing director of Blom Bank, stated that, “the recently enacted closing-price regulation is a positive step that should have been introduced a long time ago, as closing-price manipulations have been a pain in the neck.”

Much of the EFSA’s activity has been focused on restoring market operations that were suspended in the wake of the 2011 political upheaval. Prior to 2011, traders had been able to avail of a T+0 regime, by which they could buy all or part of the shares that they had already bought or sold during the same trading session, without having to wait a day or more for settlement. This intra-day trading was widely credited with helping to boost trading volumes and liquidity on the EGX since its inception, and its suspension as a precautionary measure was viewed as an unfortunate necessity by the EFSA, which was seeking to maintain stability during a difficult period.

Throughout 2011 and most of 2012, the exchange reverted to a T+1 system for government bonds and a T+2 system for all other securities. By the second half of 2012 the EFSA deemed the political and economic situations stable enough to announce its intention to revert to the T+0 mechanism, a move it first slated for December 2012, then the first week of May 2013 and finally, May 23, 2013 – a series of delays that highlighted the uncertainty of Egypt’s political and economic recovery.

While the newly reinstated T+0 mechanism has the potential to boost trading volume on the exchange, predictions regarding the scale of its effects vary considerably. However, as intra-day trading accounted for around 12% of value traded on the exchange prior to its suspension, a modest gain in overall trading volumes is a reasonable assumption.

MEASURES: The resumption of intra-day trading led to speculation that some of the other steps the EFSA took to ensure the stability of the EGX in 2011 might be reversed. In August 2012 the EFSA announced that it had approved new regulations by which it will reinstate the pre-trading mechanism for quoting stocks’ guide prices. The new rules firm up the pre-trading regime by stipulating that 25% of brokerage firms dealing on a security command for the ask price and another 25% for the bid price before the guide price can change.

While the prospect of a return of pre-trading sessions was broadly welcomed by market participants keen to return to normality after two years of restricted operations, some stability measures introduced by the EFSA in 2011 remain in place. Currently, a 10% price fluctuation cap on traded shares governs market movement and, if exceeded, results in a freeze in trading across the entire exchange for 30 minutes. A movement of 5% in any single stock, meanwhile, results in a 30-minute block on trades for that stock only. The removal of these limits is contingent on stability in the economic and political spheres.

STAMP DUTY: The measure that has garnered the most reaction recently from investors over the past year, most of it negative, originated not with the EFSA but rather the Ministry of Finance. In May 2013 the Egyptian government announced a stamp duty to be implemented from May onwards of 0.1% on all buy and sell transactions conducted on the EGX. In the context of the government’s desire to boost revenues and reduce a structural budget deficit that is becoming increasingly unsustainable as sources of international funding remain limited, the new tax might be viewed as fiscally prudent.

However, a number of leaders in the investment community have voiced their concerns about the timing of the stamp duty’s introduction, as it comes at a time of low market liquidity and turnover. The tax’s potential negative effects, many argue, significantly outweigh the potential financial return, which Mohsen Adel, the vice-chairman of EG-Finance, has estimated to be in the order of a modest LE200m ($28.5m) annually for the Treasury. The tax represents a clear example of the difficult task that lies ahead of the EFSA: that of safeguarding the stability of the exchange while also encouraging growth in the current, challenging economic climate.

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