How Egypt's capital markets measure up to global standards

 

In a challenging year for economies across the region, Egypt’s capital market reform continued apace. Short-term measures in response to the economic effects of the Covid-19 pandemic joined a series of reforms aimed at establishing the bourse as a safer and more transparent destination for domestic and international investors. While market turbulence is expected to persist throughout much of 2020 and into 2021, longer-term growth in activity is underpinned by the country’s strong economic fundamentals that – before the outbreak of the global pandemic – had prompted the government to announce in January 2020 that it would target a 6% growth rate in FY 2020/21.

History

Egypt’s stock exchange is one of the oldest and most diverse in the region, having been established during a period of rapid economic development in the 19th century. During this period trading was divided between the Alexandria Futures Market and the Ottoman Bank in Cairo. In the early 20th century the bourse moved to its current location on Sherifein Street and was subsequently affected by the Wall Street crash in 1929. By the beginning of the Second World War, the combined Cairo and Alexandria Stock Exchange (CASE) had become one of the most dynamic bourses in the region and the fifth largest in the world.

Market activity, however, suffered a decline in the post-war era, as the socialist reforms ushered in by President Gamal Abdel Nasser saw the nationalisation of some of Egypt’s most prominent companies. Egypt’s exchange did not enter another phase of growth until Nasser’s successor, President Anwar Sadat, initiated his more market-friendly Open Door policy during the 1980s that reversed many of the Nasser-era reforms. More momentum came in the following decades when, under President Hosni Mubarak, the Capital Market Law No. 95 of 1992 provided a new platform for market expansion. By the turn of the century the CASE’s main board was home to more than 1000 companies. Governing such a large corporate field was a challenge for the authorities, and the market was characterised by bad practices during this period, most notably in the area of company disclosures. A period of reform followed, which saw a significant reduction in the number of listed companies and the emergence of a more proactive regulator. In 2009 the CASE was rebranded as the Egyptian Exchange (EGX), and in April 2012 it moved the bulk of its operations to Smart Village, an IT park located west of Cairo. 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.

Oversight & Regulations

Egypt’s non-banking financial services, including the capital markets, are regulated by the Financial Regulatory Authority (FRA). Since its inception in 2009, the FRA – previously known as the Egyptian Financial Services Authority – has sought to overhaul the regulatory framework applied to key areas such as corporate governance, disclosure rules and transparency.

The Capital Market Law No. 95 of 1992 is the principal legislative framework for the sector. In 2018 it was significantly amended to establish a framework for the issuance of government and corporate sukuk (sharia-compliant bonds); regulatory clearance for the trading of futures contracts; and rules for the establishment of a commodities exchange, as well as privately-owned stock exchanges.

The EGX has worked with the regulator to introduce a number of new instruments to the market in recent years, such as the 2018 establishment of Egypt’s first real estate investment trust. The regulator and exchange authorities have also taken various steps to establish the market as a more investor-friendly platform. In October 2019 the FRA approved the lowering of a number of fees related to exchange activity in a bid to encourage investment and remain competitive in the region. The EGX’s trading service fees were reduced from 0.00625% to 0.005%, clearing and settlement fees from 0.0125% to 0.01%, and stock market commissions from 0.012% to 0.01%. Furthermore, in February 2020 the EGX moved to support exchange-traded funds by removing a regulatory requirement for minimum order quantities. This development makes it easier for smaller investors to deal in this asset class.

While market growth remains a priority, the regulator has also sought to ensure its long-term stability by enhancing governance. In April 2020 the FRA announced a regulatory change that prohibits an individual from being both chairman and CEO of a company, with listed companies given a year to comply. According to the EGX, 125 companies at the time of the regulation’s announcement would need to separate the two positions.

Main Market

As of May 2020 there were 200 companies listed on the main board of the EGX, with a total market capitalisation of LE542.6bn ($33.4bn). The range of sectors by which listed companies are divided reflects the broad base of the Egyptian economy and includes banking, health care and pharmaceuticals, real estate, trade and distribution, and energy and support services. In late 2019 this framework was revised, with the EGX adding education services as a separate industry.

A reclassification of constituent industries was executed at the same time, with companies recording revenue across a range of industries categorised according to sector that makes the largest contribution to profit. The review resulted in 42 companies being reclassified. The reform of the classification system brought the bourse in line with global best practices, while the more accurate categorisation makes it easier for investors to track specific industry performance. The undertaking also shifted some classifications, either by changing the name of the industry, merging two industries or splitting an industry into more specific segments. Of the 18 classifications, banking was the largest at the close of 2019, accounting for just over 31% of total market capitalisation as of the first quarter of 2020, followed by basic resources (9.8%); food, beverages and tobacco (9.7%); real estate (9.1%); and non-bank financial services (8%).

NILEX

In 2010 the EGX launched a secondary board for small and medium-sized enterprises. Listings 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. As of late May 2020 there were 13 companies listed on the Nilex, operating in sectors as diverse as agriculture, ICT, education and tourism. Like many secondary boards, the Nilex remains a relatively small component within the wider exchange: at the close of the first quarter of 2020 it showed a market capitalisation of LE1.6bn ($98.6m), compared the main board’s LE532.9bn ($32.8bn). However, while the market capitalisation of the main board declined by 24.8% during the first quarter of the year, the Nilex showed an increase of 38%. The exchange authorities have also taken steps to encourage new Nilex listings and help existing companies to develop their businesses, including introducing them to international financial donors. One potential source of new listings is venture capital and private equity, which Mohamed Farid Saleh, chairman of the EGX, told industry media in February 2020 were increasingly vibrant.

Bonds

As is the case with most markets in the region, the EGX is primarily an equities platform, with stock trading accounting for the majority of total traded value in any given year. The government has recently attempted to increase fixed-income trading activity by selling government bonds on the EGX. In late 2018 the EGX revealed details of a mechanism that enabled 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 regulatory move coincided with increasing appetite for Egyptian debt arising from the flotation of the pound in November 2016, followed by a period of rising interest rates and Egypt’s return to financial stability under a successfully implemented IMF programme. With Egypt’s debt instruments offering investors attractive rates, foreign capital inflows to the debt arena have grown significantly: in 2019 bond trading accounted for 44.7% of total traded value on the EGX, compared to 23.1% in 2014.

Looking to the wider debt arena, Egypt continues to tap global markets despite low sovereign ratings. In November 2019 the nation introduced a $2bn international bond offering, divided into three tranches: $500m in four-year bonds with a 4.55% yield; $1bn in 12-year bonds at 7.05%; and $500m in 40-year bonds with a yield of 8.15%. The offering was well received, being oversubscribed seven-fold within a few hours of the issuance announcement. The 40-year bonds – an unusually long tenor in the region – form part of the government’s effort to shift its debt portfolio towards longer-term instruments, thereby reducing the nation’s debt servicing costs. While some debt issuances planned for the first half of 2020 were cancelled due to the Covid-19 pandemic, in May 2020 the government released a $5bn eurobond, its largest such issuance to date. The bond was four times oversubscribed – with total bids of $22bn – and attracted investors from Asia, Africa, the US, Europe and the Middle East. The funds will be used over FY 2020/21 in large part to mitigate the impact of the Covid-19 pandemic.

Outside the Exchange

In addition to the main market, a notable amount of trading takes place on an over-the-counter (OTC) basis, whereby deals are made by buyers and sellers outside the formal exchange. In 2019 just over LE32.3bn ($2bn) worth of trades were carried out OTC, compared to LE194.5bn ($12bn) on the main market. The EGX views the OTC arena as a potentially useful pool of new listings, and in recent years it has approached companies trading on an OTC basis to advise them of the advantages of a public offering.

Egypt is also developing new platforms that will further deepen the nation’s markets. Creating a commodities exchange has been planned for some time, and in 2018 a number of amendments to the Capital Markets Law made this theoretically possible, while also allowing for the creation of private exchanges. The EGX, in partnership with the Ministry of Supply and Internal Trade, is set to launch the country’s first commodity exchange by January 2021, after the EGX completed a feasibility study for the project in October 2019. The exchange will initially facilitate wheat, corn, rice and sugar trading. Shareholders in the exchange will include the EGX, the General Authority for Supply Commodities, the Internal Trade Development Authority, and the Egyptian Holding Company for Silos and Storage.

Performance

Successive years of growth and the implementation of an IMF-recommended reform programme make the EGX an interesting prospect for investors. The value of the market’s main index, the EGX30, grew by 66.5% between November 2016 and December 2019, while the Standard and Poor’s/ EGX environmental, social and governance (ESG) index – an independent index that tracks 30 of the best-performing stocks as measured by ESG practices – expanded by 83.9%. Over the same period the travel and leisure, personal and household product, basic resources and bank sectors were the top performers. Telecommunications, and construction and materials were the only sectors to contract on the EGX, down by 13.4% and 25.4%, respectively. In 2019 trading activity on the EGX increased by 14.3%, from LE358.5bn ($22.1bn) to LE409.7bn ($25.2bn). The EGX30 followed a broadly horizontal trend during the year, ranging between 13,000 and 15,000 points. Positive market influences included the settlement of a tax dispute involving Global Telecom Holding, one of the major constituents of the index, as well the decision of the Central Bank of Egypt (CBE) to reduce key interest rates after a period of increases.

Covid-19 Effect

While the outlook for exchange performance in 2020 was initially broadly positive, the Covid-19 pandemic has had a damaging effect on both the domestic and global economy. The main board of the exchange lost nearly a quarter of its market capitalisation in the first quarter of 2020, during which it declined from LE708.3bn ($42.7bn) to LE532.9bn ($32.8bn). The EGX30, which began the year at above 13,000 points, declined to below 9000 in late March, its lowest level since October 2016. By the second quarter of 2020, the index had stabilised at the 10,000-point level.

Measures to control the spread of virus negatively affected the day-to-day operations of the exchange. One of the early responses of the authorities was to shorten trading hours for both the EGX and Nilex, limiting activity to between 10.00am and 1.30pm. By the end of the first quarter, however, a number of mitigating measures were introduced in a bid to support exchange activity. In March 2020 the Cabinet approved a range of emergency initiatives, including cutting the dividend tax to 5%, as well as lowering the stamp tax from 0.15% to 0.125% for foreign investors and 0.05% for residents. The much-delayed implementation of a capital gains tax, meanwhile, was postponed again to January 2022. Some companies, including Odin Investments, Madinet Nasr for Housing and Development, Eastern Company and Egypt Kuwait Holding, opted to support their stock prices through share buybacks. More support came in March with the announcement that the CBE would buy up to LE20bn ($1.2bn) of shares to help support asset prices.

Public Offerings

Encouraging initial public offerings (IPOs) is another way in which the EGX is attempting to deepen the market. This effort has included direct approaches by the exchange to business associations in order to solicit market entries. There were four IPOs in both 2018 and 2019, worth a total of LE5.2bn ($320.5m) and LE5.1bn ($316.9m), respectively. The final offering of 2019 was that of the Tenth of Ramadan for Pharmaceutical Industries and Diagnostic Reagents (Rameda). The IPO revealed considerable appetite for stock – the deal was oversubscribed by 117% and consisted of two tranches: a 5% offering to small investors and the remainder sold in a private offering.

Privatisation

The more challenging market conditions following the onset of the global pandemic have reduced the prospects of IPO activity in 2020, including slowing a privatisation programme of government entities that was expected to boost the IPO pipeline during the year. The long-anticipated privatisation effort got under way in March 2019 with a secondary offering of Eastern Company. The sale of a 4.5% stake in the company was nearly two times oversubscribed, with foreign investors obtaining 94% of the offered stock.

In October 2019, at an inauguration of two military-owned chemical plans, President Abdel Fattah El Sisi suggested that military-owned companies may be floated on the stock exchange. The opening of some military-operated companies to private sector investment would be a potentially significant development. In December of that year the Ministry of the Public Enterprise Sector revealed that it was planning to make eight state-owned companies public by the end of FY 2020/21, including El Nasr Mining Company, e-Finance and Banque du Caire. However, by the close of 2019 the Eastern Company offer remained the only deal to emerge from the programme, and in early 2020 the state-run Banque de Caire announced that it had postponed its planned offering of between 20% and 30% of its shares, citing market headwinds caused by the Covid-19 pandemic. The timing of further listings of state-owned companies is largely dependent on the companies’ readiness for an IPO, and whether or not market conditions will result in a fair price.

Outlook

The prospect of military companies being listed on the exchange is an significant one, and public confidence in the military establishment is likely to result in significant investor appetite. It will be a challenge, however, to balance transparency-related regulations – such as publishing of information on profits, losses, investments and transactions – against national security considerations. The issuance of non-state IPOs, meanwhile, are expected to pick up again once market conditions allow. OrthoMedics Egypt, for example, told local media in February 2020 that it was planning to offer 49% of its shares as an IPO by 2022. More IPO momentum may also emerge from Egypt’s rapidly developing private equity and venture capital sphere: two recent IPOs on the EGX – those of e-payment network Fawry and Rameda – involved companies that were backed by private equity.

More broadly, the performance of the EGX is inextricably linked with that of the economy. In the short term the speed with which Egypt recovers from the effects of the pandemic will dictate the movement of the main index. In the longer term, prospects for the market are strong. Local investment firm HC Securities & Investment expects Egypt’s market capitalisation to increase from around 15% of GDP in 2019 to 20% in 2024. Exchange liquidity may also be boosted by increased regional trade as a result of the African Exchanges Linkages Project. The initiative, led by the African Securities Exchanges Association and supported by the African Development Bank, aims to facilitate cross-border trading and the settlement of securities in Africa. Its successful implementation would connect the EGX with important exchanges on the continent, such as those in Casablanca, Johannesburg, Nairobi and Lagos.

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