Developments in the fiscal year 2004/2005

The Egyptian Capital Market has experienced significant reforms during the fiscal year 2004/200. These developments touched almost every aspect of the market. The specific reforms to the stock exchange, in conjunction with the other economic reforms had a tremendous positive effect on the performance of the Egyptian stock exchange, whether in terms of market size, activities as well as stock prices.

The reforms were reflected in the performance of the stock market significantly, not only in terms of stock prices, but also in terms of market capitalization, new issues, trading volume and trading values. This section presents the main indicators covering the activity of the stock exchange. Local stock market indices increased by 140 per cent on average during the fiscal year 2004/2005. Excluding outliers, the rate of price increase would be almost 187 per cent. For example, CASE-30 increased with almost 234.3 per cent with a volatility of monthly returns of 9.6 per cent, EFGI increased 227 per cent with a volatility of monthly returns of 9.28 per cent.

Additionally, international indices that follow the performance of the market increased by 278.6 per cent on average during the same fiscal year. IFCI-Egypt increased by 311.8 per cent with a volatility of monthly returns of 12.04 per cent. From another angle, GDRI-8 increased by almost 240.4 per cent with a volatility of monthly returns of 8.75 per cent. All these figures reflect that the stock market in terms of prices experienced abnormal growth during the fiscal year 2004/2005, which can be attributed to more economic liberalization and economic reforms adopted by the newly appointed government in July 2004.

Despite the importance of the developments in terms of return, one of the main important indicators is the volume and value of trading. Both indicators experienced tremendous growth. Value of trading reached LE 83.5 billion in comparison to LE 32.4 billion in the previous year with a rate of growth of 158.3 per cent. Additionally, foreign purchases reached LE 19.8 billion in comparison to sales of LE 12.3 billion. This implies that foreigners are net buyers in the Egyptian stock exchange.

The value of bond trading increased dramatically since the inauguration of the primary dealers market for treasury bonds in November 2004. The value of bonds traded to stocks averaged 15.6 per cent during the period November 2004 to June 2005 compared with only 0.054 per cent during the previous months in the fiscal year. Moreover, volume of trading rose from 1696.9 million shares to 2393.51 million shares in the fiscal year 2004/2005. The following chart shows monthly development of both value and volume of trading for both stocks and bonds during this fiscal year.

The activity in the stock exchange coupled with the developments in the economy induced investors to establish new companies, raise capital, and issue bonds. New Issues at establishment increased from LE 4,432 million to LE 11,608 million with a rate of growth 161.9 per cent. New issues for capital increases reached LE 20,163 million in 2004/2005 up from LE 15,005 million in 2003/2004 with a rate of increase of 34.4 per cent. New Issues of bonds (treasury and corporate) increased from LE 4,400 million in 2003/2004 to LE 18,976 million with a rate of growth of 331.2 per cent.

The increase in prices coupled with new issues, lead to the fact that market capitalization increased noticeably during this fiscal year. Market capitalization rose from almost L.E 182 billion by the end of July 2004 to LE 337 billion by the end of June 2005. As a direct result, market capitalization as a percentage of GDP rose from almost 44 per cent in July 2004 to 71 per cent in June 2005. The following chart shows the monthly development in both market capitalization in absolute terms, and market capitalization as a percentage of GDP for the fiscal year 2004/2005.

Legislation

Starting with the issuance of executive regulations for the securitization law, the executive regulations set out the procedures and rules for the operations of securitization companies. It is considered one of the main tools to assist in developing and promoting medium and long term financing such as mortgage financing and financial leasing.

Additionally, an amendment on the corporate law has been taken to allow the adoption of employee stock option (ESP) plans. This plan is expected to assist in developing the performance of Egyptian companies as it will provide incentives for employees and managers to improve the performance of the company in order to gain from their value.

Furthermore, a Prime Ministerial Decree was issued to establish the Investor Protection Fund (IPF). This fund is an insurance fund for investors against non-commercial risk. This fund is considered a building block in the Egyptian capital market as it provides insurance to investors against any misconduct by brokerage firms. An additional development in this respect is the issuance of a ministerial decree amending the executive regulations of the capital market law concerned with developing and setting a Standardized Contract between the investor and the brokerage company. This contract addresses all the relevant information pertinent to the investment decision by investors and sets out the legal relationship between the investor and the brokerage company.

Codes of Ethics and Conduct for the brokerage and fund management activities have been issued to ensure the proper conduct of brokerage firms and mutual fund managers. Moreover, a new set of Membership Rules for the Egyptian Stock Exchange has been issued for companies operating in financial intermediation.

New financial tools

One of the main drawbacks of the Egyptian Stock Exchange was the lack of new financial instruments and tools to help investors in their decision making. Thus, new financial instruments had to be introduced to the market in order to manage the increasing interest in the stock market and create some sort of diversification and variety to investors as a mean of supply to match the heightened demand as witnessed from the increase in trading value and volume.

From this perspective, several new financial instruments and mechanisms have been introduced to the market. The first of these instruments was the introduction of the primary dealers system for treasury bonds. The primary dealer acts as an underwriter for the bonds and as a market maker as well. This development had a great effect on the trading of treasury bonds in terms of value and volume of trading. In order to ensure the proper functioning of this market, an electronic link between the primary dealers, the stock exchange, and the clearing company has been established.

Additionally, there are currently two institutions: a real estate bank and a car loan company, in the process of conducting a due diligence on their financial portfolios in order to securitize them. This would be considered the first issue of an asset backed security in the Egyptian bond market. These actions have been conducted after the legal and regulatory framework has been finalized as mentioned in the previous section.

Moreover, two effective mechanisms have been introduced in the market: Margin Trading and Short Selling. In this respect, the set of requirements to license for the financial intermediaries to implement these mechanisms has been finalized and currently seven financial institutions have applied to obtain the license.

Last but not least is the introduction of intra-day trading on the same stock, in which the settlement for selected stocks would be T+0 instead of T+2 for most active stocks and T+3 for normal stocks. A set of requirements are set for applying this new mechanism on the stocks in terms of activity market capitalization.

The agenda for introducing new financial mechanisms comprises, for the first time, Exchange Traded Funds (ETFs) issued by Cairo and Alexandria Stock Exchange, tracking the movements of CASE-30 index. This is considered a further step to attract investors and provide a good means of investment diversification. Additionally, financial derivatives will be introduced by the end of 2006. 

Functional and structural reforms

In order to cope with and properly implement the introduction of the new financial tools, several functional reforms were undertaken. For example, the electronic link between the Stock Exchange and the Clearing House has been completed successfully, and this promotes and facilitates better market surveillance and permits the introduction of margin trading, short selling and intra-day trading through the verification of the investor's balances in an infinitesimal time span at the clearing house before executing orders.

Furthermore, to ensure the smooth operations of trading, a Trading Backup System and a Backup Network, which operate immediately upon the breakdown of the current systems, have been designed and set in place. Besides, the Settlement Guarantee Fund currently is applying Delivery vs. Payment for securities traded in the stock exchange.

The previous reforms meant ensuring a proper functioning and proper introduction of the new financial tools. Another development that took place to facilitate companies to raise capital quickly was establishing a link between the Capital Market Authority, the Investment Authority, the Stock Exchange and the Clearing House to expedite the process of issuing and listing local and international capital increase shares and global depository receipts (GDRs) in only 24 hours. This step is considered a major improvement in the investment environment as companies will be able to tap the capital markets quickly to finance their needs.

From the perspective of structural reforms, several steps and reforms have been undertaken. On the one hand, the chairman of the Capital Market Authority and the Cairo and Alexandria Stock Exchange have been changed to introduce new young blood in these places and promote the previous developments while at the same time making use of the experienced calibres in other places at the ministry. On the other hand a new structure of the Capital Market Authority has been approved. The new structure introduced a new sector covering Corporate Governance in a detailed manner.

In addition to the above, all the regulatory and implementing bodies concerned with the non-bank financial services will move to the Smart Village as a further step to establishing the Egyptian Financial Services Centre. This centre will comprise the Capital Market Authority (CMA), the Mortgage Finance Authority (MFA), the Egyptian Insurance Supervisory Authority (EISA), Cairo and Alexandria Stock Exchange (CASE), and Misr for Clearing, Settlement and Depository (MCSD). This centre would be the cornerstone for the establishment of the Egyptian Financial Services Authority (FSA) in the future, which would be responsible also for bank supervision.

International cooperation and corporate governance

During the fiscal year 2004/2005, the Ministry of Investment and its affiliated bodies embarked on several multilateral and bilateral cooperation projects. For example, an agreement governing the establishment of an Arab Stock Exchange (ASE) in Egypt was signed in February 2005. The ASE would target mainly large market capitalization companies in the Arab world. It is considered an opportunity for different participating exchanges from different Arab countries to have more access to financial markets and have different venues for their companies to raise capital. It is expected that the inauguration of the ASE will take place by the end of 2005.

Additionally, a Cooperation Agreement with the EU to finance the Financial Sector Development Project has been signed. Moreover, a project for developing new financial instruments in the financial markets started in cooperation with USAID. Several Memoranda of Understanding has been signed between the Capital Market Authority and the stock exchanges of Jordan, Italy and the National Association for Securities Dealers in the United States of America (NASD). Furthermore, the Cairo and Alexandria Stock Exchange applied for full membership of the World Federation of Exchanges to move up from affiliated membership. The final decision is expected to come in November 2005.

In order to enhance the best practices of corporate governance, the CMA intends to create a Transparency and Disclosure Unit inside the authority according to its approved new structure. Also, the authority has its own listing and delisting rules that encourage listed companies to apply corporate governance principles.

Further to these efforts exerted by the CMA, an Egyptian Institute of Directors (IOD) was established with the cooperation of the World Bank and the European Union. The IOD will issue, shortly, the code of corporate governance principles for listed companies in the stock exchange. Additionally the IOD will provide training to the boards of directors and executive managers of listed companies on corporate governance best practices and to acquaint them with the proper disclosure requirements to enhance the whole investment environment in the economy.