Dating back 134 years, the Egyptian Exchange is one of the oldest bourses in the world and the Middle East. In 1883, the Alexandria Bourse was established then the Cairo Bourse followed in 1903. In this article, I will lay out what I think we need to further develop one of the oldest stock markets in the world.
Egypt once had one of the oldest bourses of forward contracts, focused mostly on Egyptian cotton. By the 1940s, the Cairo & Alexandria Stock Exchanges (CASE) became among the best five bourses worldwide. Fast forward to 2017, the Egyptian Exchange (EGX)—as it came to be known—is lagging behind other global, let alone regional, exchanges in terms of market capitalisation and traded values. So what does the EGX need today to cope with tomorrow’s markets?
In my opinion, the EGX is in need of several factors to drive both supply and demand, the two main forces needed for any healthy market.
On the supply side
- Incentivise companies, especially small and medium enterprises (SMEs), to list on the main exchange and NILEX.
- Regulate foreign exchange (FX) trading through registered brokers rather than firms based in Cyprus or New Zealand.
- Activate the market-making mechanism to ensure consistent trading liquidity and orderly market trading, including allowing brokerage firms to operate as broker-dealers, rather than just brokers, thus owning securities in their names (what is known as their “street name”).
- Introduce options and futures trading in stocks and currencies (starting with large-cap stocks and major currencies vis-à-vis the Egyptian pound, e.g. the US dollar and the euro).
- Push for other exchange-traded funds (ETFs) to be set up, covering other main market indices as well as sector indices.
On the demand side
- Change all stock trading to be T+0 in terms of security settlement while maintaining T+2 for cash settlement. In other words, same-day trading should be applied to all securities.
- Allow short-selling (starting with large-cap stocks and institutional investors with certain minimum criteria).
- Improve disclosure by listed companies.
- Disclose listed companies’ free float percentages and foreign and institutional ownership changes more frequently.
- Disclose the amount of outstanding margin debt in the market to help investors gauge how overextended the market is depending on its leverage.
- Require brokerage firms to offer their clients options to invest their dormant cash balances in liquid, short-term, interest-paying instruments, such as money-market funds, short-term deposits, etc. This is as opposed to keeping idle cash in clients’ accounts earning nothing!
Liquidity is the name of the game
When thinking about trading liquidity in capital markets, investors may often think immediately about trading volumes, but there is more to liquidity than just higher volumes and more transactions. First, let us define liquidity. One definition that sums it all up is: “a market is liquid if traders can quickly buy or sell large numbers of shares without large price impact”. Thus, it is not volume alone that drives liquidity in the capital market, but it is rather the quantity, the bid-ask spread size, and consistency.
There are generally four aspects of liquidity:
- Width refers to the bid-ask spread for a given number of shares and commissions and fees to be paid per share.
- Depth is the number of shares that can be traded at given bid and ask prices.
- Immediacy refers to how quickly trades of a given size can be executed at a given cost.
- Resiliency characterises how fast prices revert to former levels after they changed in response to large order flow imbalances initiated by uninformed traders.
From the technical side, I think the EGX will have to foster market integrity at all levels. This can be achieved by emphasising that listed companies are subjected to—and are encouraged to practice—a reasonable level of disclosure while providing a reasonably transparent trading environment. Also, there needs to be a minimum requirement for all listed companies to have a certain amount of disclosure availed through a sponsored programme. That said, it is equally important not to overregulate which can easily inhibit liquidity in the market. The EGX will have to strike a balance between:
- A strong market that is accessible to investors.
- Market prices that are not subject to manipulation.
We need to keep in mind that trading rules exist to prevent undesirable market behaviour that is disadvantageous to the broad mass of investors and promote liquidity, hence the EGX needs to take a more tactical view. I think the following financial tools or methodologies will be essential to enhancing market depth as well as improve liquidity levels:
(1) Market maker
Earlier in October 2002, the Emirates Securities & Commodities Authority (ESCA)—the regulator of UAE capital markets—approved a new regulation for market making. By availing this to the market, liquidity will be boosted, volatility will be reduced, and transaction costs will be lowered.
However, this requires both skilled human capital and minimum core capital to support trading size. Even if there are no operational market makers, exchanges may even pay market makers to make markets either in monetary terms or through non-financial incentives, such as guaranteed allocation of orders flow, etc. Also, major shareholders of stocks where liquidity is very scarce may be approached to act as market makers (i.e. buyers of last resort). Furthermore, underwriters should act as market makers for the issues they bring to the market.
There may be a need to introduce the broker-dealer classification that allows investment firms to be involved not just in agency trading but also proprietary trading. High scrutiny (i.e. strong market surveillance) should be applied on investment firms’ activities to ensure capital requirements are met, margin and position limits are not exceeded, and thinly-traded stocks are traded through a call auction.
(3) Short selling
Coinciding with the introduction of market making to the UAE market, short selling was also allowed. However, short selling requires having an adequate supply of stocks to be lent. In other words, there should be a seamless stock borrowing and lending (SBL) system. Even if short selling is not introduced soon, it needs to be made available at least to market makers to help them perform their role as required. To avoid the downward pressure on stock prices, the uptick rule (the last price before shorting must not be below the previous price) can be implemented.
(4) Availing all types of orders
By making all types of orders available to investors—such as limit orders, hidden orders (i.e. investors who do not want to reveal their full orders), and basket orders—a more sophisticated group of institutional investors will be attracted to trade, especially with the advent of so-called fintech or financial technology.
(6) New listings/IPOs
Undoubtedly, the introduction of new listings and high-profile IPOs will increase the number of investment opportunities, further adding weight and liquidity to the market. Also, allowing cross-listing by foreign companies in the form of EGP-denominated Egyptian depository receipts (EDRs) will likely attract local investors to pick up foreign stocks using their local currency to avoiding FX conversion cost. It does not make sense that we have 148 brokerage firms and only 222 listed stocks! It is exactly one-and-a-half stock per broker!
(7) Share buyback
Listed companies can become a buying power if they are permitted to buy back their own shares off the market whenever they see fit according to certain conditions. For instance, the US capital market regulator lists four conditions for companies to buy back their shares:
(1) Method of purchase: To purchase all shares from a single broker or dealer in a single day.
(2) Timing: Depending on the company’s trading volume and the value of its free float, share buyback may not be allowed during the last few minutes of any single trading session.
(3) Price: The purchase price has to be less than the highest independent bid or last price.
(4) Volume: The company cannot purchase more than 25% of its average daily volume.
No doubt about it, financial markets continue to develop, including capital markets. Similarly, Egypt’s capital market needs to develop to address investors’ demands. At the end of the day, the role of capital market regulators (for example the Egyptian Financial Supervisory Authority) and self-regulated organisations (like the Egyptian Exchange) is to create an environment conducive to fair trading.
Amr Hussein Elalfy, CFA, has been the global head of research and managing director at Mubasher Financial Services BSC since July 2012.