July 2009

EGYPT: deciphering the regulatory regime

Nicholas Pratt examines the latest changes in the Egyptian funds market and what it means for prospective international investors egypt.jpgThe mention of pyramids generally causes consternation among investors as they fret over the consequences of their involvement in a multi-billion dollar Ponzi scheme. But for the Egyptian asset management industry, the country’s most visited tourist attraction is more likely to feature on the front of a fund manager’s marketing brochure rather than be a metaphor for a fraudulent investment scheme.

As of 1 July, the Egyptian market has a new single regulator for the financial sector, the Capital Markets Authority (CMA), which is modelled on the Financial Services Authority in the UK. The CMA has outlined a number of mandates and has stated that its major goals are “protecting investors from non-commercial risks; organising and developing capital markets and keeping its integrity; applying fairness and transparency principles”.

The expanded remit of the CMA is welcomed by most Egyptian asset managers says  Mohamed El-Sayad, president of Xsab Portfolio Management, a subsidiary of the El Sayad Group, which also acts as the introducing broker for Belgium-based Saxo Bank’s operations in Egypt. “The fact that the CMA is a single, supreme regulator is very good because you do not get conflicting regulations in the market. Everything is coming in a consistent way and when things are solved once they are solved for good. You do not need any additional legislation from elsewhere.”

The CMA has also proved to be open to new technologies and has adapted well to the changing requirements of the market and its investors – but it has also maintained some regulatory rigour, says El-Sayad. “In Egypt we have not seen the problems that have existed in the Far East where investors have lost money due to the poor practices of companies that were left exposed to the changes in market conditions last year.”

Standing strong
This is not to say that Egypt has been immune to the effects of last year’s financial crisis. After years of continued GDP growth, which exceeded 7% in each of the previous three years, an economic slowdown has hit the country with exports, tourism and foreign direct investment all likely to be significantly reduced when the official figures for 2008/2009 are released.

But the Egyptian government has been quick to take steps to counteract the impact of the global slowdown by increasing infrastructure investment, cancelling taxes on exports, postponing plans to cancel subsidies on electricity and natural gas for energy-intensive industries, and reducing the import of finished goods and commodities. Consequently, the International Monetary Fund has forecast that Egypt will maintain strong GDP growth over the next two years of 6% compared to the global average of 1.9%.

According to Mahmoud Shaaban, chairman of the Egypt-based Roots Brokerage House, the biggest threat to the country’s economic recovery is high inflation, which reached as high as 23.6% in August 2008, fell to 18.3% in December 2008 and reached 10.2% by April 2009. “Inflation had risen on the back of surging oil and food prices internationally and now that they have plummeted, inflation is expected to fall further,” says Shaaban. “But the limited flexibility of the Egyptian currency against the US dollar has raised non-US dollar import prices, which in turn is threatening the government’s efforts to calm down the high inflation rate more rapidly.”

The new regulatory regime is also indicative of an Egyptian government that has been prolific in its attempts to boost its financial sector ever since introducing a series of reforms in 2004 designed to improve the asset quality and capital adequacy of Egyptian banks and eliminate poor performing institutions.

More recently Egypt was ranked among the top seven by the World Bank in a survey of countries that have taken effective measures for economic reform, developing the investment climate and improving the business environment. Egypt also saw its ranking in the global Foreign Direct Investment index jump from 66 in 2006 to 20 in 2007, making it the top ranked country in North Africa.

“Though Egypt has ameliorated its position over the last few years in terms of being an attractive investment destination, I believe inflows from FDI will decline in 2009 due to the global financial turmoil,” says Shaaban. “Nevertheless, as the government still aims at increasing foreign appetite in the Egyptian market, it will exert further efforts in developing the various sectors’ performance so as to regain high proceeds from FDI once the world’s financial disorder settles down.”

In El-Sayad’s view, the decline in the Egyptian market is more a result of investors’ panic than poor corporate performance. “Right now there is difficulty in picking the right companies for my clients because they are all undervalued. It is therefore a case of waiting for the index to return to the pre-crisis level for the capital markets to correct themselves and for the listed companies to receive fair value. Until then almost any stock you pick is a winner.”

In many ways Egypt has been a victim of its own success and unique status as a feature of multiple markets in terms of the financial crisis. Not only is it a prominent component of any Africa fund, it is also heavily featured in North African and Middle Eastern funds as well as a number of emerging market funds. “So there are a lot of investors that were exposed to Egypt and they all took their funds out at once in order to derisk,” says Stephane Bwakira, portfolio manager of the Standard Africa Equity Fund at Stanlib.

Stanlib’s equity-only fund was established in 2007 as a Dublin-registered Ucits III fund that covers the African continent (with the exception of South Africa) and Egyptian stocks currently account for 12% of the portfolio. “Egypt is much bigger and a more liquid market than other African markets – $95bn (€67.6bn) in value (as of May 2009),” says Bwakira. “There are hundreds of listed companies, helped by the fact that the authorities offered a number of tax breaks to companies that listed in Egypt in order to grow the market. We tend to concentrate on the top 50.”

The market has been oversold in the past, says Bwakira, and has undergone a sizeable correction in the last few months leading to more realistic valuations. “Over the last six months the market is up 35%, but it is down 42% for the last year. There has been a massive correction and it is now rebounding. But the market still needs 60% appreciation to get back to the level it was at before the financial crisis,” says Bwakira. And while a lot of investors sold their Egyptian assets last year, the international investment world’s risk appetite is returning, as is the sense of opportunism.

“Investors recognise that many Egyptian stocks are ridiculously undervalued and that is why we have seen such a quick rally. Over the last three months the Egyptian market is up 42% and on a six month basis it is up by 35%. So you can see there is a lot of interest in both emerging markets and the Middle East. We are still buying Egyptian equities at the moment and are very comfortable with this.”

Despite being one of the strongest economies in Africa, Egypt’s main competition in the asset management space comes from the Middle East. Rasmala, an investment bank with its headquarters in Dubai, opened its Egyptian asset management business in 2000. “It started with stock picking and the normal portfolio management service. We then added some new products – such as fixed income portfolio management and private equity portfolios, says Ahmed Abou El Saad, who heads up Rasmala’s asset management business in Egypt.

“We are now managing an equity fund in the Egyptian market which is sponsored by the Arab Banking Corporation (ABC). We also have a money market fund sponsored by the Export Development Bank of Egypt. And we are in the process of launching a private equity fund on behalf of Upper Egypt Company – a state-owned organisation.”

In El Saad’s view, Egypt is one of the few markets in the Arab world that has depth in the economy and is also one of the oldest markets in the region with some attractive demographics (including a population of 80 million). “It is always on the radar for international investors, particularly because there are no constraints in terms of foreign direct investment in Egypt, which is not
the case in other markets such as Saudi Arabia or Dubai.”

Investment in infrastructure
The Egyptian authorities, in addition to the economic stimulus efforts and the reshaping of the regulatory regime, have also invested in the market’s infrastructure. The national stock exchange was renovated in the mid 1990s and further work was undergone in 2008 to bring the trading systems up to international standards and to absorb growing trading volumes. “We now have an international trading system with strong software and one of the strongest clearing houses in the region,” says El Saad. And later this year an exchange specifically for small and medium stocks, called Nilex, is due to open.

Nevertheless, says El Saad, there is still a great need for further development. “We think of the Egyptian market as being mature and with a long track record, but there is a lot to add in terms of new products and approaches. In many ways it is still a small emerging market. Right now we have the simple conventional tools. We do not have short selling, derivatives or ETFs. They have been on the shelf for some time and perhaps now is the time to look at introducing these instruments. It will give the market more depth and could make Egypt a pioneering market in the region.”

©2009 funds europe

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