"What is true for London, Paris or New York is not necessarily true for Egypt. You cannot have a market that has been closed and mothballed for decades turn back overnight into a problem-free market."
This comment by an Egyptian banker on attempts to modernize the Cairo Stock Exchange (CSE) reveals the full extent of the challenge ahead. It is not the establishment of new systems and regulations, difficult as these are, that is the main problem facing the reformers: it is the hidebound ways of the borrowers, the investors and the stockbrokers which are the most resistant to change. Until they do change, the full potential of the CSE cannot be realized: it has a tiny $5 billion market capitalization and consists of 700 companies, of which only 40 are actively traded.
"Almost nothing exists. Companies do not go and raise capital on the stock market. They do not even think about it," continues Mohamed Ozalp, whose Misr International Bank (MIBank) owns a share of a new broker El Rawad.
As for investors, Ozalp points out, along with many other commentators, that Egyptians are used to tangible assets such as property and gold. Shares and bonds are not regarded as intrinsically valuable - a perception that is likely to be reaffirmed rather than dispelled by the proposed automation of trading and settlement.
More appealing than the computer print-outs this will generate are the ornate bond certificates - representing long-defunct issues - that now decorate the walls of some Cairo brokers' offices. But these are set to become a dying species as the CSE braces itself for the paperless era.
Even the brokers are apprehensive about what lies ahead. They have grown used to a CSE system in which they deliver their orders on a floppy disk - the one sop to modernity - two hours before trading begins at 10.30 am. The opening price of a share is that at which the most trades can be matched and may have no bearing on the previous day's close. In addition, the committee of the stock exchange board, which oversees the price discovery mechanism, is bound by rules that limit a price movement to no more than 5% in a day's trading and 20% in a week's. There is currently a rancorous debate as to whether the regulation of price movements actually applies to the upside as well as the downside. Either way, these market inefficiencies are credited by some with preventing the CSE from crashing last summer when an index rise of 180% in just over a year finally ran out of steam. It is quirks such as this that Egyptian brokers would like to preserve, and they have the support of senior government officials.
Fagr El-Nour, who recently left the chairmanship of the Egyptian Capital Markets Authority (CMA) for a senior executive role in an Egyptian-Korean joint venture, Egypt Far East Bank, says that brokers who stuck with the exchange through its leanest years deserve recognition.
"They spent the best part of their lives acting as stockbrokers. They have made a contribution just by keeping the stock exchange alive rather than closing it down," he says, referring to the mid-1970s when the effects of nationalization reduced turnover to a trickle. "You cannot just tell them now the time has come for change. Go home. Go out of business. We'll start completely from new. It would have been unfair, unwise and inefficient because they had talents and expertise, albeit with chalk and blackboard and open outcry."
Designing an Egyptian model
Not all sections of Cairo's financial community are so patient with the slow rate of progress. In fact, those brokers who consider themselves progressive regard El-Nour as part of the old guard that has held up change. They are frustrated by the antiquated methods of the CSE, delays in implementing reforms and the failure to agree on what kind of system to adopt. A central clearing organization was originally slated for start-up in April 1995, but it has since been rescheduled to this April, with little likelihood of hitting that deadline either. Argument over whether a foreign system should be imported wholesale or whether parts should be grafted onto the existing set-up, is one reason for procrastination.
While progressive brokers would prefer the most expedient solution of borrowing a tried-and-tested system, El-Nour says: "It would be right to adopt an integrated system if we are just copying bids and prices. But we are designing an Egyptian model."
"In the French model [which CMA officials are studying], in the central depository, banks do take a very important role and indeed do play a very important role in the whole process. This is not the situation in Egypt. Banks do play an important role here but they may not be brokers. I am a great believer in Glass Steagall, at least in the medium term. So this is the basic difference between the French system and the system that is going to be applied in Egypt. Egypt is not adapting bits and pieces of different systems. We are designing Egyptian systems that will fit with the Egyptian way of doing things."
El-Nour adds that in overseeing the CSE, the Capital Market Authority has had to strike a balance between constant intervention and allowing the Cairo Stock Exchange management to run its own affairs without interference.
Developing an equity culture
To his credit, during his last 18 months in office, El-Nour presided over a series of initiatives including the drafting of the new 1994 Capital Markets Law, part of which is designed to improve the workings of the exchange's management and systems. He was also a strong supporter of the creation of the Egyptian Company for Clearance and Settlement (ECCS) to centralize clearing, which all observers agree will change the whole perspective of the market when it finally begins operations.
But whatever the hurdles to be cleared on the systems side, they are minuscule compared with the challenge of changing local attitudes to the stock market. Despite the long history of the Egyptian bourse, which stretches back into the last century, an equity culture has not developed. The CSE is still referred to as a new market in which speculators dominate and mainstream investors hardly participate.
"This is a new market that has a lot of peculiarities that defy modelling," says Mohamed Hossny, vice-president of Triple A Securities, one of the newer brokerages to join the exchange. "When people shy away from a security, they shy away totally. In every stock market in the world, there is always a price. But here, when people turn their backs on a share, it turns into toilet paper."
Says one leading broker: "The individual Egyptian investor is still very unsophisticated. He doesn't know the difference between a stock and a bond. Some of the brokers are little wiser."
Hopes for a more enlightened approach rest on the emergence of local mutual funds and the greater interest being shown in the CSE by foreign fund managers. There are now nine Egyptian mutual funds run by five institutions. They hold more than 8% of the securities on the Cairo Stock Exchange.
"They represent a significant presence in the market," says Hussain Chourci, a financial adviser who is also a board member of the Ahli Fund, run by the National Bank of Egypt. Chourci rejects the accusation that the funds do not play a sufficiently active role in the market. "If you consider that only say 30 stocks are actively traded, then our position in the market becomes far more significant," he explains. "In my view, the funds keep the market alive. They provide liquidity and professionalism."
Foreign fund managers have been visiting Cairo with increasing frequency in the last 18 months. "They can see the opportunity and they are anxious for research and analysis," says Hossny of Triple A Securities, "but when they ask about liquidity and the speed with which they can join and leave the market, they are still disappointed. The important thing is that they remain very interested, so it would seem that they believe that with the right market conditions Egypt is a country where they should be."
Others agree that a significant improvement in the fortunes of the Cairo Stock Exchange could come about from putting basic reforms in place even in the absence of a widespread equity culture.
"If the promised structural reforms are made, I think that merely in days, rather than weeks or months, you could have a thriving capital market in Egypt," says MIBank's Ozalp. "The system is essentially there. It is not something that needs to be created. It is just a matter of putting the rules and regulations in place and providing the product. It is like putting fuel in the tank. The car is ready to go. It just needs gas. And the money is there. Not just the E£150 billion ($43.8 billion) of liquid deposits but the funds abroad. So if you can mobilize even a small percentage of that, you can do miracles."
But first, systems have to be set straight. Apart from inefficient price discovery, the rules concerning brokers' ability to hold inventory, make markets and underwrite stock need to be clarified. They appear to forbid these activities but, certainly as far as underwriting is concerned, according to one banker, there is a case to be made for its allowance. However, because of the way the rules are currently interpreted, brokers are not required to have very much capital behind them.
The emergence of undercapitalized brokerages, manned by unqualified staff, is made possible by the low licence fee of E£62,500 ($18,300), only one-fifth of which is payable upfront. These newcomers are proving more unnerving to the professionally run brokerages than the old-timers because of their capacity to bring the market into disrepute. Their presence has also sparked a pricing war.
"There are now more than 70 of us [brokers] and in such a thin market, there simply isn't the business to go round," says one broker. "So we have a commission war on our hands, with some of these brokerages cutting prices so fine, they are virtually working for nothing - say 0.005%. Inevitably, clients are tempted by this, which makes it hard for established, qualified brokerages to pay for the quality of service, including precise execution of orders and research, that ought to be in this market."
Against this background, measures to make the market more efficient and assist it to gain depth acquire a degree of urgency. But some brokers are concerned at the form the ECCS is taking.
Aly El Tahry, who is managing director of Hermes Financial, which he established with fellow ex-Kidder Peabody executive Alladin Saba, confesses that he is puzzled by the work being done on the ECCS and its systems. "The confusion until now is that there are three distinct roles that seem to have been allotted to the clearing company - clearing, custody and central depository," he says. "Some would maintain that the custody role should be a private market service. The clearing role, however, is a service that is provided to the professionals in the field and that is linked to some sort of guarantee. There is a system insurance aspect."
"Finally, there is the central depository role, which involves the transfer of ownership, or facilitating the transfer of ownership, acting as a registrar as well as providing an easy means of transferring instruments from one owner to another."
The local custody business, says El Tahry, is already developing, with the National Bank of Egypt, Citibank and American Express among the leading players. He believes that the ECCS should be concentrating on the clearing role alone "because it involves the issue of credit and there is a risk to be taken if the system fails".
Another broker wonders why the CMA is so keen to "re-invent the wheel" when there are proven trading and clearing systems that can easily be adopted in Egypt. Publication of a recent US study of the capital markets has been stalled by the Egyptian government which was reportedly incensed by some of the conclusions drawn. One source described the document as being "an opportunity for highly qualified graduates to demonstrate their erudition. It was not well received by the authorities".
Despite the hold-ups over the ECCS, there has been some positive news for the CSE on the issuing side. This has come from government bonds and, to a lesser extent, corporate bonds rather than equities which may have to wait for a much-needed boost from the currently stalled privatization programme (see box).
Boost from bonds
The Central Bank is reported to be thinking of launching a second bond issue after the success of its E£3 billion five-year paper last summer. The tightly priced issue was aimed at institutions at a time when there was liquidity of E£150 billion in the market. Stories persist that the banks had to be stuffed with the paper which, at 12%, offered only 0.5% over bank deposit rates and therefore did not appeal to individual investors, admits one banker. However, it is clear that as interest rates began to fall in the autumn, banks and financial institutions were happy to hold a tax-exempt security offering a yield of between 17% and 18%. As a result of this, little in the way of a secondary market has developed in the paper on the CSE where the bond became the first government security to be quoted in modern times.
So far only two corporate bond issues have taken place, the first for the local subsidiary of Hoechst, done by Paribas, and the second, an issue for Victoria, a tourism project, which a banker says "fell flat on its face". Egypt Air is rumoured to be considering an issue and one broker says he has a private client with whom he is actively exploring the option of issuing equity warrants.
The opacity of company accounts frustrates both local and international investors. While Aly El Tahry believes that some leading companies are becoming used to the probing questions of researchers, he accepts that many managements have yet to be educated in the need to present their company positively and in detail. The leading international accountancy firms are nearly all represented in Cairo. Outside of advisory work, they find good business auditing blue-chip local companies which now accept the need for an authoritative signature under their accounts. The problem is that because the CMA has still not instituted standard reporting procedures for listed companies, it remains difficult for investors to compare like with like.
Investors concerned about the slowness of reform should perhaps reflect on the turbulent past of the stock market in Egypt. This would help them to realize that the institution is a survivor and, given time, will almost certainly overcome the current turmoil - but at its own pace.
The Alexandria Stock Exchange, established in 1883, was the first to be founded in the Middle East and was once the world's fourth busiest. Senior to Cairo until World War Two, the exchange burnt down in the 1970s and is now housed in a former bank. Both the Alexandria Stock Exchange and the Cairo Stock Exchange, which was founded in 1898, saw their turnover plummet after Egypt's nationalization programme in the 1950s and 1960s. By 1974 turnover on the CSE was down to E£4 million from a high of E£66.7 million, 11 years earlier. By the late 1980s, there were only 15 brokers left and the Cairo Stock Exchange was dubbed "the most exclusive coffee club in Egypt". Small wonder, then, if it takes a few years to revive it.
