Sunday, 17 February 2019

Coffee with Mohamed Farid

Chairman, the Egyptian Exchange

Six years after serving as vice-chairman of the Egyptian exchange, Mohamed Farid (official bio) was tapped as EGX chairman in August 2017. His return to government service was preceded by a five-year stint as CEO and chairman of private-sector economic think tank Dcode, as well as an adjunct at AUC and the Arab Academy for Science, Technology and Maritime Transport, and a consultant to the World Bank. Since taking the helm of the EGX, Farid has seen through the introduction of a number of new trading tools and regulations, including market making, margin trading, and changes in the criteria for inclusion in the benchmark EGX30.

In the latest edition of our “Coffee with…” series, we sat down with Farid for a chat about the EGX and the questions on everybody’s minds. Edited excerpts:

Enterprise: Not all of our readers are in finance, so let’s start with the basics: What is a stock exchange?

Mohamed Farid: The stock exchange is a platform that any one can use to invest a sum of money for a return. Be it for significant investments or incremental saving in capital markets. It’s a platform where shares — a piece of paper that represents ownership in a company — are traded just like wheat, rice, sugar. Whether they are in food or in real estate, the companies on the exchange are ones that you and I deal with on a daily basis. These daily interactions between the consumers and companies impact the stock price, which in turn, impacts the company’s ability to draw investments, which it will then spend on making the product for the consumer. This interlocking dependence between the consumer and the company is why the stock exchange matters to everyone.

E: Incrememntal savings — can you break that down?

MF: One of the biggest missed opportunities for people, is the long term incremental savings benefits that come with investing in the stock market. It’s a problem of perception borne out of a misconception. The problem for the average person when it comes to capital markets — and the stock market specifically — is deciding on which stock to buy, when to buy it and when to get out. The concerns over swings and volatility become minute details when looked at from the long term perspective. We’re talking over a period of about 20 or 25 years, where it is perfectly possible to save around EGP 1000 per month on a monthly/annual basis. The longevity of the incremental investment should yield investors not to worry about what happens in a single trading day. People think 20 years is a long time, but numbers do add up.

A point to remember — it’s about investing in indices: What enables investors to overcome the choice and timing of their incremental investments or savings decision is investing in index trackers or instruments that are not prone to the movement of one single stock. This would reduce the impact of volatility in the prices of one stock in particular by investing in the constituents of an index.

E: What’s the missed opportunity here?
MF: Just look at how the EGX has grown from a market cap of EGP 400 bn from before the EGP float in 2016 to EGP 1 tn at its highest level in April 2018. We’re talking about more than a 100% increase in the value of the companies on the exchange. Few have reaped the benefits of this growth due to the lack of wider participation in the stock market by the middle class.

E: How are opening and closing prices calculated on the stock exchange?

MF: Opening prices are the previous day’s closing prices. Closing prices are determined by what is called the volume weighted average price.You basically add up all the money spent on every trade on a stock and then dividing by the total number of shares traded.

E: What’s the role of price discovery in the morning?
MF: The role of the price discovery mechanism is to factor into the opening price the impact of a major news or disclosure that came up after the previous day’s closing price and might affect the stock price. The pre-opening session — or the discovery session — runs from 9.30 am to 10am (when trade starts on the EGX). During this session, if the news is perceived as impacting the price, you will find investors placing orders on the trading system. The object of the session is to get a theoretical matching price that is different from the closing price and is considered the opening price for the stock.  

E: Let’s talk about volatility. It’s been a crazy year on the volatility front, first in EM and then the worst December since the financial crisis.

MF: The risk premium increased, whether it is for an emerging market or a developed market. With Brexit and the US-China trade war, the risk premiums on international markets will be present for some time. This rising risk premium will affect growth in developed markets and impact the decisions of the US Federal Reserve, which is why it has been raising interest rates at a slower pace than what was originally envisaged. Especially when you look at yield curves now internationally, they’re a bit flat. This should unfold in the first three quarters of 2019, to see dynamics of growth and inflation..

What makes Egypt stand out is the economic reform story and the government’s significant desire to expand the role of capital markets in the economy. The depth of fiscal and monetary reforms accompanied by unprecedented infrastructure investments increases what is called potential economic growth rate and developing social safety nets and programs as the assumed trickle-down-effect proved not to work 100%. The government has also demonstrated that it is agile enough to respond to the volatility in international markets. Case in point, the delay of the state privatization program. Postponing the program is not a cancelation, but a clear and temporary adaptive measure.

E: What is the current IPO pipeline?
MF: We have between 3-4 private sector companies that we’ve sat with and are interested in listing. And then we have the companies in the state privatization program, nine of whom are already listed. That would be the starting point. As for the new state-owned companies listing, they should have board approval, followed by a general assembly approval, so we’re supposed to see them soon in the market. Exact dates must be announced by the governmental committee managing the program. But what we’re sure of from the discussions with the government is that there is a clear interest and persistence in pushing this forward, as a means of expanding the ownership of companies and improving governance as well as expanding avenues for funding.

E: How will state companies become good corporate citizens under the program?
MF: They’ll get to develop. They’ll have to abide by the EGX listing rules, which ensure that companies have an investor relations manager and an audit committee, are disclosing the remuneration and compensation during GA meetings for whomever is interested. I believe part of the idea of doing the listings is not just benefiting financially but its further value creation. They’ll be ready.

E: What’s the top question foreign investors are asking you?

MF: We have two main areas of questions: 1) how adamant is the gvt on the reform programme, and 2) will there be u-turns? My response is very clear that from what we’ve seen from the perseverance and magnitude of decisions that took place, there will be no u-turn in macro policies. Furthermore, macro policies are now well understood as far as lowering the fiscal deficit and improving monetary policy.

I also think it is important to dispel myths foreign investors have around private sector participation. Look at the evolution of private sector participation as a percentage of GDP. In 2010 or 2011, it was 62% and it went up to 69.5% in FY2017-18. So reforms had an impact on the vibrancy and agility of the private sector in terms of dealing with economic turbulence and challenges. Reforms made them more agile and the prospects for the economy are positive.

E: What are they happiest about?

MF: We are getting a lot of positive feedback on the reforms recently undertaken by the EGX to improve their ability to trade stocks. These include expanding the number of stocks they can trade in a day, reducing the circuit breaker timing, and enforcing an increase in the number of bilingual disclosures. Back in 2016, only around 20 companies used to issue bilingual disclosures. That has increased to 53. Investors have also taken notice on the positive impact the economic reforms have had on the market dynamics in general. Not many countries implementing a reform program has seen their markets improve as well as ours. They’re also seeing the benefits of market liberalization in sectors such as electricity, where the Feed-in Tariff program helped advance the renewables sector in Egypt.

E: The EGX has been working on developing new indices. What’s happening on that front?

MF: One index that EGX has not developed before is a total return index — one that takes into consideration dividends as opposed to just prices as is currently the case. We’re going to issue this index very soon. The EGX30 Total Return will be backdated to show people that it’s not only about price movements, but that there’s a cash component that you can’t be oblivious to because it also creates returns. Even if the price movements aren’t in your favour as an investor, you will have other components that reflect or improve some of your investments going forward. This index will be be issued sometime in 1Q2019. We’ve also recently released the EGX30 Capped, which is capped based on the max threshold of investments in a certain stock which are set by executive regulations of the Capital Markets Act. For fund managers, the index is a way for them to compare apples to apples rather than something that’s not comparable. For example if a fund manager can’t reach the weight of CIB in the index, through a capped index they’d be able to mimic this index and try to increase passive investments. It doesn’t have to be an ETF, it can be funds established with other issuers in the banking community, and even open end funds that can mimic the performance of this index.

E: Why don’t we see ETFs in Egypt the way we do abroad? It’s only Beltone that has an ETF in Egypt at the moment, right?

MF: So far, It’s basically Beltone. I believe the main issue was how you tackle ETFs. They’re not to be sold to the same investors that are betting on significant price movements because they’re less volatile. Hence, they require a different approach in marketing and educating the public towards the benefits of passive investment and incremental saving. There’s a significant education required for people to understand the concept of ETFs and the concept of an incremental saving approach through capital markets and that this diversification saves people from the difficulty associated with trying to figure out a specific stock trajection. It is a financial literacy issue that could be a hurdle. Another important aspect is the concentration of some companies in the index itself. The purpose of the ETF can be mimicked by buying three or four companies directly from the market.

E: The Finance Misnistry has recently been meeting with Asian investors. Where are the Asian investors in publicly traded equities?

MF: Their presence is very minimal so far.

E: Why? And is it an opportunity?

MF: It’s definitely an opportunity. The easier route for issuances for us is to go to the usual suspects of Dubai, London, New York. Reeling in potential Asian investors will require continuous overture and a continuous relationship maintenance from the part of the government, agencies and the private sector. A top-down approach would be government representatives meeting potential investors in addition to convincing analysts sitting on these funds that Egypt has good opportunities for investment with a unique story especially when compared to other EMs. Hopefully we’ll be able to draw more East Asian investors when we see sovereign sukuks issued. As for the private sector, further effort needs to be done on the part of the brokerages.

E: You’re a student of the market. What types of shifts have we seen in terms of composition of market participants in the last few years? And what are the changing patterns observed within institutions?

MF: In terms of aggregate figures, they’re almost the same. Institutional investors account for 30-40%, non-Egyptians around 35%, and the remaining are retail investors. Within each category, we see some differences. Historically, domestic institutional investors are more medium term but they’re now more short-term in their trading behaviour. International foreign institutions bet on the medium term of the company/market/country. When it comes to individual investors, they’re getting older. We need a new breed of young investors in the market, which is why we’re working on education and financial literacy. They’re still very active when it comes to the limited number we have but we don’t see significant young players.

E: They’re aging out? Why are there no new people coming in?

MF: It’s a lack of knowledge on capital markets and the stock market. It requires a significant education campaign from the very young, primary school to university students we’re trying hard to educate, even company employees. And this education needs to be continuous. It’s not a one-off where we train company employees on capital markets and how they can invest. It would include approaches to investing if you have a little money and time and vice versa. We need to clarify these alternatives to people because the misconception is that investing in the stock market is for the wealthy, experienced people with time. You have investment vehicles that can cater to the different types of investors.

E: So what is a good EGX company and how do you ensure that it doesn’t become a zombie company?

MF: A good EGX company is a company that has investment opportunities and is relying on capital markets to finance these opportunities. The good EGX company abides by the listing rules and has active investor relations managers doing their job properly and dealing with investors in a proficient way, if they have a proper auditing committee from the board of directors, investment committee, internal processes, and they announce material information on time. One of the exchange’s main roles is to take these closed boxes, family-owned companies and educate them about the benefits of listing to finance growth plans and the transparency needed for such a course of action. Regarding the already listed companies, we’ve established a special unit to make sure listed companies abide by financial disclosures requirements and standards, and enforcing timely and informative release of these financial reports. The unit gets down to the nitty gritty details, going so far as to have companies explain footnotes on their auditor’s reports that are not clear, and obviously, check the financials and making sure any errors are corrected to the public. We also call out companies through the EGX screen who have not sent in their financials 1-3 weeks ahead of the deadline, which allows investors the space to mount pressure on the companies to make them disclose their financials in a timely manner.

Private sector salesmanship: To be able to quantify the demand for listing and make it a KPI for the EGX’s listing department, we created in-house a customer relations management (CRM) system back in October whereby we have a lead and the lead converts to a potential company. We would then reach out to the company to follow up on its status. This will help us gauge the pipeline potential. We’re going about it in the same way a private sector company would, because listing companies is part of our bread and butter. Even prior to listing we offer potential companies advise as a way to build a relationship with the company. This is why you see us working heavily with RiseUp and we’ll be working heavily going forward with other players trying to educate them on the bourse.

E: Alright, I’m a large privately held Egyptian company and I want to go public. Why do it with the EGX and not the London Stock Exchange or Dubai or anywhere else?

MF: One would be that liquidity in the EGX for Egyptian companies would be higher than in the LSE or Nasdaq — they’re not even comparable. The second reason would be the costing — we’re way cheaper than the other markets. We also have stability in the regulations. We are well-rooted when it comes to regulatory frameworks. And we had emerging market status in the MSCI and WEF since 2002. We constantly are abreast of tech advancements, procedures, processes, though, admittedly, we need to invest in them further. That, in addition to liquidity, exposure, and access, etc. When you look at the participants from pension funds, they’re here due to the size of companies, liquidity and so forth. Furthermore, additional reforms are coming, from both the trading perspective by introducing derivatives and short-selling, which will add depth to the market. And the most importantly, there’s  the diversity of the market and sectors listed on the exchange itself.

E: Let’s look at LSE specifically for a minute. They’ve been fishing in our waters for a while now. They throw a party here and then they go to Dubai and Riyadh and make their case and then you see companies going there and three shares a day change hands. Again, why EGX and not LSE specifically?

MF: At the end, it’s competition. It’s very normal to have competition from other markets and other players, it’s about what you can offer in terms of services, liquidity, exposure and support. On liquidity especially,  investors used to investing in LSE, invest very big. You wouldn’t find liquidity in the market when you’re competing with very big listed companies. Maybe they can be benefiting by adding some GDRs in foreign exchanges, but I believe the main listing has to be in the homeland, here in the EGX. This is important for local companies to test themselves in an homegrown exchange that they can relate to. What creates liquidity in addition to institutional investors is retail. Medium term investments are being driven by institutional investors and that’s the balance you want.

E: Is it fair to say that there’s not yet a market for corporate debt here like there is in GCC? And what can we do about that?

MF: Corporate debt is a long story. We had a relatively active issuance market, bearing in mind that in all markets (and not just in Egypt), private sector debt or bonds is not actively traded much on exchanges. But they have an active primary market, where there are plenty of issuances that are not traded much. What happened during the last years, we had some bonds issued between 2002-2008 from the private sector, but at that time the interest rate environment in Egypt was quite low, enabling private sector issuers to go to the debt market. Nowadays it’s quite different interest rate environment, but we hope to see them come down soon and see more issuers. There are efforts being made to lower the cost , including approved amendments to the Capital Markets Act that reduce the listing fees for bonds. Given that bonds are very sensitive in terms of cost, we reduced this amount significantly by a tenth with the aim of promoting primary issuances and listing them on the exchange. What is still very active and you need to check it are the issuances of asset backed securities and mortgage backed securities.

E: Mortgage backed? Like the stuff that Palm Hills Development did last fall?

MF: Yes. So we have some issuances of bonds that are backed by real estate. Asset-backed doesn’t necessarily mean mortgaged-backed, such as a portfolio of loans for cars. One of the main issuers is a car leasing company, and we also recently listed securitized bonds issued by a financial leasing company owned by an investment bank. So that is the inauguration of a wave of listings on the primary market of bonds.

Getting gov’t debt on the EGX:  bonds market.We’re working closely with the Financial Ministry, the central bank and other concerned parties to get an active treasuries market on the exchange, as this is a prerequisite for an active or semi-active market for corporate bonds. This will, in turn, have a knock on effect of improving the cost of debt structure for the country. You get to see interest rates going down, liquidity risk premium decline, and you have a yield curve so companies can issue short, medium, and long term bonds.

E: What happened to Nilex?

MF: We lost track, but we’re getting it back on track. The main goal for the Nilex is for these smaller and medium-sized companies with aggressive growth plans to rely on capital markets to grow further. The main issue is that some of the companies were medium sized with no growth targets. Reforming the Nilex would be different than the EGX. On the latter, reforms can be implemented incrementally. But for the Nilex, a comprehensive sweep needs to be made. This may potentially include segregating companies between those that have growth potential and those that are not growing. Another thing we’re also looking at is funding the funders – ie listed venture capital and small private equity firms. He’s doing the diversification on your behalf. You’re investing in a company that’s investing in 10 or 20 companies. The EGX, in partnership with the European Bank for Reconstruction and Development (EBRD), is studying potential reforms we can try to adopt to bring this about. Once the study’s over, we can come with a comprehensive reform plan. The study should be done by 2H2019.

E: I’m going to walk you through instruments and concepts and ask for 1 word or sentence answers. For example, what’s a sukuk, why do we need them, what’s the status, when is it happening. So, sukuk:

MF: It’s a financial instrument that enables the issuer to raise funds to create a Sharia compliant  project.

E: Why do we need them?

MF: We need them because it’s about diversification of financial instruments and it’s one of the legitimate instruments available in the market and therefore it has to be available to the public.

E: Status?

MF: The regulatory framework is out. Whether the private or public sector are going to resort to it, that’s a different story, but the regulatory framework is there.

E: Short term bonds/debt issuance?

MF: It is a bond with a short term tenor of less than one year.

E: Short selling?

MF: It is the mirror image of margin trading, except you will be able to borrow stocks and sell them on the market as opposed to borrowing funds to buy stocks. The executive regulations were issued in 2005, but details on implementation have not been issued yet. We’re coordinating on it with the regulator who is convinced of its importance. We should be seeing it in 1Q2019. We’re done with the IT requirements to be able to monitor the market movements and assess what’s happening.

E: Will you guys report short positions to the public?

MF: No.

E: There’s a limit on the number of shares, percentage of a company that can be shorted.

MF: Of course. Historically it was 10% but this still has to be announced by the FRA according to the implementation rules to be issued by it.

E: Futures and options, which gets into commodity exchange?

MF: Initially, it would be futures and then options, that’s the natural progression. Trading platform and settlement systems are being amended and developed, while trading and settlement rules are being written. So we should be seeing it, hopefully, in late 2019.

E: What is a commodities exchange?

MF: A spot commodities exchange is a platform that allows trades in a certain commodity that has a certain specification – whether it is graded, warehoused, has a large scale of usage and a significant number of players.

E: Market making

MF: A mechanism that enables certain players in the market to create a specific market and benefit from the bid-ask spread in a legitimate way. Potential market makers will need to be licensed by the FRA. It could be a holding company that takes the license or a separate company that takes the license. The regulations are out. In terms of application and whose applying, we’ve seen some potential interest between the market players now and we’ve followed the same scientific route in terms of studying international markets, discussing their expertise and examples with the Egyptian Capital Market Association and the Egyptian Investment Management Association as much as possible, and then we come up with the rules.

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