Muhammad Nabil is a partner at Sharkawy and Sarhan, a graduate from Faculty of Law, Cairo University, and one of the firm’s top experts in the field of capital markets.
What are capital markets?
Capital markets are financial markets for buying and selling equity and debt instruments. The idea is to treat money as if it were a commodity, which in turn would treat companies and their services as a commodity as well.
Capital markets in Egypt are very competitive. The issue we face in Egypt, like any other province, is that there is no specific law that encompasses everything; you will find the regulations scattered along various legislation.
The main legislation in Egypt is the Capital Market Law no. 95 for 1992 and its Executive Regulations. Also, you will find many regulations in different factors other than capital markets, such as Companies Law no. 159 for 1981 and its Executive Regulations, EGX Listing and Desisting Rules and its Executive Regulations, Central Depository and Registry Law no. 93 for 2000 and its Executive Regulations, Law no. 10 for 2009 on the supervision of non-Financial markets and instruments, overlapping and implicating in Anti-Money Laundering Law no. 80 for 2002, and various market regulation decrees issued by EFSA and EGX, which take the form of board decisions and circulations.
The EFSA Board of Directors issued new guidelines to regulate the indirect acquisition of companies listed on the Egyptian Stock Exchange by Decision 54/2016, dated April 24, 2016 (the “Guidelines”). These guidelines helped settle some uncertainties relating to whether a Mandatory Tender Offer (MTO) in Egypt was required, if an acquisition was taking place on an offshore company that owns stakes in a listed company. Pursuant to the new guidelines, EFSA has the discretion to exempt the indirect offshore acquirer of listed companies from filing an MTO if certain conditions are met. Such indemnity is not automatic and must be applied for by the acquirer.
These guidelines came to regulate the principles that have been established in 2014 by the State Council, where the verdict overruled EFSA’s long debated decision, regarding mandating Lafarge to file an MTO with respect to one of the subsidiaries of Orascom Building Materials acquired by Lafarge back in 2008. The guidelines settled the ambiguity and the impractical hardship in cases where the purchase is an offshore holding company that owns assets/subsidiaries in various jurisdictions, and not merely an offshore Hold-co SPV.
The Guidelines state that whoever obtains (individually or in concert with related parties) over 50% of the shares or voting rights of a target (the Target), who in turn owns (individually or along with its related parties) over 33% of the shares or voting rights of a listed subsidiary (the Listed Subsidiary), may be exempt by EFSA from filing an MTO if certain conditions are met.
The conditions for exemption are as follows:
(i) The Target must also own shares in companies other than the Listed Subsidiary;The Listed Subsidiary must represent less than 50% of the book value of the assets owned by the Target as evidenced by its last audited financial statements. The report by the auditor of the Target, that is attached to such financial statements, should have no reservations over the Target’s financial position; and
(ii) The acquirer does not own (individually or along with its related parties) any shares or voting rights in the Listed Subsidiary.
Curbs on GDR Trading
With the severe USD crunch, some companies have been snapping up shares of Commercial International Bank (CIB) on the Cairo market, paying in Egyptian pounds, only to convert them into GDRs and sell them in London for dollars at a loss of as much as 30%. Last year, the Egyptian Exchange has banned the practice for local investors, mandating they be paid for GDR sales only in pounds and in Egypt, but the rule change still left the door open to overseas investors.
There are only 9.2m CIB shares, representing 0.8% of the total, left that could be traded as GDRs before hitting the regulatory maximum. EGX listing rules cap the amount of shares that can be traded as GDRs for any company. For Edita, the EGX says only 10.7m shares are left before reaching its threshold.
Other newly listed companies seek to implement GDR programs, presumably for the same reasons including the now listed, Domty.
No more offshore settlement for Un-listed share deals
At the end of May 2016, EGX issued a requirement for registering unlisted shares; the price must be settled through a bank that is licensed and supervised by the Central Bank of Egypt, especially if the actual value of the transaction is more than EGP 100,000 or if deal involved an offshore party.
Amendments to EGX Listing Rules Relating to Disclosure (EFSA Decision 47/2016):
The EFSA issued Decision 47/2016 amending the disclosure requirements of the Rules Governing Listing & Delisting Securities on the Egyptian Stock Exchange, as issued by EFSA Decision 11/2014. The main points are as follows:
• Listed companies must now disclose any pending claims, whether before an arbitral tribunal or a judicial court, as well as any verdicts issued by any of them; and not just judicial court verdicts, as was the case before. However, EFSA set a floor for disclosure in all cases, according to which listed companies may only disclose significant verdicts (those relating to payment by the company of amounts equal to 2% or more of its ownership rights, as evidenced by its last audited financial statements.
• A listed company must also disclose any verdict that issues a custodial penalty against one of its directors or primary officers. Also, any pending case where a director or primary officer is accused of company-related violations must be disclosed.
Amendments to EGX Listing Rules Relating to Governance (EFSA Decision 35/2016):
EFSA issued decision 35/2016 amending the governance requirements for the Rules Governing Listing & Delisting Securities on the Egyptian Stock Exchange as issued by EFSA Decision 11/2014. The main points are as follows:
• Joint Ownership of Affiliate Companies: An EGX listed company that is controlled by one person or a whole organization, as well as any affiliated company may not own more than a 10% stake in each other’s shares or GDRs. Control in this context means ownership of 50% or more shares and GDRs. This restriction does not apply to stakes that have been issued before EFSA’s decision on March 23, 2016.
• Disposing of Company Assets: An EGX listed company may not dispose of more than 50% of its fixed assets or any other assets related to its activities, except after obtaining an EGM approval. This only applies for contracts concluded after March 23, 2016. For the calculation of fixed assets, EFSA Circular 1/2016 uses the book value of assets net of any accounting depreciation or erosion.
• Expansion of the Scope of Treasury Shares: If the shares of the EGX listed company are purchased by an affiliate company or by a company under the control of the EGX listed company, these shares will be deemed as treasury shares as per the meaning of the law. They must be disposed of to third parties within one year from the date of purchase. Sale of treasury shares by an EGX company or by an affiliate to any affiliated or controlled company is not valid. Again, “control” in this context means 50% or more ownership of shares and GDRs.
• Reinforcing Governance: The Independent Board Member of the EGX listed company may not be a shareholder in the company any longer. In addition, the company’s internal supervisory committee must include two independent board members rather than one, as was the case before. Deadline for compliance with these rules by existing EGX Listed Companies is June 30, 2016.
• More Governance: The Board of Director report, which is submitted to the Annual OGM, must include a list of all the company’s agreements with one of its founders or main shareholders, and the date of the prior approval by the OGM for each contract.
The amendments allow the sale of shares after the General Assembly determines the time of distribution, and the date for the dividend payment. The new owner of the shares is entitled to the dividend.
Two new instruments have been introduced to Egypt’s Capital Market. In February 2016, the Executive Regulation was amended to permit the issuance of Unrated Bonds for private placement. “Unrated Bonds” are debt instruments that have not been assessed by a credit rating agency; which is a statutory requirement for the supply of any bonds under Egyptian Law. In Decision 23/2016, EFSA defined the requirement and conditions for issuing such bonds.
An underwriting company licensed by EFSA must handle the initial offering of Unrated Bonds. Thus, a company who wishes to issue Unrated Bonds must have a capital of at least EGP1 million and must have operated for at least 1 year. The bonds cannot be offered to the public and can only be subscribed by financial institutions, such as banks and investment funds, along with financially adequate persons, such as public enterprises and experienced natural persons.
Moreover, the Decision defines “Covered Bonds” as bonds issued by joint stock companies in consideration of, and backed by, a separate portfolio of its deferred financial rights, in addition to other collaterals. These Covered Bonds may be issued to credit institutions and other companies that carry out sale by installments. This may include mortgage companies; financial leasing companies and vehicle sellers may issue Covered Bonds. Companies working in other fields may also receive a license, if they have a separate portfolio of financial rights.
Furthermore, the Decision provides conditions for other assets that may be used as additional collateral for the bonds. These include undisputed notarized real estate property, or movables that can be pledged on the new Online Register for Pledge of Movables, which was introduced in 2015.
The recent regulations influenced the market currently, but this effect is not direct. However, what is evident are the various instruments that offer numerous methods of funding to companies, as debt capital market has been historically dormant in Egypt. I believe introducing new debt capital market instruments is a step into reviving this market. Nevertheless, this step needs to be followed by other advances to get the gears of market starting, such as creating visibility on the practices, requirements, timelines and associated costs. When more instruments are introduced to the market it creates an invigorating effect, and provides for a much more stable trade.
One of the key elements in capital markets is the Initial Public Offering (IPO). IPO is a complex process that involves various parties and extensive documentation. The procedure typically takes place in two stages: the first stage is listing the company on EGX, and the second stage is completing the offer on EGX and commencing the trade. This process is similar to England and Dubai’s techniques.
Calling it an IPO is a bit of a metaphor because typically it is made as a secondary offering in the EGX, as shares of major shareholders need to comply with the listing requirements. The terms of the offering acknowledges that after the completion of the contribution, a capital increase will take place equivalent to the amount of the shares offered in EGX, hence leading to a closed subscription limited to the offer’s shareholders only.
The key steps are typically as follows:
• Pre-Listing Actions:
The company seeks to agree with the investment advisor/promoter on the broad lines of the offering, and whether changes need to be implemented in the Articles of Association for compliance with the listing rules (for example, removing restrictions on share transfer, or splitting share if its values are considered high for marketability, etc.). In addition, the company must register its shares with MCDR.
• Admission for Listing:
The company presents the application for listing to the EGX listing committee only if the conditions relating to shareholding structure are met, and the offering within six months from admission. • Preparation of Offering: The company procures a fair value report by one of the IFAs, and then holds an EGM to approve the fair value report and the auditor’s report thereon. Additionally, the EGP typically delegates the board or chairman to finalize the terms of the offering, agree on the price stabilization account terms, and take all actions relating to completion of the offering. Also, the EGM approves the relevant share lock-up arrangements by the principal shareholders. Afterwards, the company procures EFSA’s non-objection on the principles and methodologies of the IFA fair value report.
• Offering Publication:
The draft offering is then presented to EGX for review and publication approval. The offering must be published within two weeks from such publication.
• Offering Completion & Announcing Trade Commencement Date
• Price Stabilization Period:
Egypt needs more knowledge and information to overcome its barriers of investment. It also needs constant practice, seeing as it is a learning process. It has been announced recently that by the end of 2016, Egypt will launch the first commodity exchange. The relation between the commodity market and the stock market comes from the fact that “commodities are drilled, dug, produced and refined by companies listed on stock exchanges”. Consequently, when the price of a certain commodity increases on the commodities exchange, companies that produce this product will make more profit, and accordingly the price of their stock will increase. However. companies that use this commodity to manufacture another product will witness an increase in the cost of its production, and make less profit. Thus, if such company is listed on the stock market, the price of its stock may decrease.
There are three objectives of any security regulation (i) protecting investors; (ii) ensuring that markets are fair, efficient and transparent, (iii) reducing systemic risk. A question arises from the aforementioned objectives;
Do the current legislation provide these objectives?
I believe, yes. Our emerging market is still in the learning process. During the past two years, there have been a lot of initiatives towards developing the market and refining its performance, despite the volatility of the Egyptian market in general. There have been significant potential reforms for the current capital market laws and regulations, such as:
• Facilitating the process and reducing the paperwork required for transfer of unlisted shares.
• More visibility on requirements and practices through compiled and updated guidelines.
• Consistency in practice.
• Future and other derivatives market.
• Offering offshore securities.
Overall, capital markets in Egypt have potential and prove to be a major necessity to create a prosperous economy.