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CBE thwarts GDR arbitrage
One of Egypt’s biggest problems in luring investment
has always been a fear on the part of foreign investors that –
should they ever wish to exit the market – they might be unable
to turn their assets into hard currency. So in May, when stock-market
investors started noticing severe delays in the standard repatriation
process, despite earlier pledges by the Central Bank of Egypt (CBE)
that it would provide them “with all of their foreign-currency
needs,” they had reason to be concerned. According to one local
analyst, “No one was getting any money from any transaction”
from May 22 until the last week of June.
The shrewd and the skewed
In the summer of last year, to allay fears of just such an eventuality,
the CBE gave assurances that foreign investors would get their returns
from the stock market in dollars, calculated at the CBE’s official
exchange rate on the day of the transaction. “Foreign investors
governed by the Investment Law are guaranteed the convertibility
of funds for repatriation,” according to a Guide for Investors
in Egypt published recently by the European Commission. “The
amount of hard currency available for repatriation is calculated
on the basis of the current exchange rate and may be transferred
in one installment if the foreign-currency account balance is sufficient
to cover the amount.”
According to sources at several brokerage companies, the reason
for the recent delays was a decision by the central bank to freeze
its foreign-currency account, effectively preventing foreign investors
from getting their hands on either their principal or their dividends.
As a Beirut-based analyst who specializes in emerging markets noted,
“the whole thing has been very hushed up.”
Citibank’s global securities department mentioned the problem
briefly in a June 5 statement, saying that the repatriation process
“was temporarily put on hold as of May 22 for review by the
Central Bank of Egypt.” That single mention, issued under the
headline “Repatriation situation in Egypt continues,”
was tempered with the hope that the CBE would unfreeze the account
in the days ahead.
While the account, apparently, was finally reopened in the last
week of June, the question remains: what could have prompted such
a radical move in the first place? Market observers concerned about
the situation said the suspension of the account was a stop-gap
attempt by the CBE to prevent currency arbitrage in the global depository
receipt (GDR) market.
GDRs – receipts for stocks in local companies that are listed
on major international stock exchanges – are designed to facilitate
the trading of shares from abroad. There are currently nine Egyptian
companies with active GDRs, all of which trade on the London Stock
Exchange. These receipts pay dividends in dollars, and the system
– as the exchange rate falls in or out of line with actual
market demand – occasionally offers the shrewd investor “relative
value opportunities,” according to emerging-market investment
guru Peter Marber, author of From Third World to World Class.
Just such an opportunity presented itself in Egypt thanks to the
skewed nature of the country’s official exchange rate. Investors
realized that they could make a profit if they converted locally
listed shares into GDRs and then converted them back into local
shares, as the proceeds from the sales of these shares were being
paid out at the official CBE rate of £E 4.64 to the dollar.
Returns on such transactions, then, would approximate the difference
between the currency’s official rate and its black-market price
vis-à-vis the dollar. The practice caught on quickly, with
such cases “almost happening on a daily basis,” the local
analyst said.
According to Angus Blair, head of investments at the Riyadh-based
Al-Rajhi Banking & Investment Corporation, a major international
Islamic investment company, “arbitrage opportunities have always
come and gone. But you never had external players trying to take
advantage of such opportunities.” He went on to say, however,
that attributing the account freeze entirely to the GDR situation
is “a bit of a red herring,” hinting that perhaps the
move had “more to do with wider foreign-currency issues.”
As of press time, the CBE’s governor and deputy governor were
unavailable for comment.
Three-step currency shuffle
There’s nothing illegal or wrong with employing an arbitrage
opportunity to make money. Indeed, a free-market assumes that if
ever such opportunities arise, they will be seized – quickly.
“Sophisticated players have chances frequently to extract interesting
returns from inefficient markets,” Marber writes. “Often
one hears of ‘arbitrage’ trades... that seep out from
the developing world’s embryonic financial markets.” GDRs
in particular often allow for such opportunities, Marber adds, because
the overseas receipts tend to be more expensive than the underlying
local shares.
In Egypt’s case, such transactions allowed local investors,
ever thirsty for foreign currency, to get their hands on dollars
at an unusually low – in fact, the official – rate. “Some
dealers believed that the market’s value... was buoyed by investors
needing dollars who bought local shares, exchanged them for GDRs,
and sold them for hard currency,” read the May 26 market report
in Al-Ahram Weekly.
According to Tamer Gadallah, a broker at Cairo-based brokerage firm
Investia, importers were using the technique to convert large amounts
of local currency into dollars. “Some big importers –
who couldn’t otherwise get their hands on dollars – bought
lots of local stocks, converted them into GDRs, then sold them again
for foreign currency. In this scenario, of course, the CBE is the
loser.” He added that several transactions were in the millions.
In effect, the arbitrage opportunity represented a three-step method
for converting local currency into foreign currency, at the unrealistic
– and hence all the more attractive – official rate.
According to another local analyst, who also preferred anonymity,
“when CBE officials saw the effect that the arbitrage situation
was having on foreign-currency reserves, they claimed that people
were abusing the system.” The CBE, he said, on June 27, in
cooperation with the Capital Market Authority, issued new, ad hoc
regulations to counter the problem: “If you could prove that
your transaction was conducted by normal methods [i.e. not via arbitrage],
you could get your money right away. Otherwise, you would have to
wait until the money was available, or you might not get it at all.”
The ultimate deterrent
While rattling the CBE, the arbitrage fad had the positive –
if temporary – effect of stimulating an otherwise moribund
stock market. “The word of the day on the trading floor was
‘arbitrage’ – inspiring a flurry of trading in stocks
with GDRs that carried market turnover up to £E 282.35 million,”
read a May 15 market report from HC Brokerage. Judging from the
day’s top 10 stocks in terms of turnover, traders appeared
to be “maneuvering for gains from the interplay with the London
Stock Exchange.” Companies with GDRs – particularly Commercial
International Bank, Al Ahram Beverages, MIBank and Orascom Telecom
– saw heavy trading, with total GDR trades on May 15 adding
up to £E 33.92 million.
But the quickening of the market couldn’t last. The decision
to freeze the CBE compensation account put GDRs back into a slumber
and, furthermore, played havoc with Egypt’s reputation as a
safe destination for investment. “The GDR market in London
is dead now,” the first local analyst said. “The GDR market
over the last two months is a trickle of what it used to be. There
is no longer any point for foreigners to buy [Egyptian] GDRs, as
they can no longer sell them locally.”
Whatever the CBE’s motivations, said Blair, “Current policies
have to become far more pragmatic. If the CBE is in fact trying
to restrict the movement of capital, that would be very bad for
the market.”
According to the Beirut-based analyst, the move – coming after
government vows to keep foreign currency available to institutional
investors – represented “the ultimate deterrent for those
foreign institutional investors who might still wish to enter the
market.” Hopefully, now that the repatriation process has been
restored, investors’ memories will be short.
Adam Morrow
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