Monday, 1 June 2020

Start-up Profile – CRED iQ

Last year we reviewed a new entrant into the financial information landscape, with the start-up Sigma Ratings which exists to provide focused and specialised information regarding anti-money laundering and its effects on creditworthiness (amongst a number of other aims). In today’s short post we will be introduced to another start-up aiming to impact the marketplace, this time in the field of information relating to commercial real estate intelligence, which is particularly apt given the market shift in focus to commercial mortgage-backed securities over the past few years – that company is CRED iQ.

 

CRED iQ, founded by Bill Petersen and Michael Haas, has the expressed aim of providing the marketplace with a flagship platform which provides for interactive commercial real estate valuation, CMBS monitoring, and also involves a ‘lead generation platform delivering objective risk assessments to CRE (Commercial Real Estate) and capital market investors’. The innovative platform provides users with commercial real estate valuations that is based on in-depth and relevant market data, trend analysis, and more than 20 years of valuation experience, whilst the interactive valuation scenarios (MyQ) enables users to navigate user-friendly software that can adjust CRED iQ valuations and observe the adjustments across loans, deals, and portfolios. There are also elements of the platform that provides information on loss projections, portfolio analytics, and there is also the opportunity to set real-time alerts so that changes in the marketplace that may be relevant to a portfolio can be incorporated instantly into the decision-making process. Additionally, the company is launching what it calls Investment Quality Scores (iQ), which it says are ‘numerical tranche and deal level objective risk assessments free from market perceived conflicts of interest’.

 

The company states that it serves a number of industries, including mortgage brokers, leasing agents, investment sales, and capital markets amongst a large list of others. The independence that the company is seeking to display should be of real benefit to those potential industries that may use the new company’s platform and services. To subscribe to the platform, the rates are $149 per month per user for the Standard package, and $249 per month per user for the Ultra package. The new company is growing well, as evidenced by a current recruitment drive for software engineers and their recent contribution to a Wall Street Journal article which saw their valuation of the Fontainebleau Hotel in Miami incorporated into the analysis being developed by the WSJ. For those readers who may be interested in learning more about the company and the platform it offers, there is a free trial available. If more information is required, then the company can be contacted here.

 

The aim to inject impartial and considered information into the CRE landscape is a welcome one, particularly as the company aims to develop useful information that is free from the conflicts of interest that can cause so much damage in a field such as this one. Hopefully the company will continue to grow and we shall monitor its progress here in Financial Regulation Matters. You can follow the company on LinkedIn here.

 

Keywords – CRED iQ, Analytics, CMBS, Commercial Real Estate, @finregmatters.


Wednesday, 20 May 2020

Dingemans Quits the Financial Reporting Council (FRC)


Simon Dingemans, the former finance chief for GlaxoSmithKline and long-term employee of Goldman Sachs, has surprisingly and abruptly quit his role as the Chairman of the Financial Reporting Council, less than a year after taking the helm. In this post we will look back at his tenure and find out why he has decided to move back into the private sector.

We analysed Dingemans’ appointment late last year here in Financial Regulation Matters, where we discussed his taking aim at the auditing oligopoly that the FRC has responsibility for regulating. At the time, Dingemans stated that ‘this is a rare opportunity to reform something so wholeheartedly’, and he made the break-up of the ‘Big Four’ and their oligopolistic hold on the auditing marketplace a priority. However, since his appointment it has been business as usual. The regulator has continued investigating members of the oligopoly, whilst also calling on members to upgrade their auditing tools. This is nothing out of the ordinary for the regulator. Yet, today’s announcement has come as a surprise for the regulator, and the market.

Dingemans, who came under pressure regarding the late filing of accounts he was a director of, had an arrangement with the FRC that he would be paid £150,000 to work a three-day part-time week, with Dingemans allowed to take on other roles as long as they did not conflict with his Chairmanship. It was announced by the FRC that the reason for his departure was because of him ‘being prevented from taking additional roles that may have conflicted with his duties at the FRC’. There has been no announcement as to what these roles may be, or where Dingemans will be going next. The FRC declared that the regulatory reform agenda is still on track – one that includes the breaking up of the Big Four – but time will tell. One element that will be of interest will be to see where Dingemans goes next, because there is an increased potential that this chain of events will be a fantastic example of the ‘revolving door’ that describes the consistent transition of regulators into industry, and vice-versa. The breaking up of the Big Four has been suspended because of the pandemic, and now it will be on the top of the agenda for the new Chair, if the FRC is true to its word. How the Big Four respond to this development will be of interest too, as they are already making moves to ‘break-up’ in principle, although this is questionable as the leading auditors have form in this area; in the aftermath of the Enron scandal a number of auditors split their auditing and consultancy services, only to restart a few years later once the media cycles had moved on to other areas of the financial system. What is for sure is that this development comes as a massive blow for the FRC, which at the same time fundamentally increases the pressure on the regulator as it seeks to protect its future as a regulatory entity.

Keywords – audit, FRC, regulation, @finregmatters

Tuesday, 19 May 2020

Johnson & Johnson Ceases Selling Talcum Powder in the US and Canada – Update


Late last year we discussed here in Financial Regulation Matters the news that Johnson & Johnson had been ordered to pay billions of dollars in damages for the side effects that talcum powder was causing. It had been suggested at the time that the spate of litigation could end up costing the giant conglomerate more than $20 billion and, just today, the news broke that the company would cease selling the product in the US and Canada.

The talc-related saga for J&J is a long one. There has been a vast number of legal actions taken against the company, with a number of claimants being awarded large amounts, with one claim leading to $417 million in damages being awarded, and in another $4.7 billion to 22 women in the US. Interestingly Forbes said recently that J&J stock may be undervalued, but that may be about to change. The Financial Times is leading the way with the reporting that the company has dropped the sale of the product in the North American market, although they have responded as expected. Firstly, the have claimed that the cessation will not be too damaging, as the market only makes up 20% of the global market and the product will remain on sale across the rest of the world. The head of the Consumer Health division, Kathleen Widmer, was quoted in the article as blaming ‘misleading litigation advertising’ as the cause for the drop in demand of the product. The company points towards a mini-legal industry that has emerged looking for claimants, with just under 20,000 lawsuits pending against the company. The company has maintained that its product is safe, although it will now be switching to its cornstarch-based baby powder instead of the talc-based product; also, its claims that the product is widely regarded as being safe is not universally accepted.

The decision will fall into the company’s decision to ‘streamline’ its product offering in light of the COVID-19 pandemic, but in reality it will not stop the avalanche of legal action that is continuously heading its way. However, there may be an opportunity to finally switch to a non-talc based product irreversibly. Yet, the continued demand for the product around the world means that this may be some way off, unless similar legal actions are repeated in other markets.

Keywords – Talc, Johnson & Johnson, retail, business, law, @finregmatters

Monday, 18 May 2020

S&P Launch Their Latest Move into the ESG Space


Today’s short post is a short report on the news that S&P Global have today launched their new ‘ESG Scores’ into the marketplace. The move is the latest by the leading credit rating agencies to stake their claim to the ever-growing need for ESG-related information.

The leading credit rating agencies, and the ‘Big Two’ of S&P and Moody’s have been making a concerted effort to increase the stake in the growing ESG-informational provider field. With S&P acquiring TruCost, and Moody’s acquiring Vigeo-Eiris, amongst other moves, the trajectory is perhaps set. I have argued elsewhere that this may result in particular outcomes for the current ‘sustainability rating industry’, and that trajectory is being proven all the time. Morningstar, earlier this year, purchased Sustainalytics outright. Moody’s acquired a majority stake in one of the oldest ‘sustainability rating agencies’ Vigeo-Eiris early last year. On top of acquiring TruCost in 2016, S&P followed that up with the acquisition of SAM (formerly known as Sustainability Asset Management). The deal saw S&P acquire the ESG Rating component of RobecoSAM, with the acquired entity taking the SAM brand whilst also allowing Robeco access to its data. One of the fundamental reasons for the deal was so that S&P could get hold of SAM’s sector leading Corporate Sustainability Assessment (CSA), which is ‘recognised as one of the most advanced ESG scoring methodologies’ and reviews more than 7,300 companies wordwide.

S&P, in its press release today, stated that the ESG Scores are based on the CSA and will be made available to the investment community via its flagship Xpressfeed data feed management interface. The Global Head of ESG at S&P was unsurprisingly pleased with the development, stating that ‘the S&P Global ESG Scores are driven by deep corporate engagement derived from private and public data, making the scores unique in the market today. For the first time ever, investors will have access to scores based on more than two decades of ESG expertise, a leading methodology centered around financial materiality, and a focus on forward looking sustainability metrics’. S&P conclude the press release with a declaration of its offerings to the marketplace, which now include these ESG Scores, its ESG Evaluation service, the S&P 500 ESG Index, and its Platts Energy Transition prices.

In an article that will be published soon, I argue that the inefficiencies which researchers have been consistently identifying in the sustainability rating space – too much divergence, no consistency, a lack of access to information, and too much competition – put the industry at a real danger of being swallowed up by the credit rating industry, which despite the many internal problems with the credit rating model, can offer solutions to the mainstream with regards to ESG and its incorporation. This news today only hastens that trajectory.

Keywords – ESG, Ratings, S&P, @finregmatters

Saturday, 16 May 2020

Updates – Contrasting News for Rating Agencies: Morningstar Settles with the SEC Whilst Fitch Enters China


Today’s short post provides two updates from the credit rating industry, with each providing particularly contrasting fortunes for the agencies involved.

Morningstar Settles with the SEC

The first story today involves Morningstar, an agency that has been trying to really carve a position for itself in the oligopolistic rating market. Morningstar had reason to be forward-looking this year with its purchase of Sustainalytics being completed in April. The development of the ESG-mainstreaming project means this purchase puts Morningstar in a string position. However, yesterday Morningstar settled with the SEC with regards to charges that it had violated regulations relating to the elimination of internal conflicts of interest. Specifically, the rule that credit rating analysts should not be involved with the sales and marketing efforts of the agency had been violated. The cost of this settlement has been reported to be $3.5 million, but the details provide flagrant breaches of the rules, which in truth are particularly clear. Morningstar was charged with a number of breaches, with one being that an analyst wrote a commentary specifically for an issuer, and sent that commentary directly to the potential client in order to obtain its business, which Morningstar duly did. Another example includes maintaining ABS ratings on clients who analysts were directly dealing with. Morningstar was also found to have breached rules relating to the maintenance of such rules and the internal enforcement of them. The charges related to between 2015 and 2016. Reuters also reports how this action by the SEC, specifically by the Enforcement Division’s Complex Financial Instruments Unit, represents one of only a few actions that the Unit can claim, mostly because of them being under-resourced.

The action reveals a number of elements. The first is that this is not a hugely impactful penalty, and if this constitutes a victory for the Unit, then the observation by Reuters that the Unit is under-funded is likely an astute one. Second, it reveals that no matter the regulations in place, there will be instances of transgression within the industry that is naturally beset with conflicts of interest. Finally, and something which is particularly interesting, it is not just the ‘Big Three’ that are transgressive in this field, which leads to the development of the understanding that it is actually the modern rating model, based on the issuer-pays system, that is the source of the transgressive behaviour – perhaps the necessary closeness between the agencies and the issuers is a fundamental temptation that will not be removed.

Fitch Joins the Chinese Party

Here in Financial Regulation Matters we have looked at the Big Three’s entrance into the lucrative Chinese domestic marketplace for ratings. The development started with S&P, who became the first non-Chinese agency to be allowed into the Chinese marketplace as a stand-alone entity. We discussed how this is linked to the country’s ‘Belt-and-Road’ infrastructure project, and it came as no surprise when, as part of the trade negotiations between the US and China, Moody’s was allowed access to the marketplace too. In a similarly unsurprisingly development, Fitch won approval on Thursday to also enter the Chinese marketplace. The important gatekeepers to the Chinese bond market – the People’s Bank of China (PBOC) and the National Association of Financial Market Institutional Investors (NAFMII) – both approved Fitch Bohua’s registration, the newly-created and wholly-owned Fitch subsidiary. In confirming the similarity to Moody’s the PBOC confirmed that Fitch’s entry was a ‘concrete implementation’ of the Trade Deal that allowed Moody’s entrance to the marketplace. Interestingly, the President of Fitch, Ian Linnell, noted how the ratings were likely to be lower than their Chinese counterparts, which could lead to a ‘tough sell’. If our understanding from previous posts is correct, then this should not be a problem. The whole point of allowing the Big Three into the Chinese marketplace is to bring an international seal of approval to Chinese bonds, which it will need to develop its marketplace and its financial production before the rest of the massive generational-defining infrastructure project really takes shape – it will likely not be as tough a sell as Linnell thinks. It will be interesting to see if China stops at the Big Three, or allows more American-based rating agencies into its market. I suspect not, because the purpose is to bring the ‘signalling’ capacity of the internationally-recognised credit rating agencies into the Chinese market for a specific reason – more entrants would likely only muddy the water and, as China is in control of who conducts business within its borders, it can do as it pleases. Perhaps this is microcosm of the larger identification that one of the most important purposes of a credit rating agency is not the information that it provides, in terms of purely knowledgeable value, but mostly its ability to ‘signal’ to a prospective party, whether that may be investors, regulatory-constrained investors, regulators, or even other states.

Keywords – Credit rating agencies, China, Morningstar, SEC, @finregmatters

Wednesday, 13 May 2020

The EU Publishes a Report on Credit Rating Practices in the CLO Market


Today’s post is just a very short alert on the publication of a report today by the EU. The report, entitled ‘Thematic Report: EU CLO credit ratings – an overview of Credit Rating Agencies practices and challenges’ is available here. The aim of the report is to examine the rating practices that underlay the development of collateralised loan obligations, with a particular focus on how risk is identified and transmitted within the process. There is also a distinct focus on the stress-testing that the agencies undertake for these products, with ESMA stating in their press release that they ‘expect CRAs to continue to perform regular stress-testing simulations and to provide market participants with granular information on the sensitivity of CLO credit ratings to key economic variables affected by the pandemic’. Steven Maijoor, the Chair of the Regulator, went further and stated that the regulator’s assessments of the agencies’ practices in this particular sector ‘highlight a number of supervisory concerns and risks associated with risking this asset class’. These supervisory concerns include:

·       The internal organisation of CRAs – specifically regarding sharing information between groups of analysts so that a holistic picture of CLO creditworthiness is reached;

·       The interactions with CLO issuers – issuers can identify which agency provides for the best ratings for a particular tranche, so ‘shopping’ and commercial conflicts are a worry for regulators;

·       Model/third party dependencies leading to potential operational risks – there is a dependency on data provided by third parties, which needs to be thoroughly accounted for;

·       Rating methodologies, modelling risks and commercial influence – because CLO models and methodologies are underpinned by assumptions, regulators want CRAs to be clear on the limitations of their methodologies;

·       The thorough analysis of CLOs – regulators want the CRAs to carefully monitor market trends and perform thorough analyses of the CLOs they rate.

Despite the conflicting messages within the final two issues – ESMA acknowledge that the CLO methodologies are underpinned by assumption, but simultaneously request that CLOs are thoroughly analysed – the majority of the issues raised by ESMA are issues that are consistently raised. The need for the protection of analyst independence, a reduction in commercial conflicts of interest, and a holistic process to examining creditworthiness are all common calls in this sector. What it does tell us is that the EU is attempting to be proactive regarding credit rating regulation in this current climate, perhaps on the back of developments including the ECB dismissing traditional rating cut-off points, and prominent politicians calling for more reform in the wake of the pandemic-induced downgrades. How the EU continues to respond will be interesting.

Keywords – EU, Rating agencies, @finregmatters

Monday, 4 May 2020

Liberty Global’s Push to merge Virgin Media with 02 Signals the post-Brexit Reality


In today’s short post, a nuanced point that is being overlooked by many in the business press will be discussed regarding the news that Liberty Global, the owner of the UK-based Virgin Media company, is in talks with Telefonica regarding the purchase of its ‘02’ brand. One of the issues that is arising out of this proposed merger, on top of the competition-based issues that will no doubt arise, is how it will be possible and, more importantly, why it will be possible when recent attempts to buy 02 (from a number of companies) have been ruled out on competition-based grounds.

It was reported late last week that Liberty Global – the massive telecommunications conglomerate ran by John Malone that also owns Formula One – was in talks with the owner of 02 – Telefonica – regarding the purchasing of the company. The supposed merger would be a 50/50 split between Virgin Media and 02, and Liberty Global would need to make a payment to Telefonica to equalise the ownership. The move would be an important one for Virgin Media, as it would at once both combine the 34 million 02 customers with Virgin Media’s base, but also provide Virgin Media with a vehicle within which it could provide its own mobile service, which up to this point has been done in conjunction with other carriers. For 02, it is apparent that Telefonica has been trying to offload 02 for a number of years, because even though 02 has recently returned to profitability, the Spanish company is heavily indebted. The company has been in negotiations with a number of other entities regarding the sale of 02, but none have come to fruition, with planned sales to Three and BT falling through – BT opted to purchase EE for £12.5 billion in 2015 instead, and the EU blocked the £10.25 billion sale to Three on competition-based grounds.

However, in today’s business press Telefonica have confirmed that it has entered into talks with Liberty Global (who have more than $7 billion in assets spare after a recent spate of sales across its holdings). It is being suggested in the press that the deal could be finalised rather quickly, with Liberty Global paying Telefonica in the region of £5-7.5 billion to equalise the difference. Yet, it was a comment in the Financial Times last week, from somebody reportedly close to the Virgin Media side of the deal, that raises concerns. The sentence read: ‘Liberty Global, which has been trying to consolidate or sell most of its operations across Europe, sees the UK’s exit from the EU as an opportunity to combine with rivals without facing opposition from regulators in Brussels, a person close to Virgin Media said’. The article itself simply moves onto the next issue, but the sentiment within the sentence above is particularly impactful. Is it the case that European competition regulators are too heavy-handed? Or, is it the case that there is an ‘arbitrage’, in a sense, that is being developed by the UK leaving the EU, in so much that there now exists an opportunity to develop monopolistic, or oligopolistic markets in a crucial sector of the economy – telecommunications? A sceptic may opt for the second understanding, and for the company in question it makes sense to chase the rewards that come with developing such markets. However, for the British consumer, the news may not be so great. Further concentration in the telecommunications market will only lead to increased prices. It may also be an indicator of what the post-Brexit landscape looks like for the British consumer, with monopolistic deals being paraded as successes whilst the knock-on effect is ignored. Of course, this may not be the case, but the economic theory is clear – the development of monopolistic markets tends to lead to increased prices for consumers. How the British Government react to this potential deal will be a good indicator to its views on protecting the British consumer in the long-run, as opposed to its need to favour business and the development of the economy – particularly with the COVID-19 pandemic in mind – in the short-term.

Keywords – telecommunications, 02, Virgin Media, Liberty Global, monopoly, competition, @finregmatters

Wednesday, 29 April 2020

Is the ECB now the Dominant Player in the European Rating Arena? Perspective may be needed…

In today’s very short post, an article in Global Capital is reviewed in relation to a recent post here in Financial Regulation Matters concerning the European Central Bank’s decision to accept now-junk status bonds as collateral.

The article, published in yesterday’s edition of Global Capital, is entitled ‘The ECB is now Europe’s foremost rating agency’, and is based on the premise that the ECB’s decision has fundamentally altered the credit rating market in Europe. This is because ‘if the ECB thinks it’s good enough to buy or hold as collateral, then it probably is’. Furthermore, the article argues that ‘a credit opinion from the ECB is invariably going to be more accurate and more timely, given that the opinion will itself have a direct bearing on credit quality’. Finally, the article cites S&P’s decision not to downgrade Italy as evidence of this power shift towards the ECB and away from the rating agencies.

However, if we return to last Thursday’s post, then we can see that this view is perhaps blinkered. The ECB is incorporating more risk than it perhaps should, and we discussed why this may be – a number of reasons were identified, including a need to keep Europe financially moving as it becomes increasingly surrounded by political pressures. Also, the article does not address the obvious issue, if its premise were to be true, that the ECB cannot be seen to be providing creditworthiness recommendations because, quite simply, what happens if those bonds fail? The moral hazard contained within the approach is evident, and for that reason we can perhaps see that the dynamic has indeed changed, but arguably only in the short term; one could argue that the EU is gambling because, with everything considered, it perhaps has to. The rating agencies are not going away, and investors will still utilise their ratings. Because of this, issuers will still pay for the ratings – this dynamic has not changed. It does allow for the bonds of ‘fallen angels’ to be priced differently and sold at different rates, perhaps, but that does not mean that now everybody will be investing in junk bonds; for many, they are constrained so that they cannot, either internally or by regulation. Also, we have yet to hear whether regulators, either from Europe or further afield, will allow institutional and structurally-important investors to hold the bonds of these so-called ‘fallen angels’ just because the ECB has changed its policies on what it allows as collateral; can the argument really be made to a regulator that the bar for creditworthiness has been reached just because the ECB said so? What happens if, after the pandemic passes, the ECB reverts to its old position? Would these investors then have to divest to be compliant with regulations? As with almost every area of finance, there are a multitude of questions that become relevant when a rule changes, all of which need to be answered. What we can say is that the ECB has not become the dominant creditworthiness-standard developer in Europe overnight, as the article states. Yes the dynamic has been altered, but it is likely that such an alteration will have, and is likely already having consequences.


Keyword – ECB, banking, investing, credit rating, fallen angels, @finregmatters

Friday, 24 April 2020

Municipality Ratings Lead to the Questioning of Credit Rating Methodologies

Today’s post reacts to the interesting article published recently in the Bond Buyer, entitled ‘How the coronavirus is impacting perceptions of municipal credit, ratings’. The article raises some very interesting points regarding the usefulness of credit ratings in the ‘muni’ marketplace, and also the impact that regulations on the disclosure and following of public methodologies may be having upon the position of the agencies.

‘Municipal bonds’ are simply bonds issues by a state, municipality, or county in order to finance any of its capital expenditure; this is similar to the process of generating sovereign bonds for countries, for example. However, with a number of major US muni issuers being hit with rating downgrades recently – including Illinois, New York, New Jersey, Connecticut, and the New York Metropolitan Transportation Authority – there are questions being raised as to how valuable these downgrades actually are. That concept is based on the understanding that a. these issuers are naturally going to be impacted by the pandemic in terms of lost revenue, but that b. they will not fail. The article discusses how municipal bonds are second to that of US Treasury bonds; the major difference between the two, as noted in the article, is that the US does not, really, need to worry about ‘balancing its books’ – it is currently in a deficit of nearly $4 trillion – however, whilst the muni-issuers do need to balance their books, the likelihood of them being allowed to fail by the Federal Government is extraordinarily low. This provides them with a protection that is particularly valuable and utilised by investors.

For this reason, a number of experts cited by the article essentially ask the same question: if this is the case, then what value does a muni downgrade have for investors? A former Moody’s analyst, Lisa Washburn, begins the analysis by suggesting that the rating agencies are using pre-pandemic rating methodologies, which are not able to usefully factor in the pandemic-related crisis and its particular intricacies. As the near-future is likely to be very unstable, the mass downgrades that are apparently coming (in all sectors, including the CLO market) are both uninformative for investors, as the argument goes, and also runs the risk for the rating agencies (and the market as a result) of the ratings overstating default risk, unnecessarily. Data is derived in the article from the Great Depression, which witnessed the same phenomenon. This issue is confirmed by the article which states that ‘none of the rating agencies have changed their methodologies due to the coronavirus’. However, the agencies have defended themselves. The Big Three and Kroll Bond Rating Agency are cited in the article as arguing that their methodologies look ‘through the crisis’, as well as being forward-looking (a consistent argument of the agencies against methodological criticism). The agencies have also argued that they a. review their methodologies regularly, b. that they are aiming to look through the crisis and then rank bonds in an orderly manner afterwards, and c. that the usage of tools like ‘outlooks’ and ‘opinions’ allow the rating process and methodological development to be ‘flexible’. Yet, the article raises the point that, on account of the Dodd-Frank Act of 2010, the wide-ranging legislation requires the rating agencies to both develop and most crucially adhere to publicly disclosed rating methodologies, and also to apply rating symbols universally. This is slightly misleading because, in that vein, the rating agencies are absolutely free to amend their methodologies in light of the crisis, but that they then must stick to them. Washburn wonders whether new rating symbols are needed for very short-term issues; she speaks about the New York MTA being dropped by two notches as representing ‘neither the opinion that there is an imminent risk to the issuer’s solvency nor that it is too big and important to fail and thus will receive the extraordinary support needed’. Whilst this sentiment may be unique to the muni market, it could perhaps be extrapolated to other markets, like the elite banking market for example – surely they are also ‘too big to fail’? The argument for more rating symbols pushes for the agencies to be more reactionary to short-term issues, and also injects more complexity into a process which is paradoxically extremely complicated yet mostly useful for its simple and easy-to-assimilate outputs (letter-based ratings). New and more rating symbols is likely not the way to go.

However, the negativity surrounding the rating agencies’ assessments of muni bonds is not universal. George Friedlander argues that the ratings in this market are quite important for a number of reasons. He rightly notes that the agencies have access to both masses of information, but also direct access to the issuer, which institutional investors do not have. Also, the agencies are specialists, with vast resources dedicated to analysing all of that available data. As the rating industry increases in size and continues to devour other industries – I have argued consistently that its natural progression is to devour the ESG rating market next – this concept will only become more appropriate. He also argues that ‘quite simply, in an environment in which the agency rating process did not exist, municipal bonds would be vastly more illiquid and difficult to price. Ratings provide a baseline from which institutional investors can adjust, higher or lower, and make changes over time as more information becomes available’.

This reminds me of a subject that arose whilst I was constructing an article that will be published shortly. I wondered ‘what do investors want from rating agencies?’ and quickly realised that finding one answer for that question is impossible. Of course, this is reflective of the dynamic and varied nature of the investor base, but it is telling that the agencies are coming in for criticism for many things which they have been historically been accused of not doing. For example, many critics have argued that the ratings are too reactive, but now people are arguing for a new set of symbols to show that the agencies are reacting quick enough, and for a short period in an exceptional era. If the agencies do not act – whether in downgrading or upgrading – they are criticised, but in this case they have downgraded and critics subsequently argue that downgrading is pointless because of the subject – does that mean municipals should not be rated at all? If a downgrade is applied but it does not take the bond into ‘junk’ status, is it really worthless? Friedlander has argued that it affects the pricing of that bond, which is a key part of the process and investing system.

Ultimately, the rating agencies will likely not care that much because their revenues and profits are consistently increasing, even after the post-Crisis regulatory era which was supposed to be ground-breaking. The reality is that the process will continue. There are issues with the rating agencies which should always be remembered, however. One of which is the issuer-pays system, which the article rightly cites as being an inherent issue for the industry. I read an article recently in which a number of hedge funds were identified as responding to the incoming pandemic quicker than most and also, Pierre Andurand stated that ‘I thought a lot of people were in denial about the potential for a pandemic and its knock-on effects… it was clear to me from February that it was going to spread to the rest of the world, that it was contagious, and that the potential death toll meant there was no other way than to have a lockdown’; this was interesting because he stated that he spent two weeks researching it, before taking the relevant actions with the money in his fund. The question then is why were rating agencies not doing the same thing? Could the rating agencies had downgraded much earlier, based upon the same ‘forward-looking’ analysis conducted by the leading hedge fund managers? Rather cynically, I wonder whether the answer lies in the answer to another question – what separates hedge fund managers and rating agencies? One answer to that question is that the hedge fund managers meet their profit-based objectives by foreseeing these trends and exploiting them, whilst rating agencies derive their profits from issuers, who would certainly react strongly to being downgraded weeks or months earlier than we have seen in the current crisis. Perhaps the whole rating industry issue, with all of the criticism that is attached to it, simply boils down to ‘how do you earn your money?’


Keywords – credit rating agencies, municipality ratings, methodology, @finregmatters

Thursday, 23 April 2020

Europe Attempts to Learn its Lessons from the Sovereign Debt Crisis and Guard Against Rating Procyclicality

The European Sovereign debt crisis, which engulfed the EU after the Financial Crisis, left an indelible mark on the structure and mentality of those charged with leading the bloc. Now, as the bloc faces yet another crisis in the form of the COVID-19 pandemic, it appears that the leaders of the EU and, in particular the ECB (European Central Bank), have learned their lessons from 2012 and are taking proactive actions against the coming wave of downgrades. However, have they really learned their lesson? Also, what are the risks that the EU is opening itself up to, financially, as well as politically? In this post we will review the unscheduled announcement recently by the ECB that it will now be accepting the bonds of so-called ‘fallen angels’ as collateral.

It is being widely reported in today’s business press that the ECB will, as long as a so-called ‘fallen angel’ was deemed investment-grade on and before the 7th April and that they remain as BB-rated (or the equivalent), accept those bonds as collateral within the ECB’s ‘collateral framework’. This, essentially, refers to the process whereby the ECB will allow for credit to enter the financial system, but provides the ECB with some level of protection. The ECB itself declares that ‘the collateral framework of the central bank is therefore important not only for risk protection and the feasibility of central bank credit operations, but also for financial conditions, financial stability and the transmission mechanism of monetary policy, in particular in stress situations’. However, how does the ECB know what collateral is worthy of being used within that framework? There are a number of options available to them, but one of the more common measures is a bond’s credit rating, as provided by the leading credit rating agencies.

With the cut-off being the so-called ‘investment-grade’ demarcation that all rating agencies have, the situation is rather simple. However, in the current situation (as we have spoken about before here in Financial Regulation Matters), there are a number of bonds and entities that sit either on the precipice, or have fallen below it. Those that have fallen below it are deemed ‘fallen angels’. With the rating agencies being criticised for rating potentially suspect entities as investment-grade in the ‘good times’ because those entities pay the agencies for their ratings, the natural knock-on effect of that is that when times go bad, those that have had their ratings inflated will quickly drop into non-investment grade; the result of this is that it is both harder for those entities to access credit, and that their bonds become ineligible to be used as collateral for other things. One of those things is accessing credit from central banks. However, in the current climate it is crucial that central banks maintain their function and maintain a level of liquidity within the financial system. So, to that end, the ECB held an unscheduled call of the ECB’s governing council on Wednesday in order to approve an alteration in their processes; that alteration was that now the ECB will accept the bonds of fallen angels as collateral within its framework. Furthermore, the ECB announced that ‘the ECB may decide, if and when necessary, to take additional measures to further mitigate the impact of rating downgrades, particularly with a view to ensuring the smooth transition of its monetary policy in all jurisdictions of the euro area’. Whilst a decision like this would not have been made hastily, it does appear to have a sentiment of haste about it. Why? The financial press have probably rightly made the connection between this move and the fact that S&P is due to deliver its next rating action on Italy and its sovereign bonds on Friday, which the prediction being that it will be going downwards. Although the two elements are separate, in that the ECB is providing waivers for the sovereign debt of certain countries like Greece, with Italy’s debt expected to be included in that, the general pressure on the EU is ramping up and the rating agencies are playing a central role in that pressure, as is their function.

The US Federal Reserve has taken similar measures in buying up ‘junk bonds’ in its asset-purchasing programme. Experts have noted the increasing rate of debt issuance around the investment-grade precipice, with UBS stating that European bonds rated BBB- (one notch above junk status) have risen from €330 billion in 2011 to €1.14 trillion, with BB rated bond issuance (junk status) also rising by €110 billion in that same time period; the sentiment is that the massive amounts of BBB-rated bonds could quickly become ineligible within collateral frameworks. Although the ECB has announced that so-called ‘haircuts’ will be applied to junk bonds so that their value is reduced as collateral, not many in the financial press are looking at the obvious issue. In Bloomberg, Marcus Ashworth noted that ‘as with the Fed, it’s a worrying this for the ECB to be holding ever more risky credit’. He qualifies this by saying that ‘but these are truly dangerous times for the economy. We’ll just have to fall back on the hope that these are temporary measures until the world recovers’. Whilst I am not sure I have ever read an economics paper that talks about the importance of ‘hope’ within an economic system, the situation for the EU is stark. With the central bank eating up more and more ‘risky credit’ for no other reason other than it must do so to keep up liquidity in its system, this fact when adjoined to the politically-fraught situation that is developing within the bloc regarding assistance for all of its members presents a really pivotal period for the bloc. Only this morning did Angela Merkel state that the pandemic is a threat to democracy as Europe knows it and, despite sounding particularly dramatic, she is probably right. There appears to be plenty of faith being put in the concept of ‘hope’, and also in refusing to accept the ratings of the agencies. While the agencies’ detractors will no doubt state that this is what should happen, the message the ECB is sending is rather strange – we will use the ratings during the good times, but not in the bad. The effect of that approach, both economically and politically, remain to be seen.


Keywords – credit ratings, EU, collateral, economics, finance, @finregmatters

Thursday, 16 April 2020

Credit Rating Downgrades in the Car Industry, as Production Restarts


At the end of last year we reviewed Moody’s decision to downgrade Ford to ‘junk’ status here, but in the current crisis it is not surprising to hear that the wider industry is coming under increased pressure. With that pressure, naturally, comes to the threat of being downgraded by the leading credit rating agencies. As the downgrade wave turns its attention to the automotive sector, we will review these credit actions and also how the industry is attempting to recover.

Although Ford’s downgrade came before the onset of the COVID-19 pandemic, a number of other automotive manufacturers were in a precarious position with regards to their credit status. Like a number of other prospective so-called ‘fallen angels’ – a term used to describe the bonds of an entity that were once investment-grade but that have now fallen past that category – there are, and were a number of very recognisable companies that are teetering on the edge of investment grade. Credit analysts have been warning of the impact that the pandemic could have on the industry since the pandemic started affecting large portions of the globe, with S&P warning that ‘we expect a material decline of light vehicle demand globally… we expect this decline will be particularly severe in the second quarter…’. This is almost common sense of course, but the reality of the picture is slowly unfolding. Recently, S&P downgraded Renault to ‘junk’ status, while it cut its outlook on Peugeot’s owner PSA to negative, with the car giant teetering on the edge of investment-grade. Moody’s placed Indian automotive manufacturer Tata Motors on review for a downgrade, threatening its investment-grade status, whilst in South Korea Fitch lowered Hyundai and Kia’s outlook to negative, leaving it hovering over the investment-grade boundary; S&P and Moody’s have warned that both companies are on a negative observation, with reductions in their outlooks (at the very least) being particularly likely. While this negative observational period may be linked to a broader negative period for the region as a whole, the underlying fragility of the automotive sector is clear to see, with car loan-backed securities making the news for failing to obtain ratings. Only recently were BMW, Nissan, Honda, and Toyota downgraded by Moody’s, which was adjoined to negative reviews being placed on General Motors, Daimler, Jaguar Land Rover, Volkswagen, Volvo, and McLaren.

As part of the industry’s response to the pandemic, manufacturers and suppliers had closed their plants. However, as some parts of the world tentatively attempt to re-open their societies, a number of automotive manufacturers are attempting to restart their operations. Daimler and Suzuki have announced plans to restart plants in Hungary, whilst Audi and Hyundai have announced plans to do the same. Renault is restarting its plant in Portugal, whilst Toyota has announced its plans to resume its operations at its plant in France from April the 22nd. Volvo plans to restart next Monday, and Hyundai has already restarted its Polish plant. Even more surprisingly is Ferrari, which has announced its plans to reopen its Maranello facility shortly, despite being within the hotbed of Northern Italy. However, it does appear that sites in the UK and in the US are remaining closed, with Jaguar Land Rover and Ford declaring that they have no plans to reopen anytime soon.

Time will tell whether these automotive giants have reacted too soon, although one would trust that as many precautions as can be taken will be. However, the financial pressure that the industry is constantly under has been magnified many times over in this current crisis, and the fear is that the rush to restart is based majoritively on that premise. If so, an increase in the spread of the infection because of such moves will likely be negatively received, particularly as car travel is severely restricted at the moment, which in turn means car purchases are equally low. Yet, if the restarting of the industry produces few problems, it is likely that it will be seen as the marker for manufacturing processes to begin to return to usual rates.


Keywords – COVID-19, business, automotive, manufacturing, @finregmatters

Tuesday, 14 April 2020

Does the Serious Fraud Office need to be supervised more?

The case that the Serious Fraud Office (SFO) brought against a number of Barclays bankers for the deal reached with Qatar at the height of the Crisis has been reviewed before here in Financial Regulation Matters and across the financial press. However, now that case has concluded with the three bankers who were prosecuted being acquitted by the courts, one of those bankers – Richard Boath – has decided to speak out about his experience and is arguing that the SFO should have its powers seriously reviewed. In this post we will look at these arguments and look at some of the consequences of taking action in this regard, and of continuing the course.

The high-profile fraud case dominated the financial press once the SFO brought charges against the three bankers – Richard Boath, Roger Jenkins, and Tom Kalaris. The five-month trial concluded with the jury returning after five hours to find all the defendants not guilty on all counts. The SFO had begun to experience criticism from before the trial took place, because the case rose through the courts a number of legal figures had stated the issues with the case as it developed; Mr Justice Jay criticised the SFO for not investigating the Qatari side of the equation enough, despite having opportunities to do so. Though the SFO argued, in its defence, that the levels of disclosure from all parties provided serious hurdles for the Office to cross, the criticism escalated after the trial concluded. Lisa Osofsky, the director of the SFO, argued that the reason for the low conviction rate of the SFO was down the high threshold applied to fraud cases, stating that ‘I wish we had come of the lower [evidential] standards for fraud because we have an antiquated system… in fraud cases I’ve got to have the controlling mind of a company before I can get a corporate in the dock. That is a standard from the 1800s… that’s not at all reflective of today’s world’. Perhaps. Yet, the critics – including those charged by the SFO, and their legal teams – have been vocal in their suggestions that something needs to change regarding the SFO.

Immediately after the trial concluded, Michael O’Kane of Peters & Peters, who represented Richard Boath, said that the Attorney General needed to review the SFO’s operational capacity, adding that ‘what was the SFO doing spending millions prosecuting Mr Boath, when he had been cleared of exactly the same conduct by the FCA?’. Whilst the FCA certainly should not be held as the standard when it comes to dealing with bank-based criminality and inappropriate actions (one need just think of their actions regarding RBS), the legal team ratcheted up the pressure, declaring ‘after a series of high profile failures, the reputation of the SFO rested on this verdict’. One of the defendants – Roger Jenkins – was a little more muted, stating that ‘I am conscious that the SFO plays an important role in the ethical functioning of our capital markets, however it is equally important that they are properly resourced to act fairly and expeditiously’. In today’s interview with the Financial Times, Boath describes his experience, and argues that the power to both investigate and prosecute fraud cases, under a process known as the ‘Roskill Model’, is inherently conflicted and needs to be reviewed by Government; Boath stated that ‘All I want is someone… to examine whether they think the SFO should continue to be allowed to exercise that privilege [of exercising the power to investigate and prosecute]’. The ‘Roskill Model’, as proposed by Lord Roskill via the Roskill Committee on Fraud Trials which published its report in 1986, is based on the concept that there was a need for a unified organisation ‘to match the breadth of a fraudster’s activities with an efficient system of detection and trial’. Essentially, the Committee called for the unification of investigative and prosecuting arms of case development, as opposed to the usual structure of separate bodies conducting these roles (like the police investigating crimes that the Crown Prosecution Service then decide to charge, or not). Whilst Roskill’s proposals came with recommendations to review this system as it progressed, the system was enacted and has maintained without much review ever since – the creation of the system created the SFO as we know it. However, with this trial, there is the potential that the system will be seriously reviewed. Boath stated in his interview that the model brings conflicts of interests and is akin to ‘marking your own homework’. The SFO is reviewed regularly by the CPS Inspectorate which is an independent body but, as the FT state, this reviewing system ‘is more relevant now due to the ever-increasing complexity of SFO cases’.

Boath describes the personal effect of the case that was brought against him and his colleagues, with the years-long process taking a particular toll on his mental health, as well as his employment career. That Boath and his colleagues was acquitted does indeed call the SFO’s processes into question, but as the SFO and its supporters argue, this should not deter a body like the SFO from bringing prosecutions; as the FT note in citing the SFO’s supports, ‘it is the function of a criminal justice system to have some acquittals in any cases brought’. This is, of course, very true. The importance of prosecuting fraud in high finance is extremely important, as cases continue to be seen around the world – the SEC only yesterday announced that it was alleging that Goldman Sachs employees have been bribing officials in Ghana. The impact of these so-called white-collar crimes is often downplayed or lessened in comparison to so-called ‘blue-collar crimes’, and that process must stop by whatever means possible. Perhaps it is time to review the evidential standards required to prosecute fraud, as Osofsky stated, although what she is proposing is fundamental review of the concept of company law in the UK, which has a long, storied, but also cemented tradition. The courts have been renowned for refusing to lift the so-called ‘corporate veil’ for anything other than outright fraud which can be easily proved (for the most part), which brings into question whether such a traditional stance is appropriate for the modern and often overly-complicated financial arena. However, the protection afforded to companies and their members is fundamental to the growth of the economic arena since corporate law was formalised. Threatening that concept with a weaker corporate veil, and more intervention from ‘the state’, is something that we will not likely see because of its philosophical implications regarding the very nature of ‘capitalism’. A wise person would argue that the SFO needs to consider this when it takes its actions, but restricting its approach, in any way, almost makes its position impossible and renders its effect almost useless. The SFO is, indeed, between a rock and a hard place more than ever before, and one can be sure that its detractors will smell blood in the water since the Barclays trial. How the ‘state’ defends the SFO will be indicative of its views on the progression of ‘capitalism’ as we know it, arguably.


Keywords – SFO, Fraud, Barclays, Business, @finregmatters

Friday, 10 April 2020

Confusing Messages from the ESMA Chief on Rating Procyclicality

During the Sovereign Debt Crisis in Europe in 2010/12, the idea of monitoring the credit rating agencies’ timeliness of ratings came to the fore. Since then, the EU has been pushing for more impactful regulatory endeavours in the credit rating arena, with many missing the mark. Yesterday, the ESMA Chief Steven Maijoor turned his attention to the issue of procyclicality again as the CRAs being to downgrade a number of countries, with a number of others teetering between investment and non-investment grade status.

Maijoor started by stating that ‘the timing of ratings actions needs to be carefully calibrated’. This is because of the fear that procyclicality will be rearing its head once more, just like it did a decade ago. The concept of procyclicality is described as when credit ratings ‘are stricter during an economic downturn than in an expansion’. Scholars have discussed how, in good times, the ratings tend to be ‘inflated’ but that when the market turns, the ‘massive’ raft of downgrades contributes to massive flows out of particular areas of the marketplace, sometimes via the market responding to the downgrades or sometimes because areas of the market must respond to the downgrades, either because they are regulatory constrained, or constrained by internal investment policies. In the wake of the post-Crisis reforms, regulatory constraints should no longer be applicable, but the fear is that this will not stop the outflow of funds should a greater wave of rating downgrades occur. Another reason why procyclicaclity is so impactful is because of the oligopolistic structure of the industry; we saw recently how when one agency performs a downgrade on a particular entity, the others tend to follow.

Maijoor continued, however. He stated that ‘what’s important is the timing between taking into account the increased risks of poorer credit quality and not acting procyclically, and making sure the timing of these downgrades is done in an appropriate way’. He followed this up with ‘they need to do this independently. We cannot and should not interfere in the ratings processes themselves’. Now, regular followers of Financial Regulation Matters will know that I am often the first to criticise the rating agencies when they deserve it, but on this occasion the tone of the ESMA is not helpful in the slightest. In one breath Maijoor is increasing the pressure on the rating agencies to take action that will benefit the EU in dealing with a sovereign debt crisis, that it is tremendously susceptible too anyway because of its multi-State structure, but on the other hand declares that the ESMA and EU should not interfere. Whether one is a supporter of the agencies or not, it has to be remembered that they operate privately, and for the marketplace – not for the EU. If it were any other time it could be written off as Maijoor simply commenting (which he should be careful to do in his position as Chief of the European financial regulator), but the EU is bordering on crisis. The UK has left, France (before the pandemic) was witnessing civil unrest every week, and the EU’s handling of the pandemic where Italy has been concerned will likely result in a serious problem once the pandemic passes. The project as a concept is in danger, and applying pressure to the rating agencies to provide leniency is not appropriate, and that is before we get into the issue of procyclicality. It must be noted that procyclicality is an inherent issue within the rating industry (particularly at the top end, but in reality throughout), just as the conflicts of interest that come with the issuer-pays system are inherent too. However, what is the solution? Are the agencies supposed to trust the central banks who say the downturn will be temporary and will ‘snap back’ once the pandemic passes? Are they supposed to stagger the release of their downgrades? If so, who gets downgraded first? Whilst a crisis reveals the inefficiencies of the rating industry, a crisis also reveals the inefficiencies of others, and in this crisis the EU is being examined like it never has before. Yet, if the agencies do not downgrade quickly enough, then complaints regarding their timeliness will emerge once more – technically, the agencies provide a service for investors and nobody else, and they need the information as soon as they can receive it.

Maijoor raises a valid point, but perhaps he should not be the one to make it.


Keywords – credit rating, EU, procyclicality, sovereign, downgrades, @finregmatters

Friday, 3 April 2020

Two of the “Big Three” Affirm the US Sovereign Credit Rating

In continuing the new approach of providing small updates on the credit rating industry here in financial regulation matters, today’s brief post assesses the recent announcements by both Fitch and S&P regarding the sovereign rating of the United States.


Just before last week’s downgrading of the UK’s credit rating, as we covered here Fitch had, on the 26th March, affirmed the US’ credit rating as AAA, with a stable outlook. Despite warning that the coronavirus pandemic was inflicting an unprecedented shock on the market, Fitch believes that both a. the country is deploying adequate resources (financially, at least) as part of its $2T stimulus package, and that b. as long as the pandemic clears before 2021, the agency expects the drop in GDP to reverse sharply and bounce back. All of the agency’s analysis is caveated by the development and potential continuation of the pandemic, naturally. Yesterday S&P followed suit, affirming the US credit rating as AA+, with a stable outlook. S&P expect continued political disputes to affect the economic progression of the country but, like Fitch, sees the recent stimulus package as positive in terms of dealing with the economic impact of the pandemic. S&P also envisage a strong 2021, pandemic depending. However, both agencies seemingly agree that the debt and fiscal deficits are likely to continue to worsen, as we know they will, but that this will have a negative effect for quite some time moving forward.

Thursday, 2 April 2020

State Intervention Sees HSBC Threaten to Leave the UK

The COVID-19 pandemic has created a global scene that is producing some incredible reactions. One of which is the level of state-backed intervention that is occurring in the UK and US, with the respective Conservative and Republican governments announcing record financial packages. However, as part of that intervention, we are starting to see elements of state intervention in private business that is not being received well by the market. In this post, we shall examine the Bank of England’s decision, as part of its role as the British regulatory framework’s top supervisor, to apply pressure to banks to cancel dividends. For HSBC, and its structure, this has proven to be a particular issue.

It was reported recently that a number of the UK’s largest banks had received pressure from the Prudential Regulation Authority, the regulatory arm of the Bank of England, to halt their dividends ‘after they were warned against paying out billions of pounds to shareholders during the coronavirus pandemic’. Amongst the group were Lloyds, RBS, Barclays, HSBC, Santander, and Standard Chartered (Nationwide, the building society, was also included), who all had also agreed to cancel any plans for share buybacks. In a somewhat unusual display of authority, the PRA sent a ‘formal request’ to the companies, although it went further by declaring that is was ‘ready to consider use of our supervisory powers’ if the banks did not comply with the request. Barclays, for one, had responded by stating that whilst it was a difficult decision to cancel dividends, they thought it ‘is right and prudent, for the many businesses and people that we support, to take these steps’. However, the sentiment was not shared across the group.

On the 14th April, HSBC was due to pay a dividend of $4.2 billion. For HSBC, more than four-fifths of its profits comes from Asia and, in Hong Kong specifically, a large proportion of that dividend was due to be paid to retail investors who ‘rely on dividends for a significant part of their income’. It has been suggested that a number of the banks’ Boards were waiting for the regulator to impose this move, in line with EU freezes witnessed last week, to protect them from shareholder criticism, but for HSBC the effect has been immediate. For the first time since records began in 1946, the dividend freeze has resulted in shares in the bank falling by nearly 10% in both London and Hong Kong trading, wiping nearly £8 billion from its valuation. Fitch Ratings, yesterday, changed the bank’s outlook to Negative. This has spurred the HSBC Board to consider a number of elements. The Financial Times, citing an ‘executive’, suggest that the HSBC Board are annoyed that the decision sends out a message that the bank is in a weak position, when in fact they are not. Yet, despite official communication that says the Bank fully understands the decisions of the PRA, and that there are no discussions ‘to review HSBC’s global headquarters and no plans to reopen the issue’, this has not stopped speculation. Originally based in Hong Kong from when it was founded in 1865 as the Hongkong and Shanghai Banking Corporation by Thomas Sutherland, to 1993 when it moved to the UK to aid its takeover of Midland Bank, the bank is now placed in a delicate position of being between two very different social structures. The anger that is supposedly spurring such discussions regarding re-domiciling elsewhere will inevitably be countered by the reason HSBC moved to London in the first place – to escape the clutches of the Chinese Government. If they were to move back to Hong Kong, that issue would re-emerge. There is apparently anger because ‘for the regulators at the Bank of England to put a gun to the head of the board of directors is terrible’, but this sense of freedom to whatever it wants would certainly be curtailed in a similar, if not more extreme fashion in Hong Kong. It is more likely that this supposed outburst is the bank’s attempt to exert its influence over the regulator as, in the coming post-Brexit and now post-COVID-19 arena, the UK will need the City of London to be as strong as possible, with losing HSBC to Hong Kong representing, prospectively, a massive blow. Yet, it is likely that the PRA both know and anticipated this. For its position, it cannot become a victim of extortion every time it seeks to implement a regulatory endeavour that does infringes, at any level, upon the freedoms of the banks.


Keywords – banks, HSBC, Hong Kong, China, UK, @finregmatters

Wednesday, 1 April 2020

EU asks for information on how Credit Ratings are used

In doing something slightly different for financial regulation matters, this post is just a small update for those connected or interested in the credit rating industry. The EU, on the 30th March, has published a call for comments on the availability and use of credit rating information and related data. As stated on the ESMA’s website, ‘the purpose of this call for evidence is to gather information on the specific uses of credit ratings as well as how the users of credit ratings are currently accessing this information’. This reflects an alteration in regulatory direction that a number of entities have been calling for – instead of just focusing on the rating agencies and mis-regulating because of a lack of scope, a greater focus needs to be placed on the users of credit ratings. This call for information is the EU’s attempt to start that process. I am reminded of my own journey in which the scholarly literature is massively negative regarding the credit rating industry and its usefulness, but in having spoken to a number of practitioners, there were more people than I had anticipated who found the ratings useful in their business practices – this is, of course, not to say that this sentiment is universally shared amongst practitioners. Yet, regulatory speaking, this is a positive move from the EU and, arguably, should have happened much sooner. It seems to be a direct reaction to the phenomenon we are witnessing at the moment; a lot of regulatory capital was expended on reducing regulatory reliance, and the use of credit rating subsequently increased, rather than decrease had many had expected.

The call is currently open and will remain open until the 3rd August 2020. ESMA have stated that ‘input is welcomed from all interested stakeholders, including users of credit ratings such as public authorities and financial market participants, credit rating agencies, as well as distributors of credit rating data’. The aim of the endeavour is to consider options that will improve access to and use of credit ratings, and also whether there is scope to improve the usability of the information provided for on rating agencies’ websites – the sentiment to this can be seen to be somewhat of an antithesis to the sentiment that was promoted when ending regulatory reliance was at the forefront of global regulatory efforts.


Saturday, 28 March 2020

Rating Agencies Take Aim at Sovereign Debt Ratings

In this short post today, we will look at the news recently regarding the rating agencies’ declarations regarding two countries’ sovereign debt ratings, what underpins them, and what may be next for countries facing up to the COVID-19 pandemic, amongst a number of other impactful factors.

The first news came from South Africa. As was to be expected on account of the other two rating agencies downgrading South Africa to ‘junk status’, Moody’s finally took the leap and cut South Africa’s rating to Ba1, from Baa3, with the outlook remaining negative. In providing details as to why Moody’s finally followed S&P and Fitch in downgrading South Africa to junk status, albeit 3 years later, the agency stated that the key driver underpinning the downgrade was ‘the continuing deterioration in fiscal strength and structurally very weak growth, which Moody’s does not expect current policy settings to address effectively’ (sign-in required). The agency then went on to detail the reasoning for the negative outlook it ascribed, stating that the country’s access to funding will be negatively impacted by market conditions, thus making the prospect of recovery that much harder. This negative view on the country’s progression is shared by many onlookers and experts, with economists warning of further upheaval as South Africa’s GDP is predicted to continue to fall. For its part, the Government of South Africa has admitted that the downgrade comes at the worst possible time and that it, along with the COVID-19 pandemic, ‘will truly test South African financial markets’. It is highly likely that the South African economy will experience more hardship in the near future.

The second country to have its rating changed recently by one of the Big Three is the UK, with Fitch cutting its sovereign rating to AA-, the same as Belgium and the Czech Republic. It is also putting the UK on a negative outlook as it predicts that a further cut could follow. In detailing why it took this action, Fitch stated that ‘a significant weakening of the UK’s public finances caused by the impact of the COVID-19 outbreak and a fiscal loosening stance that was instigated before the scale of the crisis became apparent’ was at fault. Furthermore, the negative outlook was based upon the agency’s view that ‘reversing the deterioration in the fiscal metrics beyond 2020 will not be a political priority for the UK government. Moreover, uncertainty around the future trade relationship with the EU could constrain the strength of the post-crisis economic recovery’. The UK Treasury has recently stated that its borrowing is the right course of action to protect the economy, but given the downgrade comes only a few short months after a recent improved assessment by Fitch, the volatility will be worrying for all concerned. With health experts suggesting the UK’s measures to fight the COVID-19 pandemic could extend into months, the economic impact of such measures will only add pressure to this downward movement for the country’s sovereign rating.

In other news regarding sovereign debt ratings, Mexico saw its rating cut by S&P to BBB from BBB+, with the agency declaring that the pandemic, alongside the shocks to the price of oil, were determining factors in its decision. In a similar vein, Oman saw its rating from S&P lowered even further into junk territory, on account of the country’s dependence on oil revenue. Fitch recently cut Ecuador’s rating to CC because its fuel-dependent economy is struggling, alongside its decision to recently renegotiate some of its commercial responsibilities. Elsewhere, analysts have suggested that Germany’s prized AAA rating may come under threat as its increased spending in reaction to the pandemic takes hold. With Nigeria and Angola all experiencing downgrades recently because of their dependence on oil price movements, whilst Russia and Saudi Arabia only just escaped downgrades from S&P. With Russia’s banking system being sized up for downgrades by both S&P and Moody’s however, the volatile climate looks set to be represented in the sovereign bond market also. The sovereign debt analysts at all the rating agencies will be working hard to keep abreast of the ever-changing conditions, with many more rating decisions likely to be forthcoming. Analysts are predicted downgrades globally by much bigger delineations than we are currently seeing, and the current trend makes that difficult to argue with.


Keywords – ratings, sovereign debt, downgrades, COVID-19, business, @finregmatters