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.