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

Thursday, 26 March 2020

SoftBank Challenge Moody’s and Raise Questions over Rating Timeliness

The giant Japanese conglomerate SoftBank, a holding company that holds shares in Sprint, Alibaba, Uber, and many others, was recently downgraded by Moody’s dragging it further into ‘junk’ status. However, it has decided to take aim at this decision and has suggested that Moody’s has ‘biased and mistaken views’. Is this retaliation to Moody’s justified, or is it a company, and a CEO, under increasing pressure as its debts continue to build?

SoftBank, founded in 1981 by Masayoshi Son (now CEO), went public in 1994 and was valued at $3 billion. Since then, it has gone on to become one of the world’s largest public companies, and Japan’s second largest behind Toyota. However, recently there have been concerns from the market that the company was exposing itself to too much debt, with the Financial Times reporting that SoftBank currently has $55 billion in net debt. It was on this basis, supposedly, that Moody’s took its recent decision to downgrade SoftBank’s credit rating by two notches, from Ba1 to Ba3. In order to reduce this debt burden, SoftBank have been planning to sell a number of its shares in the companies it holds stakes in, and increase the scale of a share buyback. It plans to sell a total of $41 billion of its shares, which the FT recently labelled as am ‘emergency’ asset sale to stem the collapse in its share price as a result of the Covid-19 pandemic. It had not been confirmed which shares would be liquidated, but analysts have suggested that its shares in Alibaba, totalling nearly $140 billion, would be a prime source of such liquidation (Son was an early investor in Alibaba).

Yet, for Moody’s, this was an ‘aggressive financial policy’ that was to form the basis of the downgrade. The rating agency suggested that the company’s value would be reduced significantly if it liquidated even parts of its stake in Alibaba, and also Sprint. Motoki Yanase, a Moody’s senior credit officer, said that ‘asset sales will be challenging in the current financial market downturn, with valuations falling and a flight to safety’. SoftBank have in turn stated that the downgrade ‘deviates substantially’ from Moody’s stated rating criteria and, as such, creates ‘substantial misunderstanding among investors who rely on ratings in making investment decisions’. As part of its official statement, SoftBank has asked Moody’s to withdraw the rating. Whilst analysts have suggested that removing the rating will likely not make much difference to the company, as it will still incur higher borrowing and refinancing costs, the unusual move is still very much a notable one. Yet, Moody’s competitors do not share their view, with S&P declaring that although it recently cut its outlook on SoftBank to negative, the planned share sales had the ‘potential to ease the downward pressure on its credit quality’. SoftBank, predictably, agree with this, stating that Moody’s rating was based on ‘excessively pessimistic assumptions regarding the market environment and misunderstanding that SBG will quickly liquidate assets without any thorough consideration’. Some analysts have fallen in line with this argument (albeit reluctantly it seems), with an analyst from CreditSights being quoted by the FT as saying ‘as much as we hate to pick sides, we do not follow Moody’s rationale here… we would go as far to say Moody’s are using the [SoftBank Group] asset sale announcement as an excuse to re-rate a credit which was overdue a downgrade’.

This brings forth an interesting issue. On one side we have Moody’s downgrading, and on the other we have its main rival and other analysts suggesting that either a. the share sale may work, and b. that the Moody’s downgrade is potentially behind the curve. There are two issues which shed more light on this. SoftBank still has an investment-grade rating from JCR, a Japanese rating agency and, as a result, is issuing significant amounts of debt into the Japanese domestic credit market. However, its position is becoming increasingly precarious but not, crucially, because of its debt exposure (though it is, of course, all interrelated and an important factor). It has been noted that one of the company’s biggest issues is that its bets on particular industries have put it directly in the crosshairs of the Covid-19 pandemic and the world that it is creating. Its ownership of companies like Uber and WeWork are coming under increasing pressure in the current climate, and the stability of the company’s $100 billion ‘Vision Fund’ is worrying investors (the fund invests in emerging technologies among other things). The company is heavily invested in industries that rely on the concept of ‘sharing’ like Uber (taxiing and shared-ride services), WeWork (co-working spaces), and Chinese company Didi Chuxing (ride-sharing). These sharing-economy industries are suffering badly at the moment and this should be one of the key aspects affecting its creditworthiness. In its rating rationale (available here [though sign-in is required]) Moody’s state that ‘it is unclear why SBG is undertaking such a dramatic recapitalisation during a time of severe stock and market volatility’. Perhaps, the exposure to industries that are capitulating in the current climate is just one, albeit a major factor in the need to reduce its debt burden so rapidly. This will, of course, be known by Moody’s, so the question can be raised as to why that factor is not included within its rationale, with the agency instead going with ‘it is unclear’ why the company are taking such apparently drastic measures. The more transparency that can be articulated via rating rationales the better, and this is a common request of the rating industry. It is likely why analysts are suggesting that Moody’s is using this stock liquidation as an excuse to downgrade when they should have done this a while ago. We spoke yesterday of the glaringly-obvious importance of ESG-consideration in the rating process in the light of the current climate, and this rating downgrade perhaps alludes to that sentiment further. A very helpful comment on social media with regards to yesterday’s post said that nobody could have foreseen the Covid-19 pandemic coming, which is absolutely true. However, moving forward, the experience can be utilised (whilst it is also worth stating that the outbreak began around the turn of the year in China, which may have raised some alarm bells, even if just on a very conservative basis). That the globalised world can be ground to a halt because of the spread of disease must now be hardwired into the rating process when an agency considers ESG in its processes, and factored in accordingly. A company which is heavily invested in the sharing economy should, with the benefit of hindsight, have this factored into their creditworthiness assessment moving forward and, perhaps, indefinitely so. The title of the post is with regards to timeliness affecting the opinion that onlookers have of rating agencies, but perhaps the key here for Moody’s is to be incredibly articulate and open with its rating rationale, even it just declares that it has attempted to connect the dots in order to come to a rating decision; stating that it is ‘unclear’ why a company is taking a certain decision will only ever lead to accusations that harm the authority of a rating agency, rather than promote it (whether rightly or wrongly).


Keywords – Moody’s, CRAs, SoftBank, Covid-19, business, @finregmatters

Wednesday, 25 March 2020

The Wave of Credit Downgrades Rises on the Horizon

A number of financial media outlets, including Forbes, the Wall Street Journal, and the Financial Times are all reporting that a wave of downgrades is soon to be upon us because of the effects of the Covid-19 pandemic. In this post, we will take a look at those who have been downgraded, those likely to be downgraded, and also the wider effect of these downgrades. Also, it will be worth asking why so many downgrades are on the horizon because, as one journalist recently wrote (Cezary Podkul of the WSJ), ‘a bond rated AAA is supposed to keep that grade, even in tough times like these’. This is the theoretical foundation of the credit rating differentiation, so why so many downgrades?

On the 17th March, Forbes reported that ExxonMobil had been downgraded by S&P, to AA from AA+. On the same day, S&P took aim at Boeing, downgrading the beleaguered aircraft manufacturer’s rating by two notches, from AA- to BBB (just two notches above ‘junk status’. There are, perhaps, other reasons for these particular downgrades. Boeing is undergoing one of the most difficult periods in its history (as we have discussed before here in Financial Regulation Matters) and, as ExxonMobil’s CEO Darren Woods stated immediately after the downgrade, the company is aiming to reduce its capital and operating expenses as a result of the tumultuous climate, something S&P cited as being one of the reasons for the downgrade. However, there are a number of other high-profile companies being downgraded which onlookers are suggesting is just the start of a larger wave. Lufthansa was recently downgraded to junk status by Moody’s, S&P cut Lufthansa and British Airways’ parent company IAG to one notch above junk, whilst cruise ship operators Royal Caribbean and Carnival have been placed on a negative outlook credit watch by S&P. We already know that Kraft-Heinz has been downgraded to junk, whilst Macy’s suffered the same fate not so long ago. S&P recently said that default rates in the US were surging past 10%, up from 3.5% just last month. The effect of this is that a number of other companies may be caught in the general downturn, leading to further downgrades. The result of this, as one commentator mentioned, is that it may be the case that there will be too much ‘junk’ debt flooding the marketplace and not enough investors with the appetite or capability to absorb it.

The downturn has continued to affect sectors. The insurance sector is experiencing some losses (the Philadelphia Contribution Group was recently downgraded by AM Best). In the troubled CMBS market, S&P recently stripped a AAA grade from a $215 million bond backed by mortgages on the Destiny USA mall. Cezary Podkul and Gunjan Banerji of the WSJ discuss how a number of bonds attached to industries like shopping malls, hotels, airlines, and even local governments are all in line for downgrades, with the rating agencies stating that ‘the global recession is here and now’ and that there has been a ‘severe and extensive credit shock across many sectors, regions and markets’. A further casualty has been Delta Airlines, who have seen their credit status reduced to junk status by S&P. Yet, even though these companies on the brink have been downgraded, a number of AAA rated entities and bonds are being downgraded, which Podkul and Banerji quite rightly note should not be the case, with AAA-rated entities being regarded as safe as Treasury bonds. The sentiment is that such potential shocks should have already been factored into a rating, rather than waiting for them and then reacting via downgrades. According to their article, there are more than 100 downgrades that have been related to the Covid-19 pandemic, and many more are planned. So, how much responsibility should we lay at the feet of the rating agencies?

The unfortunate conclusion is that a number of onlookers who have suggested the rating agencies have very little informational value to add to the marketplace, and are merely reactionary in nature, will be validated by these recent events. The key question is, perhaps, whether we should expect the agencies to foresee a crisis like the one currently enveloping the world, or at the very least whether they should factor in the potential of a crisis of this magnitude happening. Is the Covid-19 a so-called ‘black swan event’? If we accept that this is a black swan event, then the position of credit rating agencies is a difficult one. However, if we suggest that the concerted move into considering ESG-related issues fundamentally within the credit rating production process should have impacted the development of top-rated ratings so much that shocks like these are considered, then the position of the agencies is less precarious. That sentiment would suggest that the rate of downgrades should have been reduced because environmental and/or social elements should have been considered more. Maybe not. Yet, the subjectivity of the ‘E’ and ‘S’ elements, as compared to the ‘G’ element, is now perhaps being revealed to be a major issue with the concerted incorporation of ESG-related information. They are really important elements of the impacts upon businesses, as we are now seeing, and their incorporation is vital. But, finding an agreed-upon understanding of what ESG means, and how it impacts upon creditworthiness, appears to be a fundamental issue. What is clear is that work needs to be done on this issue, on behalf of the agencies, and it needs to be done very quickly. Another raft of downgrades has the potential to affect the authority of the rating agencies, although a number of people would suggest they are somewhat immune to such pressures anyway.


Keywords – credit rating agencies, downgrades, ESG, @finregmatters

Monday, 23 March 2020

British Rail Services “Nationalised” in Response to Covid-19

In response to the global pandemic involving the transmission of the Covid-19 (Coronavirus) disease, a number of extraordinary measures are being put in place around the world. In the UK, the Conservative Government has taken a number of steps which, ideologically, go against their principles. Today, the latest in a line of extraordinary measures was taken when the Department for Transport stepped in to, essentially, nationalise the rail industry in the UK on an emergency basis. The developments and details of that extraordinary measure form this post.

Rail services, along with other modes of travel like aeroplanes and coaches, were quick to suffer the natural consequences of the worsening of the Covid-19 pandemic. A number of rail operators had already started to reduce their services before the British Prime Minister requested that non-essential travel be avoided, and this was accentuated by a further reduction in services in places like London (where up to 40 underground stations were closed last week). The Transport Secretary Grant Shapps stated last week that the aim was to reduce services, but to allow some services to continue so that keyworkers could still perform their duties, and so that freight services could continue delivering much needed supplies across the country. However, today, the Department for Transport spectacularly announced that the Government was taking emergency measures ‘to support and sustain necessary rail services as operators face significant drops in their income’.

Those significant measures centre around the headline-grabbing move to temporarily suspend the franchising system and ‘transfer all revenue and cost risk to the government for a limited period, initially 6 months’. What does this mean? Essentially, the Government has guaranteed the survival of all rail operators who choose to sign up to these measures. The sentiment is that all the operators will fall in line, as there is little chance of survival without doing so. Yet, there are a number of key elements to the decision. Although it has been suggested today that the franchising system ‘had long had its day’ before today’s announcement, the reality is that the rail system in the UK is, as from today, essentially nationalised and that marks a huge turnaround. Second, it is clear from the wording from the DfT that this is not a pre-determined system, and could go on longer than the 6 months cited. Those representing the rail industry supported the moves, whilst the Shadow Transport Secretary also welcomed the moves and suggested that these events will form part of the discussion on how the rail industry moves forward after the crisis. The Government have not just guaranteed the rail industry, but put in place measures for rail passengers to be refunded on all tickets, so as to remove any penalty for abiding by the promoted guidance – not all providers were willing to refund all tickets, like advance tickets. The Government has also placed a cap of 2% of the cost base of the franchise, which they suggest incentives operators to perform adequately but will see a reduction in the profits being extracted by the private companies. In the event that an operator takes the unlikely decision to reject this approach, the Government has said that they stand prepared to step in and rescue the operator and take it over.

So, there are a number of conclusions. Yes the Conservative government has essentially nationalised the rail industry, but this is not nationalisation. It is a response to an emergency which will not be repeated, so the suggestion from Labour that this decision will form part of any post-crisis discussion on the formulation of the rail industry are probably wide of the mark. Also, the argument that this decision will be more cost-effective for the taxpayer in the long-run is accurate. However, this leads to a much more important discussion about what capitalism has become, or perhaps what it has always been. The decision by the Government to nationalise rail operators, and guarantee that any operator who fails will be saved, fundamentally proves that the concept of ‘too-big-to-fail’ is pervasive in the modern society. It is highly likely that the airline industry will prove the same concept, as too might many other sectors. The question is whether these events will be remembered once the crisis is over, or whether it will be ‘business as usual’? Any sort of liberal economic theory now has to be understood in context, and arguably should always have been (as demonstrated by the Financial Crisis) – when push comes to shove, the market cannot support society alone. It is the ‘lender-of-last-resort’ principle that makes capitalism as we know it possible. It is for this reason that there are now claims surfacing, more than before, that this time ‘small people should get the bailouts’. For the time being, that is being promised (in a number of senses, although not universally) but whether or not the principles underlying those claims survive after the crisis has passed is another thing altogether and, most likely, will have a familiar conclusion.


Keywrods – Covid-19, rail, trains, economics, politics, business, @finregmatters

Saturday, 14 March 2020

The Airline Industry under Threat from the Coronavirus Pandemic

Of course, the title of this post is a little misleading in that the airline industry is not the only industry facing extraordinary pressure because of the global pandemic. However, it does provide an interesting case study to show how the pandemic can affect an industry in a number of different ways. Just some of those pressures will be discussed in today’s post.

One of the first consequences to the airlines was the detailing of a number of ‘ghost flights’ taking place around a number of important hubs. These ghost flights describe the process whereby an airline will fly an empty (or severely reduced capacity) flight in order to maintain a specific slot in an airport’s schedule. A number of slots on high-profile routes can be worth tens-of-millions of dollars to an airline, and a massive secondary market exists for such slots. However, under EU rules as just one example, an airline must use 80% of these allocated slots or risk losing them to a competitor. As the slots are particularly lucrative and important for the futures of a number of airlines, it is more prudent to fly the planes from and into empty airport slots, rather than lose that slot; this is irrespective of how long the decline in consumer demand may last. The airlines, and a number of onlookers concerned with the environmental impact, as well as other issues (such as increasing the health risk to employees unnecessarily) complained about this and, earlier this week, the EU relaxed these rules on account of these concerns.

The measure is a temporary but required one because the industry is coming under increasing pressure. A number of European hubs have been closed, or airlines have reduced or stopped flights to certain places – Italy being a prime example. In addition, President Trump recently declared a travel ban on a number of European countries, with more likely to follow (the rumour at the time of writing is that the UK will soon be added to the list). Today, Jet2 turned flights around on their way to Spain, whilst Tui have cancelled a vast number of flights between the UK and Spain, leaving travellers scrambling for airports. The US airlines are continuing to fly to Europe, if only to bring back employees and US citizens. However, for other airlines the situations is more dire. Norwegian budget airline Norwegian Air temporarily laid off more than half of its staff and ground 65% of its flights. British Airways, a stalwart of the international airline marketplace, has already warned that jobs will be cut because of the pandemic, in a memo entitled ‘the survival of British Airways’. It is almost certain that a US ban on British flights will have a massive impact upon the fortunes of BA, even though its parent company IAG is strong. The wider suggestion is that the industry could lose up to £90 billion in revenue this year, and that is on the basis that the pandemic subsides at some point this year, which is by no means guaranteed. On top of this, the associated hotel and hospitality industry is suffering also, with revenues predicted to plummet this year. So, what may the industry look like in the aftermath of the pandemic?

This pandemic is the worst-case scenario for the airline industry. This is because flights will be the first thing to be considered as aggravating the situation (as we have already seen), and then once the pandemic subsides the return the skies will surely be gradual and people deem the risk to slowly subside. So, the impact is immediate and the recovery will be gradual. If that becomes the case, then a number of airlines will surely suffer. With such tight profit margins anyway, the number of failures in this marketplace will surely increase. If that is so, how will national governments respond? Will the British government step in to save BA if it fails? One would imagine so. One suggestion has been that airlines will instead seek to survive however they can, and then raise prices for good in order to both consolidate their recovery and protect against future shocks. It will likely then become a competitional or anti-trust issue, although whether the position of consumers is prioritised over the stability of the industry will be something worth watching. One thing is for sure, and that is that the industry will likely not look the same when the planes return the skies as usual.


Keywords – airlines, planes, coronavirus, pandemic, @finregmatters

Wednesday, 4 March 2020

Concerns Raised over ESG Ratings, but Why?


An article in today’s edition of the Financial Times, entitled ‘Heavy flows into ESG funds raise questions over ratings’, attempts to shine a light on the business of ESG rating agencies, or Sustainable rating agencies, as the process of incorporated ESG (Environment, Social, and Governance-based) considerations into investment decisions is becoming more mainstream. However, upon reflection, the sentiment of the article is a little understated so, in this post, we will assess the article closer and think more about the trajectory of this industry (particularly in relation to the much larger credit rating industry).

The article begins my making valid points regarding the increasing importance of such ratings, with the discussion focusing on the fact that a growing number of investment indices are now focusing on the ratings much more as well as banks now offering better borrowing terms for entities that can demonstrate stronger ESG scores. I analysed this trend in my recent book The Role of Credit Rating Agencies in Responsible Finance (available in preview here), as well as in an article entitled Sustainable Finance Ratings as the Latest Symptom of ‘Rating Addiction’ and it is indeed true that a number of elements are fuelling this mainstreaming of the ESG considerations, rather than traditional models such as thematic or ethical investing: a reaction to the Crisis-era version of investing; entities such as the PRI; the entrance into the field of the large credit rating agencies, which has essentially formalised and certified the niche investment models for the mainstream investors (as there is less focus on purely ethical or thematic investment principles and more on the returns-based aspects). However, the article quickly shifts towards research conducted by MIT Sloan School of Management (in August of last year) that suggests that there is a large divergence between the ratings of the sustainable rating agencies, and especially when compared to the credit rating agencies – who themselves are ostensibly incorporating ESG into their rating decisions much more – with the example of Facebook being docked points and concerns raised from Standard & Poor’s, whilst MSCI maintain average ratings.

Yet, Berg, K├Âlbel, and Rigobon (the scholars from MIT and the University of Zurich) attempt to ‘quantitatively disentangle’ the divergence witnessed between the ratings of the top five sustainable rating agencies, which they find can be substantial. Their analysis leads them to conclude that the divergences witnessed in the field are because of an inherent issue – ESG ratings are very subjective, and the differences in underlying methodologies between the agencies is at the core of the divergence. The sentiment is that the methodologies are so radically different between the sustainable rating agencies, as opposed to the credit rating agencies for example (whose ratings on entities are often much closer), that it is difficult for investors to know which is useful and which is not. The FT article then looks at issues that underpin this divergence, including potential informational disclosure-based issues which may impede a ‘full’ rating, for example. Furthermore, the President of MSCI is cited as an example of the tone of the argument, when he mentions that homogeneity witnessed in the credit rating agencies is not, and should not be aimed for in the sustainable ratings industry. However, how true is that sentiment?

It is interesting to note that, for the credit rating industry, increased competition was identified as an early post-Crisis solution to the perceived ills within the industry. This then led to a number of regulatory initiatives aimed at increasing competition, including the Rule 17g-5 Program from the SEC (an article I produced in 2018 reviews the Program here) which aims to increase the informational flows within the industry from issuers, so that agencies can offer competing unsolicited ratings to act a check on the paid-for agency’s ratings – although, the SEC recently admitted that this Program has not been the greatest of successes. Other regulatory focuses have resulted in similar failures, which I argued in my first book entitled Regulation and the Credit Rating Agencies: Restraining Ancillary Services is based upon a fundamental misunderstanding of the rating agencies, their function, and their actual importance to the marketplace. I have since developed this discussion in a forthcoming chapter within Regulation and that Global Financial Crisis: Impact, Regulatory Responses, and Beyond within which I suggest that the ‘regulatory licence’ that scholars have argued permits rating agencies to continue is now better described as a ‘market licence’ i.e. it is the market that permits the agencies to grow, and in fact always has – regulators have merely reacted to market preferences. It is these preferences which are the key, and that sentiment is being displayed in the FT article; the market does not want too much competition when it comes to third-party verification, as it quickly becomes a hindrance. The sentiment of the article and the MIT-based research was that the divergence between the ratings is because the underlying methodologies of the leading five sustainable rating agencies cannot be standardised. Whilst industry officials may suggest that this standardisation should not be desired, that is not them speaking from an investor’s viewpoint. For the investor, the viewpoint is very different. The rating feeds into a wider consideration, and divergences increase doubt, which potentially increases risk which is the opposite of the function of any rating agency.

Ultimately, it is telling that when there is no competition, there are concerns and when there is too much competition there is concern. This Goldilocks-like situation has developed because the fundamental dynamics of the marketplace are being ignored because of the outcome, which is not progressive and certainly not appropriate for regulatory purposes. What would be more appropriate is embedding into the understanding that a. the marketplace actually wants third-party verification, but increased competition increases divergence which destroys the point of having that verification, b. a clearer regulatory aim is required in order to increase the likelihood of regulation being successful. A clear aim with regards to credit rating regulation would be to reduce transgressive behaviour, especially in the field of structured finance. One way to do this would be to apply an element of personal liability to the rating committees of the rating agencies on structured finance ratings, with a particularly high bar for that liability – the emails correspondence obtained after the Financial Crisis with analysts admitting that anything submitted would more often than not get high ratings would be a good example of that high bar. However, I absolutely acknowledge that this is likely very unworkable indeed, and for a number of reasons (internal communications would grind to halt, the rating agencies would vehemently defend their position either by way of abstaining from providing certain ratings [thus closing an important marketplace] or lobbying, and it would need a regulatory appetite the like of which we have not seen before). However, the principle of the discussion is important – a misaligned or mis-articulated regulatory focus will always result in unsuccessful regulations, and that is clearly the case in the rating industry. The lessons from the much smaller sustainable rating industry are clear: the regulatory focus on affecting the competitive structure within the rating industry has been a waste. Placing this ‘market-licence’ theory at the core of the regulatory mindset would be a good start moving forward, although the toe-in-toe-out approach currently being taken with the removal of regulatory reference but continued regulation does not suggest that any successes will be expected soon; it is likely the very opposite.

Keywords – sustainable rating agencies, sustainable ratings, ESG, credit ratings, @finregmatters

Monday, 24 February 2020

The Iconic Macy’s Downgraded to “Junk” Status


Quite often here in Financial Regulation Matters, we have looked at the experience being faced by British retailers against the onslaught of online commerce but, of course, the experience is shared with American ‘bricks-and-mortar’ retailers. In this short post we will review the fortunes of one of America’s most iconic department stores – Macy’s.

Macy’s, founded in 1951 by Rowland Hussey Macy, is one of the most iconic American department stores. To provide some context for the marketplace, Bloomingdale’s is another iconic store but it operates under the Macy’s Inc. holding company, which used to be known as the ‘Federated Department Stores’ holding company before it purchased Macy’s in 1994 and re-branded. Macy’s Inc., in the last full financial year, recorded revenues of nearly $25 billion. However, earlier this month the company announced a set of plans to revive what are quickly becoming ailing fortunes. As part of what the company has labelled ‘Operation Polaris’, the plan is to shore up profitability by way of closing 125 stores over the next three years and targeting 2000 corporate job cuts, as well as shutting corporate offices. This marks a shift for the company, who will be moving its central headquarters to New York and, in the process, closing its Cincinnati base (as well as large offices in San Francisco and Ohio). The company’s CEO, Jeff Gennette, recently stated that the company had ‘significant work to do to improve the bottom-line’, and that the company hoped that the cuts would generate about $600 million of savings this year alone. Yet, for investors and onlookers, there is little to be excited by. A number of comments have been reported in The Financial Times, including ‘kind of the same thing – and it hasn’t worked’, to ‘nothing new [and it fails to] solve the major problems that plague Macy’s’.

Now though, it is the turn of the credit rating agencies to have their say, with S&P taking the lead. Both Moody’s and Fitch have the company at one grade above ‘junk’ status but for S&P, the time has come for the company to be placed in its non-investment grade category. S&P stated that the chain’s ‘competitive advantage has diminished more than we expected’ and that the downgrade ‘reflects our view that Macy’s improvement trajectory is weaker than our prior expectations and execution risks are elevated as the company pursues its Polaris strategic plan against an ongoing difficult industry backdrop’. A large proportion of S&P’s rating is based upon the understanding that not only are shoppers’ attitudes and preferences changing, but that the company has a large number of stores that it has acquired over the years that now leave it ‘saddled’ – the shares in Macy’s dropped nearly 5% on the announcement of the downgrade. Experts in the field doubt whether Macy’s has the managerial competency to save itself, with it being noted that its revival plans are well behind rivals such as Target, Costco, and Walmart who are facing similar pressures in the marketplace; a Marketing Professor at Columbia University recently remarked that ‘I know this sounds awfully critical, but Macy’s is a rudderless mess. Current and past management is truly clueless as to what to do to successfully position the company for the future’. Interestingly, rather than blame the online retail space for its woes, some experts have agreed that this is not necessarily the issue for Macy’s (who are doing quite well online), but that the issue is that they are failing to bring people into the stores by updating them and customising the experience for customers who do shop in stores; this is what they mean by poor management.

With the pressure building on the company, it will be interesting to see how they develop. It seems incredible that their only response to falling customer interest will be to cut jobs, stores, and offices but then not work to upgrade what they already have. The company is planning to invest in its online offerings and will build a new hub in Atlanta to service this offering, but it surely must seek to lead in the marketplace rather than react to the fear that the online marketplace will take over and dominate. People still shop in-store. However, if they are overlooked or have their experience essentially limited because the company are concentrating on other matters then, of course, they will stop coming. Macy’s seems to be at an important cross-roads in its development and its identity, and particularly how it perceives its own identity, will likely be the key to its future success.

Keywords – Macy’s, Retail, business, cuts, @finregmatters