Sometimes governments disagree with rating agencies. This usually happens when a government insists on its financial strength but the agency disagree.
At this point, the government has a few options. China has its own credit rating agency, Dagong which, though privately-owned, continues to rate China well above the United States. Europe considered a similar move as the sovereign debt crisis first started to break.
Or governments can make life difficult for existing agencies. Russia placed the international agencies between a rock and a hard place over national-scale ratings for entities sanctioned by the EU and US. Europe has insisted on more competition in the credit rating market, and on agencies sticking to a timetable for sovereign rating actions, which is meant to ensure an orderly market (downgrades on a Friday after market hours) but which the agencies fear could create false markets.
The latest incarnation of European liquidity rules falls into the latter camp. Upset at the presence of “sovereign caps”, which limit the rating of covered bonds and asset backed securities to a certain level above their host jurisdiction, the Commission has thrown a hissy fit in its final version of the Liquidity Coverage Ratio.
From the final rules: “Country ceilings precluded the covered bonds issued in those Member States from reaching credit quality step 1, irrespective of their credit quality, which in turn reduced their liquidity compared with covered bonds of similar quality issued in Member States that were not downgraded.”
In effect, this argues that jurisdiction is not a part of the credit quality of covered bonds — a view that might make sense in whatever imaginary single market utopia the Commission exists in, but which will come as a big surprise to anyone trading in or investing in covered bonds.
Caixa Geral really ought to go back to its bankers, which led a seven year on Tuesday at 64bp over swaps, and ask why, since the Commission says all jurisdictions are equal, it didn’t match the 10bp through which Commerzbank achieved on Monday.
The Commission continues: “Funding markets within the Union have become greatly fragmented as a result, which highlights the need to find an appropriate alternative to external ratings as one of criteria in prudential regulation to classify the liquidity and credit risk of covered bonds and other categories of assets.”
And we’re back to shooting the messenger. Perhaps funding markets fragmented because of the unsustainable debt burdens of some member states, and the lack of meaningful reforms or progress on debt mutualisation. Or perhaps it was because of the rating agencies. Much easier to blame them than to fix the problem.
Actually, cutting ratings out of regulation is not a bad idea. The agencies themselves have been saying it for years, fed up with being the whipping boys for regulatory arbitrage. No ratings in regulation means no cliff effects, and less chance of being dragged into structuring debates or being beaten up by investors and bankers alike. It means lowering the stakes, and getting closer to the ideal of pure, free floating, objective credit opinions.
The trouble is, it’s very hard to do. The Basel Committee had a go just before Christmas, based on decomposing ratings into some of their key inputs, such as loan-to-value or net debt-to-Ebitda. But there is still no obviously better solution.
Regulators should certainly keep trying to improve the system but not because they think their credit analysis is better than the agencies.