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Europe's 'downgrade diary' flags up new market pressures
August 5, 2013 / 8:29 AM / 4 years ago

Europe's 'downgrade diary' flags up new market pressures

By Marc Jones
    LONDON, Aug 5 (Reuters) - New European rules requiring
credit agencies to announce their rating decisions to a pre-set
timetable are likely expose the region's shaky sovereign
borrowers to more bursts of market pressure.
    But they may also have an impact further afield.
    Under the CRA3 rules taking effect at the start of next
year, credit rating firms will have to make the dates of their
sovereign reviews - when downgrades, upgrades or outlook changes
usually happen - public in advance.
    Ratings are a key part of the financial system because
investors use them to judge how likely they are to get their
money back, but the financial crisis has led to unease that the
market is relying on them too much.
    Europe's changes aim to make the secretive ratings process
more transparent, reduce the clout of big firms like Standard &
Poor's, Moody's and Fitch, and stem
the constant downgrade rumours that unsettle investors.
    But behind the scenes some policymakers are warning that the
plans could end up creating what one called a "downgrade diary"
that speculative traders could use to target vulnerable states.
    Regulators and rating agencies are worried too, concerned
that having specific dates for moves risks producing "cliff
effects" whereby markets gyrate in anticipation of possible
rating changes and then correct on the news.  
    "It will be similar to the way you get stock market
volatility ahead of Fed, ECB and Bank of England meetings as the
market tries to second-guess what they will do," said Alan Reid,
managing director of DBRS, the largest rating firm outside the
big three.
    "In between the (rating) decisions there will be less
volatility, but overall there could be more because right around
those dates you would concentrate it."
    Analysts are not exactly sure how big the pre-rating
decision price swings will be under the new rules.     
    Mario Draghi's "whatever it takes" promise last year on
behalf of the euro has reduced market sensitivity to ratings,
but traditionally it has been high, especially if a move or
outlook change takes rating in or out of investment grade
territory, or makes such a move likely.
    The ECB's two-tiered lending system, where banks are allowed
to borrow 5 percent more if the bond they put up as collateral
is rated in the AAA to A- band, also plays a big role. 
    When Moody's downgraded Portugal by four notches in July
2011 following Greece's debt restructuring, Portuguese and Irish
bond yields leapt almost 250 basis points and European shares
lost 3.5 percent in the space of two days.
    And an International Monetary Fund study last year showed
that a top agency putting a country's rating on
"downgrade-watch" on average leads to a 100 basis point widening
in Credit Default Swap Spreads (CDS) in advanced economies and
one of 160 bps in emerging borrowers.
    "We would have to adjust what we do and start thinking about
who is vulnerable as those dates approach," said Deutsche Bank
senior euro zone economist Mark Wall.
    "If you have deteriorating fundamentals, if there has been
disappointing progress on structural reforms, then there is the
risk of a downgrade and the market is going to be looking at
    Agencies will be able to change their ratings outside the
pre-set timetable but only in extreme cases, for example if a
government falls or makes a sudden huge change to its finances. 
    Rating watchers wonder whether some countries will try to
"game" the new system by leaving bad news until just after
reviews, but for traders the limited room for manoeuvre means
they can position fairly confidently for key rating dates.
    There are likely to be plenty. Even if just the big three
agencies - S&P, Moody's and Fitch - are included, 28 European
Union sovereigns being rated twice a year still adds up to 168
potential bouts of market stress.
    And it doesn't stop there either. One of the quirks of the
new rules means that if a country in another part of the world
is rated by an analyst based in Europe, it too will be subject
to the new requirements.
    For S&P that is roughly half of the 127 countries it rates
and includes most of Africa and the Middle East, and for Moody's
and Fitch it is a similar story.
    African and Middle Eastern markets are for the most part
more thinly traded than those in Europe meaning, the price moves
could be larger, though the limited liquidity could at the same
time reduce the appetite for major short selling.
    "The Nigerians thought we are mad when we told them about
these new rules," said one top rating agency sovereign analyst
who requested anonymity.

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