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Added Scope: Eurosystem accepts a fifth rating agency

April 20, 2024
in Business
Added Scope: Eurosystem accepts a fifth rating agency
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8 February 2024

By Diana Gomes and Anamaria Piloiu

The Eurosystem has accepted Scope as a new rating agency alongside Fitch, Moody’s, S&P and DBRS. This has a number of implications, including a wider range of credit opinions and expertise being considered for monetary policy purposes. The ECB Blog explains.

Credit rating agencies are private companies which assess the creditworthiness of issuers of financial instruments – be they governments, commercial banks or corporates. Many investors in the financial markets rely on rating agencies because it would be too costly for them to evaluate the credit risk of each issuer or debt instrument themselves. Central banks also use these ratings in their regular activities. That is why the recent acceptance of a fifth rating agency ­– Scope Ratings – has important implication for the Eurosystem and financial markets.

The ECB and the national central banks of the euro area use the rating information provided by these agencies during the implementation of monetary policy operations, either via the provision of loans to banks or via the direct purchase of assets in the financial market. For instance, the Eurosystem grants loans only against adequate collateral, which must be credit-rated. The credit risk information provided by ratings is important to mitigate financial risks to the ECB and the national central banks of the Eurosystem. The Eurosystem adheres to prudent and transparent standards and therefore only accepts high-quality assets in its monetary policy operations. Concretely, this means that the assets which the Eurosystem accepts as collateral or for purchases must meet minimum credit quality requirements and comply with specific eligibility conditions. To be eligible as collateral, assets need to have at least a BBB- (or the equivalent in another rating schema) from at least one accepted rating agency. In lending operations, the rating also affects how much money a commercial bank can borrow using an asset as collateral. The lower the rating, the higher the so-called haircut applied by the Eurosystem. Until recently only four rating agencies – Fitch Ratings, Moody’s, S&P Global Ratings and DBRS Morningstar – were accepted by the ECB. Chart 1 shows the share of financial assets rated by these four agencies.

Chart 1

Historical evolution of the use of credit rating agencies for monetary policy purposes

EUR billions (main axis) and percentages (secondary axis)

Sources: Eurosystem collateral database and authors calculations

The acceptance of Scope Ratings is a milestone for the Eurosystem. It offers a more diversified set of credit opinions, and therefore improves the ability to adapt and respond to evolving market dynamics. The addition of a new rating agency also broadens the pool of eligible collateral assets when the newcomer provides credit assessments of assets and issuers that are not rated by the other accepted agencies. Banks can then further diversify their collateral pools for central bank lending, which ultimately makes the implementation of monetary policy smoother.

The recognition of the fifth rating agency is also a milestone for the rating provider market. New players mean more competition, which is good for issuers as they can choose from a greater variety of agencies. Investors, too, benefit from a wider range of expertise, but also from greater transparency resulting from the Eurosystem’s efforts and requirements related to improving disclosures around ratings, processes and methodologies.

The Eurosystem conducts its own due diligence

Precisely because these ratings are so important, the Eurosystem conducts its own due diligence and does not mechanistically rely on them. To do so, the Eurosystem closely studies rating methodologies, rating reports and other relevant publications to fully understand how the rating decisions are made. This gives the Eurosystem a nuanced understanding of the information contained in credit ratings, for example by allowing it to disentangle qualitative judgment in rating decisions. This means that, in certain circumstances, the Eurosystem may deviate from the rating agencies’ opinions and apply discretionary measures such as country waivers. The most recent example was the acceptance of Greek sovereign debt instruments as collateral and for bond purchases in certain asset purchase programmes during the period when the associated sovereign rating was below the minimum acceptable rating threshold.

To be able to conduct its own due diligence, the Eurosystem accepts only credit rating agencies that are registered with the European Securities and Markets Authority (ESMA) and comply with the relevant acceptance criteria. The criteria cover crucial aspects such as rating disclosure, transparency and rating quality. For instance, credit rating agencies have to demonstrate a broad rating coverage across Europe and across asset classes. More specifically, a rating agency must demonstrate historical (at least three years) and current rating coverage for several asset classes, of at least: (i) 10% of eligible euro area assets; (ii) 20% of the nominal amount of eligible euro area assets; (iii) in two-thirds of the euro area countries. This rating coverage requirement is needed to ensure the Eurosystem’s risk protection and the efficient execution of its monetary policy framework. At the same time, this may help stimulate competition at the European level and support the integration of fragmented EU capital markets into a larger-scale EU capital market union, as more companies can benefit from a rating which allows them to potentially access the financial markets for funding.

The Eurosystem has consistently been open to additional credit rating agencies and engaged with external stakeholders such as smaller rating agencies, members of the European Parliament or ESMA. Of course, a number of ESMA-registered agencies – currently 29 – have specific focuses on certain assets or jurisdictions, which makes it difficult for them to comply with the Eurosystem rating coverage requirements and acceptance criteria. Importantly, the acceptance of a credit rating agency by the Eurosystem does not imply an endorsement of its ratings. It should also not be regarded as an assessment by the Eurosystem of the intrinsic quality of the rating agency. Instead, the acceptance is merely an acknowledgment that the rating agency complies with the Eurosystem’s needs for conducting its own scrutiny effectively.

Accepting Scope Ratings marks a milestone which fosters competition, transparency and the diversification of credit opinions in the credit rating agency industry, which benefits not only the Eurosystem, but also issuers and investors.

The views expressed in each article are those of the authors and do not necessarily represent the views of the European Central Bank and the Eurosystem.

Check out The ECB Blog and subscribe for future posts.

>>> Read full article>>>
Copyright for syndicated content belongs to the linked Source : European Central Bank – https://www.ecb.europa.eu//press/blog/date/2024/html/ecb.blog240208~6b987d0cf3.en.html

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