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