14 February 2017

Paul Goldschmidt: Time to revisit the governance of Rating Agencies?

The author reviews the role of CRAs in light of new political challenges ahead such as the rise of Marine Le Pen and other nationalist parties whose plans imply modifying unilaterally the rights of the investors in French debt securities.

For ratings of securities issued by sovereign States, taking account of the “political” risk associated with both the capacity and the willingness of the issuer to meet its obligations was a standard part of the procedure. In the past most of these “sovereign” ratings were issued in connexion with securities denominated in another currency than the issuer’s “national” currency; indeed the issuer had always the latitude to monetise any debt issued in his own currency, fulfilling his “legal” repayment obligation  (whatever the value – expressed in purchasing power – of the nominal amount repaid).

The advent of the Single currency (€) has fundamentally changed this situation: the countries that participated in EMU abandoned their “monetary” sovereignty which deprives them of the ability to monetise debts denominated in a currency that they no longer control; their debt becomes, at a stroke, the equivalent of a “foreign currency” obligation. This implies that participating States must accept to abide by a “collective discipline” if they are to enjoy the continued confidence of investors. Such confidence came under severe stress during the 2011/12 Eurozone “sovereign debt” crisis when sharp fluctuations appeared in interest rate differentials (spreads) between debt securities issued by Members of EMU. This was principally a reflexion of the failure by some of them to comply with the rules of the Stability and Growth Pact and other commitments, to which they had adhered.

Since that time, a world-wide increase in “national populist” movements has taken hold. So far, neither in the United States nor in the United Kingdom, have these developments had any direct consequences with regard to their “solvency” because nearly all their indebtedness is denominated in USD or £ respectively; the situation is completely different in EMU Member States that are subject to similar political pressures, such as in France or in Italy.

The declarations of Marine Le Pen concerning her intention to leave the Eurozone, to revoke the independence of the Banque de France and to resort to the “printing press” to finance social security commitments and service the country’s debts have direct implications with regard to France’s solvency. It means modifying unilaterally the rights of the investors in French debt securities (60% of which are held by foreigners) by altering the currency in which the debt will be repaid.
 
Indeed, the decision to repay its debt in the new (devalued) “national currency” is a violation of the indenture governing each issue and constitutes an event of default both practically and legally. A significant devaluation relative to the € is, indeed, one of the main objectives being pursued in order to restore French competitivity in its main export market (the Single Market), a further fall in the parity with the dollar (which has fallen by 30% since May 2014) being far less significant.
 
The most immediate consequences of implementing Marine Le Pen’s proposals are as follows:

• The loss of access by France to international capital markets ;
• The need to institute exchange controls and limit withdrawals from banks to prevent capital flight;
• Severe imbalances in the balance sheets of entities whose foreign obligations exceed foreign claims, leading to bankruptcies (a likely situation as evidenced by the chronic deficit of the French balance of payments)
• The contagion to the whole of the French economy of a crisis of untold proportions.

In such a context, a domino effect of bankruptcies would most likely lead to the implosion of the single currency and to the spreading world-wide of a major economic and financial crisis.

Full article

© Paul Goldschmidt