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Methodology for Analysing Relationships Between Rated Entities and the State under the International Scale
Piatok, 11 Január 2019

1 Scope of methodology

This Methodology for Analysing Relationships Between Rated Entities and the State under the International Scale is used to evaluate the influence that the state represented by the national government, regional and municipal authorities as well as other government institutions has on creditworthiness of rated entities, i.e., both financial and non-financial organizations.

Not being a comprehensive document, this methodology contains references to other methodologies of the ERA in particular, to those for assigning credit ratings under the international scale. This methodology is inapplicable for ratings of regional and municipal authorities or small and medium-sized businesses.

Rated entities, whose standalone creditworthiness assessments (SCA) have to be adjusted depending on the influence that the state has on them, are regarded as government-related rated entities. This implies that creditworthiness of such rated entity is determined not only by its standalone creditability, but also by its systemic importance for the national economy as well as by state influence on operating activities, financial standing and ownership structure of the rated entity.

Before applying this methodology, a preliminary rated entity SCA calculation is typically required. For that purpose, methodologies covering specific types of rated entities are applied, with possible adjustments for the influence of the state represented by the national government or regional authorities. If it is impossible to assess SCA but a rated entity is characterized by a very high level of importance for the national or regional economy and there is a significant or very significant state influence, the Agency sets a parity between a credit rating of a rated entity and the creditworthiness assessment of the national government or applies a discount to the sovereign risk level.

This methodology shall be applied on a permanent basis until a new edition is approved by the ERA´s Rating methodology reviewer.

Credit ratings assigned according to this methodology shall be reviewed in accordance with ERA internal documents, on an ongoing basis and at least annually.

In order to keep this methodology up to date, ERA shall review and amend it in the following cases:

  • over three instances of deviation from this methodology while performing rating activities over the course of one quarter;
  • requirement for amendments based on the results of methodologies application monitoring conducted by the methodology group;

ERA shall review this methodology in accordance with its internal documents within one calendar year after the latest review date. A review may bring amendments to the methodology or leave it unchanged until the next review.

Any deviation from this methodology in the course of its application shall be documented and disclosed on ERA’s official website simultaneously with a credit rating or a credit rating outlook publication and with an indication of reasons for such deviation.

If any errors that already affected or may potentially affect credit ratings and/or credit rating outlooks are detected in this methodology, ERA shall conduct its analysis and review in accordance with the established procedure. If errors discovered in this methodology may impact any previously assigned credit ratings, ERA shall disclose such information on its official website.

If the planned amendments to this methodology are material and affect or may potentially affect the current credit ratings, ERA shall do the following:

  1. disclose on its official website the full information about the planned amendments to the current methodology, with an indication of reasons and consequences that such changes may entail, including impact on credit ratings assigned in accordance with this methodology;
  2. assess the need for revision of all credit ratings assigned in accordance with this methodology within six months after the latest amendment date;
  3. revise credit ratings within six months after the latest amendment date, if the assessment results identify a need for revision.

The methodology was designed with assistance of ACRA RM. 

2   Methodology basic principles

The state possesses a wide range of instruments to support national issuers. This statement is based on the ability of national governments to issue money, manage budget reserve funds, amend existing legislation, in particular, establish tax burden, govern cross-border cash and trade flows, allocate tax revenues among budgets of various levels as well as control activities of corporate entities and financial institutions associated with the state. Consequently, the state can shift fiscal and other cash flows in its favour, thereby ensuring continuous cash inflows into the state budget for timely servicing and repayment of debt.

The main criterion that calls for SCA adjustments within the framework of this Methodology is the likelihood of state authorities providing extraordinary support to a government-related rated entity in the event of potential severe deterioration of the latter’s finances.

A significant stake in the share capital of a rated entity owned by the state shall not be regarded as a necessary and sufficient condition for credit rating adjustment for state support. At that, within this methodology not only state support of rated entities under direct control of the state can be assessed, but also that of rated entities, not owned by the state.

If the state provides direct guarantees for financial obligations of a rated entity, ERA regards risks of such instruments as equal to the level of a sovereign risk and assigns the respective rating to them. If the state guarantee covers only a part of financial obligations of a rated entity or its selected financial instruments, a rated entity’s SCA shall not be automatically adjusted to the sovereign risk level.

3   Analysis structure

Figure 1. Structure of analysing relationships between a rated entity and the state


Fig_1

* If it is deemed impossible or impractical to determine the rated entity’s SCA, Stage I can be omitted.

Source: ERA

4  Analysis procedure

4.1.     Systemic importance of a rated entity

In order to define the likelihood of state authorities providing support to a rated entity, ERA analyses the latter’s systematic importance for the national economy and social sphere.

If a rated entity is an integral part of the national economic infrastructure or if it performs socially important functions, it may be an indication of its systemic importance. Termination or malfunction of a systemically important rated entity may entail negative economic and social consequences for the national or regional economy and cause reputational damage to the government.

Criteria for assessing systemic importance may include not only rated entity’s influence on functioning of separate sectors of economy or its economic role for a selected region, but also its importance as a source of income for national or regional budget.

The Agency distinguishes the following levels of systemic importance of rated entities:

  • Very high — a rated entity is an integral part of the national economy or performs socially important functions.
  • High — a rated entity is an important part of the national economy or performs socially important functions.
  • Medium — termination of rated entity’s operations will entail limited economic, social or reputational consequences for the national or regional economy.
  • Low — termination of rated entity’s operations will not entail negative economic, social or reputational consequences for the national or regional economy.

Systemic importance level is defined by the Agency in accordance with assessment of factors, summed up in Table 1. 


Table 1. Systemic importance assessment

Systemic
importance
factor

Weight

Assessment

Financial stability

40

1 — deteriorating financial standing of rated entity (e.g. default of major financial institutions or institutions that are part of a state system guaranteeing against risks of financial instability) may trigger financial crisis;

2 — rated entity is a major financial institution, and deterioration in its financial standing may trigger long-term financial instability (outflow of depositors, crisis of credibility in the financial market, liquidity crisis);

3 — rated entity is among major non-financial companies, and its default would trigger crisis of credibility in the financial market and confidence to the state;

4 — default of rated entity may destabilize financial system, which may be cured by regulatory measures;

5 — default of rated entity may cause short-term volatility in financial markets, but it would not impair financial stability in general.

Social functions

20

1 — rated entity performs a socially important unique function, and it is a monopolist in such segment;

2 — rated entity performs a socially important unique function, and it is a dominant player in such segment;

3 — rated entity performs a socially important unique function, and it is a key player in such segment;

4 — rated entity performs a socially important unique function, and it is one of the players in such segment;

5 — rated entity performs no socially important unique functions.

Economic policy

15

1 — rated entity performs monopolistic quasi-governmental functions in the economic development sphere (infrastructure development, support to economy sectors/exports, etc.);

2 — rated entity acts regularly as an agent in conducting state economic policy (large-scale projects, support to economy sectors);

3 — rated entity acts frequently as an agent in conducting state economic policy;

4 — rated entity acts rarely as an agent in conducting state economic policy;

5 — rated entity never acts as an agent in conducting state economic policy.

National security

20

Rated entity manufactures products vital for the national security (defense, food, energy), and its share in the national market is:

1 — monopolistic;

2 — key;

3 — significant;

4 — low;

5 — Rated entity manufactures no products vital for the national security (defense, food, energy).

Employment

10

1 — rated entity is a very large employer for socially exposed groups on the national scale;

2 — rated entity is the largest employer for socially exposed groups on the regional scale;

3 — rated entity is the largest employer in a large city;

4 — rated entity is the largest employer in a small mono-city;

5 — deterioration in financial standing of rated entity and relevant job cuts would not give rise to social tensions.

Source: ERA


The weights shall be summed up as follows: in case the factor score is 1 pt, the weight is added unchanged; in case the factor score is 2 pts, the weight is added multiplied by 0.75; in case the factor score is 3 pts, the weight is added multiplied by 0.5; in case the factor score is 4 pts, the weight is added multiplied by 0.25; in case the factor score is 5 pts, the weight is added multiplied by 0. As a result of weighing all the factors, a rated entity systemic importance shall be assigned to one of the above four levels: “Very high” (the sum exceeds 40), “High” (the sum is 20–40), “Medium” (the sum is 10–20) or “Low” (the sum is less than 10).

4.2.     Level of state influence on a rated entity

When assessing a level of state influence on creditworthiness of a rated entity, the Agency relies upon economic nature of existing interrelation rather than on formal criteria of a legal status or exposure to state regulation.

ERA distinguishes the following levels of state influence on a rated entity, which may lead to SCA adjustment:

  • Very strong influence: operating activities and financial results of a rated entity fully depend on state decisions and actions.
  • Strong influence: operating activities and financial results of a rated entity significantly depend on state decisions and actions.
  • Moderate influence: operating activities and financial results of a rated entity (extraordinary support) depend on state decisions and actions in exceptional cases.
  • Weak influence: operating activities and financial results of a rated entity depend on state decisions and actions in accordance with current legislation, which is taken into account with regard to SCA assignment in dedicated methodologies. 

The level of state influence on creditworthiness of a rated entity is built on a number of factors including shareholder control as well as operational and financial control. ERA takes into account not only the state’s actual stake in the rated entity’s share capital, which in itself is not a sufficient condition for very strong influence on a rated entity, but also the actual degree of the state involvement into its operating and financial activities. One of the key criteria is assessment of actual ongoing state support as well as its extraordinary support. State support may include direct financing of operating or capital expenditures, subsidizing tariffs or interest expenses, guarantying market debt obligations, taking part in state projects or other actions that help to improve rated entity’s operating results. Main criteria, used by the Agency for assessing the level of state influence, are summed up in Table 2.


Table 2. State influence level assessment

State influence level

Very strong

(level 1)

Strong

(level 2)

Moderate

(level 3)

Weak

(level 4)

Control

Shareholder and operating control

Operating control, no shareholder control

Shareholder control, no operating control

No control

Ongoing support

Ongoing direct subsidizing, investment program financing

Participation in state procurement and projects

Indirect support through demand stimulation

No ongoing support

Extraordinary support

Multiple cases of getting support from the state, willingness of the state to provide support in the shortest possible time

Several cases of getting support from the state in the past

One-off cases of getting support from the state

No cases of getting support from the state

Source: ERA


As a result of assigning and weighing (each having 33.3%) all the above factors, state influence on a rated entity shall be assigned to one of the above four levels: “Very strong”, “Strong”, “Moderate” or “Weak”.

If a significant part (above 70–80%) of a rated entity’s debt is guaranteed by a supporting state government body, or a rated entity’s budget allows for the debt servicing and repayment, the Agency reserves the right to expertly adjust the state government body’s influence upwards — up to the “Very strong” level.


4.3.     State’s ability and propensity to provide support

State support may vary by jurisdiction or time period. The analysis shall be aimed at determining:

  • Is the state support sufficient or limited? and
  • Would the state provide support and, if yes, to what extent?

The state’s ability to provide support is generally higher when the government has reserves or special-purpose anti-crisis funds, sovereign debt is insignificant, and the budget is well-balanced. In most cases, such states have high credit ratings (see Table 3).

Table 3. State’s ability to provide support

 

Factors that make the state’s ability to provide support

higher

lower

Sovereign credit rating

High

Low

Reserves/funds

Substantial reserves, anti-crisis funds, etc.

No reserves, anti-crisis funds, etc.

Budget

Surplus

Deficit

Sovereign debt

Low

High

Source: ERA

The state’s propensity to provide support to national issuers is generally lower in mature economies, because such support may be considered a violation of market competition principle and give rise to blames in other taxpayers. In emerging economies, where state acts as an insurer against social and economic risks, the likelihood of extraordinary support is higher. Moreover, the likelihood of extraordinary support is higher in those countries where the share of budget revenues generated by rent taxes is high, as expenditures for non-social projects are less sensitive to public mood in such countries.

Table 4. State’s propensity to provide support

 

Factors that impact the state’s propensity to provide support

positively

negatively

Budget expenditures

Flexible budget rules allow higher expenditures for priority purposes

Inflexible budget rules limit expenditures

Budget revenues

High share of revenues from rent taxes on excess profits (generally, in extraction sector)

High share of personal income taxes

Maturity of financial and economic system

Low (in emerging economies, in the absence of a risk insurance and hedge system, governments are more inclined to support issuers)

High (in developed economies, state support may be considered a violation of market competition)

Source: ERA

4.4.     Final credit rating assignment

The adjustment of the rated entity’s SCA depends on the level of systemic importance and the state influence on such rated entity. The likelihood of extraordinary state support to a rated entity is assessed using Table 5.

Table 5. Likelihood of extraordinary state support

Systemic importance

Very high

High

Medium

Low

State influence

Very strong

Extremely high

Very high

High

Moderate

Strong

Very high

High

Moderate

Moderate

Moderate

High

High

Moderate

Low

Weak

Moderate

Moderate

Moderate

Low

Source: ERA

In order to assess the potential state support, it is also necessary to determine the credit quality category of a rated entity, by comparing its SCA with the rating or creditworthiness assessment of the supporting institution (SICA) (see Table 6).

Category 1 is assigned to those rated entities whose SCA is equal or exceeds the supporting institution’s rating or creditworthiness assessment. The final rating of a rated entity whose SCA is higher than the rating of the supporting institution may be set equal to the credit quality of the supporting authority, in case the analysis shows that systemic importance of, and state influence on, a rated entity may affect its creditworthiness (for example, there are risks of growing taxes, dividend payments or other forms of income appropriation by the state under unfavorable conditions; risks of socially or politically important projects, etc.).

Category 2 is assigned to those rated entities whose credit quality is comparable with the credit quality of the supporting authority. Category 3 is assigned to those rated entities whose credit quality is moderately lower than the credit quality of the supporting authority. Category 4 is assigned to those rated entities whose credit quality is lower than the credit quality of the supporting authority. Category 5 is assigned to those rated entities whose credit quality is much lower than the credit quality of the supporting authority.


Table 6. Rated entity’s credit quality category

 

Rating or SICA of state authority

SCA/Rating

ААА

АА+

АА

АА-

А+

А

А-

ВВВ+

ВВВ

ВВВ-

ВВ+

ВВ

ВВ-

В+

В

В-

ааа

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

аа+

2

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

аа

2

2

1

1

1

1

1

1

1

1

1

1

1

1

1

1

аа-

2

2

2

1

1

1

1

1

1

1

1

1

1

1

1

1

а+

3

2

2

2

1

1

1

1

1

1

1

1

1

1

1

1

а

3

3

2

2

2

1

1

1

1

1

1

1

1

1

1

1

а-

3

3

3

2

2

2

1

1

1

1

1

1

1

1

1

1

bbb+

3

3

3

3

3

2

2

1

1

1

1

1

1

1

1

1

bbb

3

3

3

3

3

3

2

2

1

1

1

1

1

1

1

1

bbb-

3

3

3

3

3

3

3

2

2

1

1

1

1

1

1

1

bb+

4

4

4

4

4

4

3

3

2

2

1

1

1

1

1

1

bb

4

4

4

4

4

4

4

3

3

2

2

1

1

1

1

1

bb-

4

4

4

4

4

4

4

4

3

3

2

2

1

1

1

1

b+

4

4

4

4

4

4

4

4

4

3

3

2

2

1

1

1

b

4

4

4

4

4

4

4

4

4

4

3

3

2

2

1

1

b-

4

4

4

4

4

4

4

4

4

4

4

3

3

3

2

1

ccc+ or lower

5

5

5

5

5

5

5

5

4

4

4

4

4

4

3

2



Maximum adjustment applicable to rated entity’s SCA shall be determined using Table 7. The actual adjustment shall be determined by the rating committee, and it may be lower than that derived from Table 7.

Table 7. Maximum adjustment to rated entity’s SCA

 

Credit quality category

1

2

3

4

5

Likelihood of support

Extremely high

SCA

Parity

Parity

Parity

Parity

Very high

SCA

Parity

Parity-1

Parity-2

Parity-4

High

SCA

Parity-1

Parity-2

Parity-3

Parity-5

Moderate

SCA

Parity-2 (not lower than SCA)

Parity-3 (not lower than SCA)

Parity-4 (not lower than SCA)

Parity-6

Low

SCA

SCA

SCA

SCA

SCA


Source: ERA


The SCA adjustment shall be determined on the basis of assessments of state’s ability and propensity to provide support (see Section 4.3). Adjustment ranges are shown in Table 8. The final support level used to determine credit rating shall fall within those intervals, subject to expert assessment of the quality and volume of state support.


Table 8. SCA adjustment depending on state’s ability and propensity to provide support

 

State’s propensity to provide support is

sufficient

limited

State’s ability to provide support is

sufficient

(Maximum SCA adjustment) х (0.5 to 1.0)

(Maximum SCA adjustment) х (0.3 to 0.7)

limited

(Maximum SCA adjustment) х (0.4 to 0.8)

(Maximum SCA adjustment) х (0 to 0.5)

Source: ERA

Assessment of sub-sovereign and municipal governing authorities’ influence on the SCA

In the event of a rated entity receiving support from a sub-sovereign or municipal authority, ERA shall take into account that the latter’s credit rating acts as a constraint providing the maximum possible amount of support. In this case, a rated entity’s basic factors and systemic importance modifying factors should be assessed within the context of the supporting state government body, not within the country’s context as a whole.

The SCA shall be adjusted in line with Section 4 of this methodology.

If the SCA is deemed impossible or unreasonable, but the systemic importance of the rated entity for the regional economy is high, then, in line with Section 4 of this methodology, the Agency shall establish parity between the credit rating of the rated entity and that of the sub-sovereign or municipal governing authority.


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