(The following statement was released by the rating agency)
Oct 8 - Fitch Ratings has assigned the European Stability Mechanism (ESM) aLong-term Issuer Default Rating (IDR) of 'AAA' and a Short-Term IDR of 'F1+'.The Outlook is Stable.
The key credit strengths that underpin ESM's 'AAA'/'F1+' ratings are as follows:
--- exceptionally strong mechanisms for exercising callable capital, includingan 'early warning system' (EWS) to ensure timely management of its capital needs
--- relatively high capitalisation ratio and the requirement that paid-incapital/reserves will always be equal to at least 15% of outstanding debt
--- high-quality and liquid assets that will always be equivalent to at least 12months of maturing ESM liabilities
--- the ESM's preferred creditor status (PCS)
--- the strength of its governance in terms of management as well as thecomposition of the board of governors that underscores the strong politicalsupport for the ESM
--- prudent investment guidelines adopted by the ESM for the management of itsreserves and capital.
ESM is a multilateral lending institution aimed at providing emergency financialassistance to euro Area Member States (EAMS) in financial distress. It has beencreated as a permanent financial assistance institution, and will succeed theEuropean Financial Stability Facility (EFSF; 'AAA'/'F1+') which is a temporaryguarantee vehicle. Financial assistance will comprise loans, credit lines, loansfor the purpose of recapitalisation of financial institutions, and sovereignsecurities purchased either in the primary or secondary market. ESM was createdby a treaty signed on 2 February 2012 by the 17 EAMS and incorporated in anamendment of Article 136 of the Treaty on the Functioning of the European Union.Following its ratification by Germany, the treaty has entered into force and ESMofficially started operations on 8 October 2012.
The ESM is owned by the 17 EAMS, on the basis of their contribution key, equalto their share in the European Central Bank's capital. Subscribed capitalamounts to EUR700bn, of which EUR80bn will be paid in between 2012-2014. Theremaining share, EUR620bn, can be called in case of need. According to ESM'sfounding treaty, a capital call can be launched to revise ESM's lending capacityor replenish capital in the event of credit losses. Most importantly, to avoid adefault from ESM on its debt obligations, an emergency capital call procedure,unique among multinational development banks (MDBs), has been established. Itallows the ESM's managing director (currently Klaus Regling), to call capitalwithout approval of the governing bodies to ensure timely payment. Capital callspayments have to be received within seven days. The commitment of EAMS toprovide callable capital is legally binding.
The ESM maximum lending capacity of EUR500bn is backed by EUR700bn of paid-inand callable capital. Moreover, 92% of the EUR500bn lending capacity (whichwould be financed by the ESM from public debt markets) would be covered bypaid-in capital and the callable capital of EAMS shareholders currently rated'AA-' and above by Fitch, which compares favourably to other 'AAA' MDBs rated byFitch. The explicit and legally binding mechanism to pay-in additional capitalif required to maintain the creditworthiness of the ESM is crucial foroff-setting the principal credit and rating weakness relative to peers which isthe potentially large and very concentrated risk exposures that it may incur.
ESM will be better capitalised than other European MDBs: it will be endowed witha substantial amount of capital, representing 11.4% of subscribed capital, anddisbursed in five equal instalments (20% each), the first two being paid in 2012and the final in H114. The founding treaty limits ESM lending to EUR500bn andstipulates that paid-in capital must represent at least 15% of debt issuedduring the phase-in period; as lending will be funded by debt, this implies thatthe ratio of paid-in capital to loan must be maintained above 15% ofoutstanding loans. Hence, when operating at full capacity, the equity to assetsratio will stand at 13.8%, which is in line with other 'AAA' rated EuropeanMDBs.
EAMS's strong willingness to support is also reflected in the preferred creditorstatus (PCS) granted to ESM. PCS materially reduces the ESM's sovereign creditrisk arising from its lending facilities and enhances recovery prospects in theunlikely event of default. In contrast with other MDBs, PCS is clearly stated inthe ESM founding treaty, which indicates that ESM financial assistanceinstruments will be junior only to the IMF. However, the PCS will not apply toEFSF facilities existing at the time of signing the ESM treaty in February 2012that are transferred to or supplemented with additional financing from the ESM,including the EUR100bn loan agreed by the EFSF to the Spanish government insupport of the restructuring and recapitalisation of the Spanish banking sector.
PCS is an important credit mitigant given the ESM's role of providing supportfor sovereigns in financial difficulties. In addition, ESM's financialassistance will be subject to policy conditionality as set out under amemorandum of understanding (MOU) with the national authorities that, ifeffective, will reduce the credit risk faced by the ESM. As withpolicy-conditional financing provided by the IMF, the ESM could chose to suspendloan disbursements in the event that the conditions are not met.
The ESM will always have sufficient liquidity to meet all its obligations overthe next 12 months . Funds from the paid-in capital will not be lent, and usedas a liquidity buffer consisting of two tranches. A short-term (ST) tranche,made of highly liquid investments with a minimum rating of 'AA', that will haveto cover at least six months of future payments due from beneficiary countries,with a minimum overall size of EUR5bn. The remainder will be managed in amedium and long-term (MLT) tranche, made up of longer-term assets (three yearsmaturity maximum) and may include euro area (EA) sovereign assets rated below'AA' (but not the assets of sovereigns in receipt of ESM financial assistance).ESM's operational guidelines specify that the ST tranche plus 50% of the MLTtranche must cover ESM's liquidity needs for the next 12 months. They also statethat the maximum amount which ESM is allowed to invest in EA sovereign bondsrated below 'AA' is limited at EUR5bn and this amount is not included in thecalculation of the liquidity buffer needed to cover ESM's obligations over thenext 12 months.
The rating is robust to downgrades of 'AAA' shareholders into the 'AA' ratingcategory. However, as Fitch has previously commented, in the event that Greecewere to exit from the eurozone, the ratings of all sovereign and sovereign-ratedentities in the eurozone, including the ESM, would be placed on Rating WatchNegative as Fitch re-assessed the broader political commitment to the euro andthe potential contagion and financial implications of a Greek exit.
ESM's ratings will be reviewed in light of any amendments to the ESM treaty orchanges in Fitch's understanding of the current constraints and creditenhancements implied by the treaty and operational guidelines. For example, ifunder Article 19 of the treaty, the ESM were to adopt new instruments thatmaterially changed its potential credit profile, the rating of the ESM would besubject to review.
For all of Fitch's Eurozone Crisis commentary go to
(Caryn Trokie, New York Ratings Unit)