OPINION: BRICS rating agency fast becoming a reality
Opinion / 27 July 2018, 9:00pm / Sello Mashao Rasethaba
CAPE TOWN - At the BRICS leaders’ Summit yesterday, the BRICS Business Council submitted its annual report, adopted at the weekend in Durban.
In December 2016, the BRICS Business Council Financial Services Working Group (BBC FSWG) set up an expert group to assess the viability of establishing a BRICS credit rating agency on market-based principles.
The FSWG chairpersons comprised Luiz Antonio Martins from Brazil, Nikolay Vukolov from Russia, Naina Kidwai from India, Yan Bing from China, plus myself and, later, Geoffrey Qhena from South Africa.
Their report was submitted at the annual meeting of the BRICS Business Council in Durban.
An expert group has been constituted by the BRICS FSWG to examine the feasibility of setting up the credit ratings agency, BRICS RA, by the BRICS nations.
The group has been mandated to assess the needs of BRICS RA, its scope of services and identify its optimal ownership structure and regulatory framework, as well as to devise a broad implementation plan for setting it up.
Interim recommendations of the expert group were submitted to the BRICS FSWG in March 2017. This report summarises the recommendations of the expert group.
Investors are enthusiastic regarding BRICS RA as it will provide a sharper differentiation of credit quality across emerging markets.
The proposed ratings agency will aid the BRICS nations’ efforts to raise funds from capital markets and develop their bond markets, to meet their immense funding requirements, especially in core sectors such as infrastructure.
The BRICS RA will provide for an appropriate and relevant methodology for credit evaluation and bring an independent, relevant and emerging (and frontier) markets-informed view. This will enable investors to evaluate and compare the credit risk of debt instruments across markets and optimise their investment decisions.
Global funds (insurance, pension and private capital) have a strong interest in investing in emerging markets.
Similarly, multilateral development banks (the World Bank, African Development Bank, Asian Development Bank, New Development Bank, Asian Infrastructure Investment Bank, etc) are deeply invested in emerging markets.
Such large investors will significantly benefit from the credit evaluation offered by the proposed BRICS RA; and, in a way, supplement their internal credit evaluation models.
Large investors across emerging economies welcome the idea of a BRICS rating agency.
In the global investor survey undertaken by the Russian chapter across 24 countries in 2016, 73percent supported the idea of a BRICS RA.
However, investors believe that the credibility of the BRICS RA will depend on its analytical independence, ability to provide differentiation of risk across emerging market borrowers and regulatory accreditation in its areas of operations, especially in a market dominated by large global credit rating agencies (CRAs) and strong local CRAs in most of the BRICS nations.
BRICS RA will be a supra-national institution and essentially rate fixed income, cross-border products of entities of the BRICS and other countries. It may also rate local currency issuances of multilateral institutions and banks. While the BRICS RA may also have capabilities to assign credit ratings to sovereigns, the management of the BRICS RA (once set up) can make a call as to when (short, medium or long-term) to offer this as a commercial service.
In addition, macro-economic research services on emerging markets are envisaged as being complementary to the ratings services for the BRICS RA.
These may also be provided by the entity, including on a commercial basis, to users within the BRICS nations to start with. This will not only improve financial viability but also help in establishing the credibility of the new institution faster with a franchise of deep macro-economic insights.
In the longer term, BRICS RA could also rate local currency debt by local issuers in other emerging and frontier markets - especially where the credit rating market is not under-developed.
This will not only help the BRICS RA in expanding to newer markets but also help improve the financial viability.
The expert group recommends that the BRICS RA shall adopt the issuer-pay business model since it is well-tested and globally accepted.
The BRICS RA should be set up as a private sector entity to ensure private-sector efficiencies, independence from government influence, credibility and acceptance by global investors.
The expert group recommends that the BRICS RA has a well-diversified shareholding and, by and large, is equally distributed between the five BRICS nations. A single shareholder/entity will not have a stake above 9.99percent.
The BRICS RA should have majority private ownership. This is essential to showcase independence from government influence, which will be crucial to build credibility with and acceptance by global investors. On the governance and operational aspects, too, private-sector efficiencies can be derived to ensure commercialisation on market-based principles.
There should be at least 51percent private ownership: comprising private financial institutions from each country, registered private credit rating agencies, and multilateral agencies and banks. No entity will have a stake of more than 9.99percent, and the entire private ownership to be, by and large, equally distributed among the BRICS nations.
There should be not more than 49percent government ownership, either directly or indirectly through public-sector entities such as EXIM Bank and other development financial institutions. No single government entity will have more than 9.99percent shareholding, and the entire government ownership should ideally be equally distributed among the BRICS nations.
Given the diversified ownership of the proposed BRICS RA, a single promoter-shareholder to drive the establishment and commercialisation of the BRICS RA is not envisaged.
The expert group suggests one lead shareholder (preferably a private financial institution) be identified by each of the BRICS nations. These lead shareholders will together act as the “promoter group” of the BRICS RA and carry out all activities related to set-up and formation of the new rating agency.
In addition, the new rating agency will need the support of “technical advisers” in its initial stages. The expert group suggests a voluntary network of well-established credit rating agencies registered in each of the BRICS nations be formed, with the BRICS RA drawing on the members of the network for technical advice and support.
Members of this network of rating agencies (acting together as technical advisers) will provide valuable insights to the BRICS RA on the market insights, regulations, prevailing credit evaluation frameworks, as well as facilitate interactions with the regulators, financial institutions and other agencies to ensure a faster establishment and a smoother start-up for the new rating agency.
The BRICS leadership is requested to encourage the formation of the network of established credit rating agencies in each of the BRICS nations as an initial first step to build co-operation. This will facilitate deeper understanding of credit markets and unique risk and business practices. In addition to members of the network providing technical advice to the proposed BRICS RA, the network of rating agencies can also provide support to issuers and investors in the BRICS countries in accessing cross-border capital from among BRICS nations (on a bilateral or multilateral basis).
The supra-national rating agency should be housed in a jurisdiction that has well-established and conducive regulations governing credit rating agencies. While international financial hubs such as London, the EU, Singapore and Hong Kong (a special administrative region of the People’s Republic of China) could possibly serve as a “neutral” jurisdiction where the proposed BRICS RA can be established, given that this is a BRICS initiative, it would be preferable to locate the new ratings agency in a BRICS nation based on the suitability of regulatory framework.
A comparative analysis of credit rating regulatory frameworks of all BRICS nations was undertaken to identify most suitable regulations and jurisdictions for the BRICS RA.
In this analysis, 18 indicators across four key parameters were analysed. These parameters covered information availability, transparency, restrictions on ownership and shareholding, market acceptance, reliability and independence and ease of establishing operations.
Among the BRICS countries, India, Brazil and South Africa are seen as having the most conducive regulations for setting up the BRICS RA. Lack of strong support from the local market has been voiced by Brazil (Brazil has deleted all references to ratings in banking regulation); hence India and/or South Africa emerge as the preferable options among the BRICS nations.
The BRICS RA will be governed by the regulations of the country where it is hosted.
Irrespective of the jurisdiction, the expert group recommends that an “endorsement document” be signed by the respective regulators in each BRICS country, to provide acceptance of BRICS RA ratings (for cross-border transactions) by capital market regulators and also External Credit Assessment Institutions acceptance by central banks for calculation of risk-weights based on BRICS RA ratings. This will facilitate ease of establishing the BRICS RA, and a more widespread use of its ratings. The endorsement document will comply with the International Organisation of Securities Commissions principles and provide a framework for mutual co-operation that enables enforceability of regulations across BRICS nations.
Support from the BRICS governments, in terms of incentivising investors and enabling regulatory acceptance is instrumental for the success of the BRICS RA; no direct financial support is envisaged.
The BRICS RA will require support from the BRICS governments in encouraging and nudging investors in the respective countries to seek ratings from the new entity. In addition, government support will be required in garnering regulatory accreditations through an endorsement document, and recognition as an external credit assessment institution with the BRICS central banks. This will allow financial institutions to utilise BRICS RA ratings for their capital risk-weight computations.
In addition, the BRICS governments should actively encourage established credit rating agencies in their respective countries to form a network among themselves, as detailed earlier.
The BRICS RA is expected to be financially viable as an independent entity, and break-even is expected in its fifth year of operations.
A preliminary financial feasibility assessment of the BRICS RA has been undertaken by the expert group. This exercise assumes that the entity will initially cater to cross-border funding by member development banks and loans extended by multilateral agencies to projects in the BRICS countries, apart from providing research services.
As per preliminary estimates, it will require an investment of $35million to $50m (depending on the country where it is hosted) over the first four years to cover establishment costs, regulatory fees and losses. Overall, the BRICS RA is expected to generate cumulative losses of at least $20m in the first four years before breaking even in its fifth year. The return on equity in the steady state is expected to be in the high teens, and close to 20percent.
A network of emerging market credit rating agencies should be formed (in fact, encouraged as one of the first steps) to spearhead the establishment of the BRICS RA.
To fast-track the process of setting up the BRICS RA, the BRICS governments should encourage the formation of a voluntary network of well-established credit rating agencies, one each from the BRICS nations, members of which can guide the formation of the BRICS RA.
To be successful, the BRICS RA will depend on support from established local credit rating agencies to have a stronger understanding of the risk environment in each of the BRICS nations, as it also facilitates faster regulatory cohesion, level analytical approaches and ensures market outreach. Partnering CRAs should be willing and capable of co-operating with each other and be credible in terms of quality and independence as well as sound and transparent rating processes.
The successful finalisation of the report was due to the support and guidance of BRICS governments from the ideation stage to final report preparation.
The report was referred to the 25-member BRICS Business Council and is mentioned in the annual report submitted at the BRICS Summit of the leaders.
Sello Mashao Rasethaba is on the South African BRICS Business Council, chairperson of the African Entrepreneurs Council and the Black Business Council. He serves in the B20 Trade and Investment Task Force and is the member of the B20 High Level International Business Advocacy Caucus.
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