EU watchdog warns rating agencies against knee-jerk pandemic downgrades

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LONDON, April 9 (Reuters) – Rating agencies should avoid deepening the coronavirus crisis by rapidly downgrading countries and companies as the pandemic plunges economies into recession, the securities market chief said on Thursday. of the European Union.

Steven Maijoor, chairman of the European Securities and Markets Authority (ESMA), said the watchdog has stepped up its interactions with rating agencies to understand how they are responding to the COVID-19 crisis.

The pandemic has crippled large swaths of the economy, with France already in recession as businesses are forced to take out loans and lay off millions of workers to stay afloat.

But central banks have said the slowdowns will be temporary, followed by a pick-up in economic activity once restrictions on the movement of people are lifted.

“The timing of rating actions needs to be carefully calibrated,” Maijoor said of a sector dominated by just three companies, Moody’s, Standard & Poor’s and Fitch.

Fitch downgraded Britain’s sovereign debt rating at the end of March, while Italy’s rating – already not too far from non-investment grade – is expected to be reviewed by S&P and Moody’s in the coming month. .

The pandemic has raised an issue known as procyclicality, last seen during the financial crisis a decade ago.

Lawmakers then approved direct regulation of rating agencies by ESMA in the EU in a bid to prevent a repeat of what they saw as sovereign downgrades worsening the euro zone’s debt crisis. euro.

There should be a significant increase in downgrades given the impact of COVID-19 on the economy and the deterioration in credit quality should be properly reflected, Maijoor said.

“But what’s important is the timing between pricing in the heightened risks of lower credit quality and not acting pro-cyclically, and making sure the timing of those downgrades is performed appropriately”.

“They have to do it independently. We cannot and should not intervene in the rating processes themselves,” Maijoor added.

VOLATILITY

Financial markets have suffered bouts of extreme volatility over the past month, with stock indices seeing their biggest moves since Black Monday in 1987 as investors gauge the recession.

Maijoor said trading platforms, clearinghouses and settlement systems were operating adequately under unprecedented circumstances when most staff were working from home.

After the last financial crisis, global multi-trillion dollar over-the-counter derivatives markets were forced to clear their trades to improve safety and transparency.

“It was a stress test of this new system and it worked well,” Maijoor said.

There have been high levels of redemptions and stress in money market funds, but central bank interventions such as liquidity injections have limited stress, Maijoor said.

“It’s clearly a question we need to investigate further, but there are no conclusions at this stage,” Maijoor said.

A “modest” maximum of 100 billion euros of assets in the funds were subject to redemption stops and other liquidity management tools during the market crisis, Maijoor said. The market for EU funds represents around 15,000 billion euros.

ESMA’s banking and insurance counterparts have asked banks and insurers to suspend dividends during the crisis and reconsider the payment of bonuses, but so far there has been no formal guidelines for asset managers.

“It is important that all participants in the financial markets realize that difficult times are ahead and that they must look from this perspective when making decisions on remuneration or in terms of dividend policy,” Maijoor said. .

Several EU states, including France, Italy, Spain and Austria, have banned the short selling of shares, but so far Germany, as well as Britain, which still operates under EU rules, have held back.

“At this stage, the ESMA Board is of the opinion that there is no need for a Europe-wide ban, but it is good to have this tool in the box. tools,” Maijoor said. (Reporting by Huw Jones, Kirsten Donovan)

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