Nordine Abidi European Central Bank Matteo Falagiarda European
Nordine Abidi European Central Bank Matteo Falagiarda European Central Bank Ixart Miquel-Flores European Central Bank Unconventional monetary policy and credit rating dynamics 10 October 2018 ECMI Annual Conference: Sustaining Growth through Innovation in Capital Markets Disclaimer: The views expressed are those of the authors and do not necessarily reflect those of the European Central Bank.
Rubric Rating and corporate QE 2 www. ecb. europa. eu ©
Rubric Motivation "The ratings [. . . ] are and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell, or hold any securities. " (Rating Agency Disclaimer) Nevertheless, still important reliance on CRAs by market participants: • Direct: restrictions on investing in non investment-grade bonds • Indirect: benchmark with underlying ratings Less known: • Explicit reliance on CRAs by major central banks for monetary policy (ECB, Fed, etc. ) • This paper: Ø Investigate the relationship between CRAs behavior and unconventional monetary policy Ø Understand the consequences of central banks reliance on CRA’s for credit judgement 3 www. ecb. europa. eu ©
Rubric This paper • Well known trade-off faced by CRAs (pleasing the issuer vs. reputational costs, Bolton et al. , 2012) • Corporate Sector Purchase Programme (CSPP) of the ECB: Ø Ideal laboratory experiment for identification: • • • Unexpected by market participants Direct link between ECB purchases and corporate entities Rating-based rule of thumb for CSPP eligibility v The eligibility to be purchased by the ECB under the CSPP relies explicitly (but not entirely) on a rating-based rule-of-thumb (“a minimum first-best credit assessment of at least credit quality step 3”) v We call it first-best rating rule ↔ at least a BBB- from at least one CRA 4 www. ecb. europa. eu ©
Rubric Intuition: rating-based rule of thumb CSPP-eligible Below, but close to, eligibility Below, but farther away from eligibility 5 www. ecb. europa. eu ©
Rubric The first-best rating rule at work Sources: Company website 6 www. ecb. europa. eu ©
Rubric The first-best rating distribution in March 2016 Bonds by first-best rating (March 2016 – number and percentages) Sources: Bloomberg, Authors' computation. 7 www. ecb. europa. eu ©
Evolution of the first-best rating distribution Rubric CSPP Short Movie (January 2015 - December 2017 – Kernel density) 8 www. ecb. europa. eu ©
Rubric Concluding remarks and policy recommendations Sum up: v The CSPP appears to have had a significant impact on the behavior of CRAs v The impact is mostly noticeable for bonds located below, but close to, the CSPP eligibility frontier Policy recommendations: v Acknowledging the (unintended) effects of the explicit reliance on CRAs when designing conventional and non-conventional monetary policy v No normative conclusions on the use of external rating agencies and on the ESCF… Ø …whose key role is well documented (Bindseil et al. , 2017) 9 www. ecb. europa. eu ©
Rubric Background slides 10 www. ecb. europa. eu ©
Rubric Additional Remarks v Eligibility and purchases: Eurosystem conducts appropriate credit risk and due diligence procedures on the purchasable universe on an ongoing basis, that limits the risks on the portfolio of the ECB. v Central bank operations and CRA’s reliance. 11 www. ecb. europa. eu ©
Rubric Size of the CSPP Overview of the CSPP (Eurosystem corporate bond purchases under the CSPP - EUR bn. and Percentages. ) Sources: ECB, Authors' computation. 12 www. ecb. europa. eu ©
Rubric Size of the CSPP ECB QE programmes (Eurosystem purchases under the APP - EUR bn) Sources: ECB, Authors' computation. 13 www. ecb. europa. eu ©
Rubric Number of bonds in the frozen list in March 2016 Dynamics of the number of corporate bonds with at least a rating (Bonds with at least a rating – March 2016. ) Sources: ECB, Authors' computation. 14 www. ecb. europa. eu ©
Rubric This paper • Unconventional monetary policy measures and CRAs behavior: Corporate Sector Purchase Programme (CSPP) of the ECB • Ideal laboratory experiment for identification: • Rating-based rule of thumb for CSPP eligibility • Direct link between ECB purchases and corporate entities • Main findings: Ø CSPP Gradual upgrades of final credit ratings… Ø … thereby increasing the set of eligible bonds Ø Rating upgrades more noticeable for bonds located below, but close to, the eligibility frontier 15 www. ecb. europa. eu ©
Rubric The context 16 www. ecb. europa. eu ©
Rubric CSPP timeline 17 www. ecb. europa. eu ©
Rubric CSPP institutional framework CSPP eligibility criteria: 1. Issued by a firm established in the euro area 2. Issued by a non-bank corporation 3. Denominated in euro 4. Minimum remaining maturity of six months and a maximum remaining maturity of less than 31 years 5. Other criteria (e. g. risk management, diversification) 6. Rated with a minimum a first-best credit assessment of at least credit quality step 3 (rating of BBB- or equivalent) 18 www. ecb. europa. eu ©
Rubric CSPP institutional framework Data collected CSPP eligibility criteria: 1. Issued by a firm established in the euro area ✓ 2. Issued by a non-bank corporation ✓ 3. Denominated in euro ✓ ✓ 4. Minimum remaining maturity of six months and a maximum remaining maturity of less than 31 years 5. Other criteria (e. g. risk management, diversification) 6. Rated with a minimum a first-best credit assessment of at least credit quality step 3 (rating of BBB- or equivalent) 19 ✓ x www. ecb. europa. eu ©
Rubric CSPP institutional framework Data collected CSPP eligibility criteria: 1. Issued by a firm established in the euro area ✓ 2. Issued by a non-bank corporation ✓ 3. Denominated in euro ✓ ✓ 4. Minimum remaining maturity of six months and a maximum remaining maturity of less than 31 years 5. Other criteria (e. g. risk management, diversification) 6. Rated with a minimum a first-best credit assessment of at least credit quality step 3 (rating of BBB- or equivalent) ✓ x Around 1750 bonds in March 2016 from 16 euro area countries 20 www. ecb. europa. eu ©
Rubric Intuition: rating-based rule of thumb CSPP-eligible Below, but close to, eligibility Below, but farther away from eligibility 21 www. ecb. europa. eu ©
Rubric The first-best rating rule at work Sources: Company website 22 www. ecb. europa. eu ©
Rubric The first-best rating distribution in March 2016 Bonds by first-best rating (March 2016 – number and percentages) Sources: Bloomberg, Authors' computation. 23 www. ecb. europa. eu ©
Rubric The credit rating channel • Well known critical friction related to CRAs: reliance on fees from issuers as a main source of revenue (Bolton et al. , 2012) CSPP Short Movie (January 2015 - December 2017 – Kernel density) • Institutionalized CRAs oligopoly • Rating-based rule of thumb: at least BBB- for at least one of the CRAs • Trade-off: QE eligibility premium vs. reputational costs Sources: Bloomberg, Authors' computation. 24 www. ecb. europa. eu ©
Rubric Our predictions • Prediction # 1: The CSPP has triggered an increase in the probability of becoming CSPP eligible • Prediction # 2: Securities located below, but close to, the eligibility frontier are likely to have experienced positive rating adjustments Ø Hypothesis: Bonds around the eligibility frontier are affected similarly by macroeconomic shocks 25 www. ecb. europa. eu ©
Rubric Roadmap of the empirical strategy 1. The aggregate effects of the corporate QE (Prediction # 1) 2. Cross-sectional variation in the CRAs response (Prediction # 2) 3. Firm-level characteristics around the frontier 4. Robustness checks 26 www. ecb. europa. eu ©
Rubric The aggregate effects of the corporate QE 27 www. ecb. europa. eu ©
Rubric Placebo test Month dummy coefficients (Month dummy coefficients from Eq. 3 – Dashed lines denote 95% interval) Sources: Bloomberg, authors' computation. 28 www. ecb. europa. eu ©
Rubric Cross-sectional variation in the CRAs response The non-linear effects of the CSPP (results of Eq. 4 (Section IV. B) bonds with at least a publicly available rating in March 2016 – Eligibility coefficient) Sources: Bloomberg, Authors' computation. 29 www. ecb. europa. eu ©
Rubric Around the CSPP eligibility frontier 30 www. ecb. europa. eu ©
Rubric Firm-level characteristics around the frontier Total assets Leverage ratio (EUR million) (in percent) Sources: Orbis Europe, Bloomberg and other sources. 31 www. ecb. europa. eu ©
Rubric Additional findings and robustness checks Sharpen the identification: • Controlling for other fundamental factors Ø Ø Ø • Euro-denominated vs. non-euro-denominated bonds (control group) Ø • Other EA controls (CESI, unemployment rate, IP, stock market index, PMIs) Country-level controls (unemployment rate, IP, stock market indexes, expected default frequencies) Industry-level controls (stock market indexes) Issuer-level controls (leverage) Bond-level controls (bid-ask spread, returns, size) No credit rating inflation for non-euro-denominated bonds Bonds rated also by non-eligible CRA’s (control group) Ø No credit rating inflation for bonds rated by the non-recognised CRAs 32 www. ecb. europa. eu ©
Rubric Additional findings and robustness checks Additional exercises: • Step-by-step rating migration Ø Credit rating inflation driven by bonds observing only one rating change • Controlling for CRAs competition Ø Credit rating inflation driven by bonds rated by two CRAs Ø No specific CRA inflated credit ratings in a systematic way • Rating shopping Ø Credit rating inflation stronger for rating-shoppers (ask/withdraw rating) • Controlling for CRAs disagreement Ø No significant role played by CRAs disagreement 33 www. ecb. europa. eu ©
Rubric Additional findings and robustness checks Additional exercises: • Vulnerable versus less vulnerable countries Ø Credit rating inflation observed in both groups of countries • Probit model • Unfrozen list of bonds • Weighting by bond size • Bonds with no rating in March 2016 34 www. ecb. europa. eu ©
Rubric Concluding remarks and policy recommendations Sum up: v The CSPP appears to have had a significant impact on the behavior of CRAs v The impact is mostly noticeable for bonds located below, but close to, the CSPP eligibility frontier Policy recommendations: v Acknowledging the (unintended) effects of the explicit reliance on CRAs when designing conventional and non-conventional monetary policy v No normative conclusions on the use of external rating agencies and on the ESCF… Ø …whose key role is well documented (Bindseil et al. , 2017) 35 www. ecb. europa. eu ©
Rubric Share of bonds rated at least BBBShare of corporate bonds rated at least BBB- by the four recognized CRAs. (March 2016. ) Sources: ECB, Authors' computation. 36 www. ecb. europa. eu ©
Rubric Credit rating inflation: 1 -year window around March 2016 Set of first-best rating distribution, frozen list (Between March 2015 and March 2017. ) Sources: ECB, Authors' computation. 37 www. ecb. europa. eu ©
Rubric Summary statistics 1 38 www. ecb. europa. eu ©
Rubric Summary statistics 2 39 www. ecb. europa. eu ©
Rubric Summary statistics 3 40 www. ecb. europa. eu ©
Rubric Excluding investment grade bonds not in the ECF and vice-versa 41 www. ecb. europa. eu ©
Rubric The non-linear effects of the CSPP far below the eligibility frontier 42 www. ecb. europa. eu ©
Rubric The non-linear effects of the CSPP far above the eligibility frontier 43 www. ecb. europa. eu ©
Rubric Controlling for additional macro factors 44 www. ecb. europa. eu ©
Rubric Controlling for additional bond-level factors 45 www. ecb. europa. eu ©
Rubric Non-euro denominated bonds 46 www. ecb. europa. eu ©
Rubric Non-euro denominated bonds 47 www. ecb. europa. eu ©
Rubric Non-eligible CRAs 48 www. ecb. europa. eu ©
Rubric Number of ratings per bond CRA’s Competition (Number of ratings of the four recognized CRAs at a bond level – March 2016. ) Sources: ECB, Authors' computation. 49 www. ecb. europa. eu ©
Rubric CRAs competition 50 www. ecb. europa. eu ©
Rubric CRAs pivotal role (identifying pivotal CRAs) 51 www. ecb. europa. eu ©
Rubric CRAs pivotal role (no change in the number of CRAs) 52 www. ecb. europa. eu ©
CRAs pivotal role (at least one change in the number of CRAs) Rubric 53 www. ecb. europa. eu ©
Rubric CRAs pivotal role (at least one rating bucket change) 54 www. ecb. europa. eu ©
Rubric CRAs pivotal role (only one single rating bucket change) 55 www. ecb. europa. eu ©
Rubric CRAs pivotal role (more than one single rating bucket change) 56 www. ecb. europa. eu ©
Rubric Vulnerable versus less vulnerable countries 57 www. ecb. europa. eu ©
Rubric Bonds with no credit rating in March 2016 Bonds with no credit rating (Coefficient of eligibility. ) Sources: ECB, Authors' computation. 58 www. ecb. europa. eu ©
Rubric Probit estimation (marginal effects) 59 www. ecb. europa. eu ©
Rubric Unfrozen list 60 www. ecb. europa. eu ©
Rubric Weighting by bond size 61 www. ecb. europa. eu ©
Rubric Harmonised rating scale 62 www. ecb. europa. eu ©
Rubric CRAs market share in the EU CRA Market Share (Percentages. ) Sources: ESMA, Authors' computation. 63 www. ecb. europa. eu ©
Rubric First best ratings by country Distribution of corporate bonds with at least a rating (Distribution per Jurisdiction - Percentages, Number – May 2016. ) Sources: Bloomberg , Authors' computation. 64 www. ecb. europa. eu ©
Rubric First best ratings by industry Distribution of corporate bonds with at least a rating (Distribution per Industry- Percentages, Number – May 2016. ) Sources: Bloomberg , Authors' computation. 65 www. ecb. europa. eu ©
Rubric First best ratings by maturity Distribution of corporate bonds with at least a rating (Distribution per Maturity - Percentages, Number – May 2016. ) Sources: Bloomberg , Authors' computation. 66 www. ecb. europa. eu ©
Rubric Firm-level characteristics around the frontier Profit margin Return on equity (ROE) (percent) Sources: Orbis Europe, Bloomberg and other sources. 67 www. ecb. europa. eu ©
Rubric Firm-level characteristics around the frontier Net income Number of employees (EUR million) (units) Sources: Orbis Europe, Bloomberg and other sources. 68 www. ecb. europa. eu ©
Rubric Firm-level characteristics around the frontier Total assets Operating revenues (EUR million) Sources: Orbis Europe, Bloomberg and other sources. 69 www. ecb. europa. eu ©
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