New ECB rating agency Scope puts greater weight on euro zone protection mechanisms

Scope, Europe’s first ECB-approved credit ratings agency, promises to put more weight on the euro zone’s improved ability to navigate crises although it has concerns about Italy and France and warns the Dutch election result could trouble its coveted triple-A grade.

By joining a soon-to-be-five-member group that the European Central Bank uses to judge government bond collateral values, Berlin-based Scope could play a significant role in any future financial market crisis.

It also fulfils an ambition held by policymakers for a domestic player since the height of the bloc’s debt troubles 15 years ago, when mass downgrades by U.S. agencies like S&P and Moody’s were openly blamed for stoking the turmoil.

Scope says its European roots give it a native appreciation of the way the euro area has tooled itself up, part of the reason it became the first agency to restore the investment-grade rating of financial-crisis poster child Greece.

“One of our distinguishing characteristics … is that we emphasise the multiple improvements in Europe’s institutional set-up,” said Scope’s top sovereign analyst, Dennis Shen, when asked how the agency assigns ratings compared with S&P, Moody’s, Fitch and DBRS Morningstar – the other firms on the ECB’s list.

“We take such institutional enhancements very seriously,” Shen told Reuters in the firm’s first in-depth interview since winning the ECB’s approval earlier this month, citing an example of how COVID-related support measures would outlast the pandemic.

While the euro zone has pledged to do “whatever it takes” and jointly issued debt for the first time during the pandemic, its debt load remains eye-watering.

Italy, France, Spain, Portugal, Belgium and Greece all have debt-to-GDP ratios well above 100 per cent while Cyprus, Ireland and Luxembourg and the only euro zone members expected to be spending a smaller share of their tax revenue servicing debt interest payments in five years’ time.

For Italy that figure is forecast to be nearly 10 per cent by 2028. Scope assigns Italy a “stable” outlook, but “risks remain,” Shen said, “given the weak growth and fiscal outlook”.

It is also one of the countries that could be caught by the European Union’s excessive deficit procedure (EDP) in coming years, which would technically prevent the ECB from using its crisis-fighting Transmission Protection Instrument (TPI) if markets turn on Rome again.

“Italy will be vulnerable if it finds itself in an adverse scenario in which yields rise again and markets are not certain whether debt is going to be eligible for any ECB intervention,” Shen said.

NEXT CRISIS

The ECB uses the best rating available from its approved agencies to determine a bond’s collateral value when commercial banks borrow from it.

A 3-tiered system assigns an AAA to A- rated bond around 5 per cent more worth that one graded BBB+ to BBB-, while anything below that is ineligible unless the ECB bends the rules.

During the euro zone crisis Canada-based DBRS offered Italy a lifeline by holding its rating at A- for far longer than S&P, Moody’s and Fitch, so the country’s government bonds maintained maximum collateral value at a crucial time.

Scope, which has fewer than a dozen sovereign analysts, has also recently lifted Portugal to A- but effectively warned that France’s AA rating could be downgraded by assigning it a negative outlook.

“The finance ministry has been taking measures – that does have some (favourable) impact on the debt trajectory, especially if this is accompanied by stronger growth,” said Shen, still forecasting France’s debt to hit 112 per cent of GDP by 2028.

That may not bode well for any future crisis when borrowing levels could jump again, and given the current inflationary environment would be expected to help erode debt.

Last week’s Dutch election win by the far-right Geert Wilders could also have rating implications, Shen said.

“Governance risks are a challenge in the longer run for one of the world’s remaining AAA-rated sovereigns … But the rating is not imminently at risk.”