Among the many reforms instituted in the aftermath of the financial crisis of 2008, dealing with the weaknesses embedded in the operations of Rating Agencies emerged among the main priorities. Both in the United States and Europe a battery of legislative measures were adopted covering their accreditation, their transparency (publication of their methodologies), their responsibility and their supervision which together form a coherent “regulatory” environment in which these Agencies now operate.
It is appropriate to recall that the purpose of “ratings” is to provide assistance (and not serve as a substitute) for evaluating risks associated with the timely service of debts of a given issuer. The 2008 crises, (linked to the failure of subprime debts in the USA) had brought to attention the need to distinguish between ratings of ordinary debt securities (which are direct obligations of the issuer) and structured securities (resulting from more or less complex tiring of underlying securities and their derivatives). If the methodology for evaluating these risks was different, the objective of evaluating an issuer’s capacity to meet its obligations remained the same.
For ratings of securities issued by sovereign States, taking account of the “political” risk associated with both the capacity and the willingness of the issuer to meet its obligations was a standard part of the procedure. In the past most of these “sovereign” ratings were issued in connexion with securities denominated in another currency than the issuer’s “national” currency; indeed the issuer had always the latitude to monetise any debt issued in his own currency, fulfilling his “legal” repayment obligation (whatever the value – expressed in purchasing power – of the nominal amount repaid).
The advent of the Single currency (€) has fundamentally changed this situation: the countries that participated in EMU abandoned their “monetary” sovereignty which deprives them of the ability to monetise debts denominated in a currency that they no longer control; their debt becomes, at a stroke, the equivalent of a “foreign currency” obligation. This implies that participating States must accept to abide by a “collective discipline” if they are to enjoy the continued confidence of investors. Such confidence came under severe stress during the 2011/12 Eurozone “sovereign debt” crisis when sharp fluctuations appeared in interest rate differentials (spreads) between debt securities issued by Members of EMU. This was principally a reflexion of the failure by some of them to comply with the rules of the Stability and Growth Pact and other commitments, to which they had adhered.
Since that time, a world-wide increase in “national populist” movements has taken hold. So far, neither in the United States nor in the United Kingdom, have these developments had any direct consequences with regard to their “solvency” because nearly all their indebtedness is denominated in USD or £ respectively; the situation is completely different in EMU Member States that are subject to similar political pressures, such as in France or in Italy.
The declarations of Marine Le Pen concerning her intention to leave the Eurozone, to revoke the independence of the Banque de France and to resort to the “printing press” to finance social security commitments and service the country’s debts have direct implications with regard to France’s solvency. It means modifying unilaterally the rights of the investors in French debt securities (60% of which are held by foreigners) by altering the currency in which the debt will be repaid.
Indeed, the decision to repay its debt in the new (devalued) “national currency” is a violation of the indenture governing each issue and constitutes an event of default both practically and legally. A significant devaluation relative to the € is, indeed, one of the main objectives being pursued in order to restore French competitivity in its main export market (the Single Market), a further fall in the parity with the dollar (which has fallen by 30% since May 2014) being far less significant.
The most immediate consequences of implementing Marine Le Pen’s proposals are as follows:
– The loss of access by France to international capital markets ;
– The need to institute exchange controls and limit withdrawals from banks to prevent capital flight;
– Severe imbalances in the balance sheets of entities whose foreign obligations exceed foreign claims, leading to bankruptcies (a likely situation as evidenced by the chronic deficit of the French balance of payments)
– The contagion to the whole of the French economy of a crisis of untold proportions.
In such a context, a domino effect of bankruptcies would most likely lead to the implosion of the single currency and to the spreading world-wide of a major economic and financial crisis.
Should this scenario appear remotely realistic, would it not behoove the Rating Agencies to integrate these risks in their analysis and adjust their ratings according to the possibility or even the probability of a victory of the French National Front? Or will one have, once again, to wait for the crisis to occur before taking these risks into consideration? Having been given the task of supervising the Agencies, the authorities will no longer be able to shirk their share of responsibility.
There is maybe a fear that any such intervention by the Agencies as well as their supervisors or the ESRB (European Systemic Risk Board) might trigger events that could provoke or accelerate the very developments that they seek to prevent and for which they might be held accountable. However, the rating Agencies have every incentive to protect their reputation because they would not survive this time around a new challenge to their professionalism. Similarly, the controlling Authorities must fully assume their role including the fiduciary responsibilities they assume towards those who have bestowed their trust in their judgements.
If these actors could muster the courage to explicit the nature of the “political” risks associated with the servicing of sovereign debt securities and outline the financial consequences in the event of default, it would undoubtedly be a powerful tool to draw the attention of markets and public opinion at large. Such an attitude might knock a heavy blow to the credibility of the advocates of “national-populism”; conversely, the cowardice shown by the political and institutional authorities would – if no action was taken – force unacceptable risks upon the European Union, the Member States and individual citizens.