Editorial: Ratings in moderation

It looks as if it may get a lot more complicated for banks to sell structured products to institutional investors in Europe, though it hasn't happened yet. For banks, read subsidiaries of foreign banks; and for institutional investors, read pension funds and insurance companies, which are banned from buying products issued by entities rated below Single A by Standard & Poor's (S&P).

Many institutional investors are bound to buy only well-rated assets, which often means those that are Single-A or above. That didn't really matter until the ratings agencies downgraded Italy and Spain below Single A, taking the ratings of foreign bank subsidiaries with them.

This is where it becomes a bit complicated, but keep your eyes on the way in which rating agencies interpret the word ‘core'.

Five years ago, in Latin America, foreign subsidiaries of Spanish banks were better rated than the Latin American countries within which they operated. You can take Brazil as an example. The complication comes in the way that rating agencies decide the workings of sovereign ceilings. While the agencies have said in the past that foreign subsidiaries of higher rated banks (or companies) cannot breach the country ceiling, that principle was eased and exceptions were made for strategically ‘core' subsidiaries.

The upshot is that an Italian subsidiary of a Double-A rated French bank would likely follow the rating of the mother company or, at worst, would be a notch lower, paying some heed to domestic affairs. But now the goalposts have been moved. In January, BNL was downgraded by S&P to the BB+ Italian sovereign ceiling, in spite of an admission by the agency that the Italian bank was extremely core to its owner, the BNP Paribas group. Almost complete ownership of BNL - which contributed 8.4% to the French bank's capital as of June 2011 - would appear to indicate an important and close relationship, but this was not good enough for S&P.

The new rating agency approach to foreign-owned subsidiaries will lead to a lot more thought for pension funds, insurance companies and asset managers when buying structured products, especially in Italy and Spain.

Retail investors are more brand led and tend to care less about these ratings, but the new agency approach to foreign-owned subsidiaries will lead to a lot more thought for pension funds, insurance companies and asset managers when buying structured products, especially in Italy and Spain.