Fitch Ratings-Moscow/London-28 December 2012: Fitch Ratings has assigned Russia's Bank National Clearing Centre (NCC) Long-term Issuer Default Ratings (IDRs) of 'BBB-' with a Stable Outlook and a Viability Rating (VR) of 'bb+'. A full list of rating actions is at the end of this comment.
NCC is a key operating subsidiary of the Moscow Exchange Group (MEG), which was formed as a result of the merger of the MICEX and RTS exchanges, and is the largest and virtually the only major stock exchange in Russia. NCC is a central clearing counterparty (CCP) on foreign exchange (FX), securities and derivatives markets. In its role as an intermediary between market participants, NCC acts as a counterparty for each trade and is ultimately responsible for the performance of trading obligations notwithstanding the failure of one or more clearing participants.
RATING RATIONALE AND DRIVERS: NCC's IDRS, SUPPORT RATING, NATIONAL RATING
NCC's IDRs reflect the support that Fitch believes it is likely to receive, if needed, from the Central Bank of Russia (CBR) and/or other government authorities. In assessing the likelihood of CBR/state support, Fitch considers the high systemic importance of NCC due to its major role in ensuring the proper functioning of local financial markets and its unique infrastructure. A failure of NCC to perform its functions fully and in a timely fashion could lead to serious confidence-related issues and have a material negative impact on the whole Russian financial system.
The support-driven IDRs also consider liquidity support mechanisms which the CBR has already put in place for NCC because of its unique role, namely unlimited USD/RUB swap lines and a collateralised liquidity facility. The ratings also consider the regulator's potential readiness to provide further liquidity support should it be needed.
The one-notch difference between NCC's Long-term IDRs and those of the Russian sovereign ('BBB') reflect Fitch's moderate concerns about the timeliness of potential support, because NCC and its counterparties are operating in potentially volatile and leveraged markets and any material delays in provision of support may effectively result in economic losses for counterparties. The rating differential also considers the limited state ownership of NCC and the lack of any CBR/state written commitment/obligation to provide support. Support has not been required to date, and so there is no track record to draw on.
RATING SENSITIVITIES: NCC'S IDRS, SUPPORT RATING, NATIONAL RATING
NCC's IDR's could be upgraded or downgraded if there was a similar change in Russia's sovereign ratings. Any failure or prolonged delay by the CBR/state to provide support, if needed, could also result in a downgrade of the ratings.
RATING RATIONALE AND DRIVERS: NCC'S VR
NCC's VR of 'bb+' reflects its strong ability to withstand severe market stresses. This is due to high liquidity, sound collateral mitigation of market risks, good capitalisation, and robust earnings. At the same time the VR is constrained by high operating risks, the weak Russian legal environment for trading derivatives (although this may improve significantly in H113) and contingent risks related to the broader MEG.
The challenges and uncertainty from the recent consolidation of clearing of MEG's other businesses (in particular, equities and commodities futures and options) with NCC (Fitch understands they would account for about 10% of total opened positions), as well as a possible shift to partial collateralisation from a full pre-deposit basis for some lines of business, and an extension of settlement terms from T+0 up to T+2 (or even longer for some products) may increase risks. However, Fitch takes comfort from NCC's extensive track record and experience in managing collateral-based risks.
NCC has never faced a loss due to an inability to close out counterparties' positions. In Fitch's view, NCC's collateral levels provide sufficient coverage of potential replacement costs arising from counterparty defaults. However, the current legal environment may limit NCC's ability to enforce collateral under derivatives transactions in certain situations (specifically, in case of a counterparty bankruptcy), although most legal inefficiencies could be resolved with the adoption of new regulations planned for review by the State Duma in Q113.
NCC's loss absorption capacity is significant. The prudential capital adequacy ratio (N1) stood at 21.3% as at end-3Q12, comfortably above the regulatory minimum of 10%. Fitch estimates that this capital buffer could allow NCC to withstand a stress more severe than that of September 2008. Robust earnings generation (RUB2.9bln net income in 9M12, annualised ROE of 35%) further mitigates risk.
NCC has a solid liquidity cushion and no debt. Liabilities consist of interest-free accounts of trading parties (mainly used for pledging of collateral), which are not particularly volatile. These also proved to be countercyclical with NCC reporting an inflow of customer funding in the crisis of 2008 due to the loss then of confidence among market participants, who became less willing to deal with each other directly. In any case, due to NCC's policy to hold assets in cash and liquid securities rated above 'BB-', which can be repoed with the CBR, customer accounts were 88% covered by available liquidity at end-Q312. In this calculation, Fitch excludes RUB22bn that may be used for a future share buyback (see below) and RUB24bn of accounts with a foreign subsidiary of a large Russian bank, which may be fiduciary, in Fitch's view.
The risks of the broader MEG mainly relate to its capital and governance. For example, MEG's Fitch core capital (FCC) eroded massively (FCC/total assets ratio of 1.2% at end-H112) as a result of what Fitch considers an expensive merger with RTS, resulting in substantial goodwill on MEG's balance sheet. An additional RUB22bn of equity was reclassified to liabilities due to a put option which MEG provided to former RTS shareholders for their 14.5% stake in MEG, exercisable if they are not able to sell their shares through a planned group IPO in 2013. However, if the IPO is successful, MEG's equity will be restored by this amount. Capital should be replenished gradually through sound earnings (consolidated net income of RUB4.2bln in 1H12). Therefore the risk of NCC's capital being withdrawn by MEG to support the broader group is limited. There is some risk of NCC's liquidity being used to pay the put option if it is exercised, but this would not be critical for NCC's liquidity.
RATING SENSIVITIES: NCC's VR
The VR could be upgraded if Fitch's concerns about group capitalisation reduce as a result of a successful IPO or earnings retention, and improvements in the Russian legal and regulatory environment reduce risks related to transactions with derivatives. A track record of loss-avoidance in case of counterparty bankruptcies, demonstrating consistent court practice in respect to collateral, would also be positive.
Losses driven by insufficient collateralisation, repetitive or prolonged IT-system outages, frequent/substantial utilisation of CBR liquidity facilities or a significant decrease in loss absorption capacity could put downward pressure on the rating.
The rating actions are as follows:
Long-term foreign currency IDR: assigned 'BBB-'; Outlook Stable
Long-term local currency IDR: assigned 'BBB-'; Outlook Stable
Short-term IDR: assigned 'F3'
Support Rating: assigned '2'
Support Rating Floor assigned 'BBB-'
Viability Rating: assigned 'bb+'
National Long-term rating: assigned 'AA+(rus)'; Outlook Stable
+7 495 956 9901
Fitch Ratings Moscow
26 Valovaya Street
+7 495 956 2408
+7 495 956 6657
Media contact: Julia Belskaya von Tell, Moscow, Tel.: + 7 495 956 9908/9901, firstname.lastname@example.org
Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable criteria, 'Global Financial Institutions Rating Criteria', dated 15 August 2012 are available at www.fitchratings.com.