Fitch Ratings-Moscow/London-20 December 2013: Fitch Ratings has upgraded Russia's Bank National Clearing Centre's (NCC) Long-term Issuer Default Ratings (IDRs) to 'BBB' from 'BBB-' with a Stable Outlook, and the Viability Rating (VR) to 'bbb' from '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 (MOEX), which is by far the largest stock exchange in Russia. NCC is a central clearing counterparty (CCP) on foreign exchange (FX), securities, REPO 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 in case of the failure of one or more clearing participants.
KEY RATING DRIVERS: NCC'S IDRs, SUPPORT RATING, SUPPORT RATING FLOOR, NATIONAL RATING
The upgrade of the Long-term IDR and an upward revision of the Support Rating Floor (SRF) reflects Fitch's view of the high probability of support for NCC's given its important role in ensuring the proper functioning of local financial markets and its unique infrastructure. A failure of NCC to perform its functions could lead to serious confidence-related issues and have a material negative impact on the whole Russian financial system.
In October 2013 NCC was granted the status of a qualified central counterparty by the Central Bank of Russia (CBR), a designation which recognizes NCC's special role and confirms its compliance with certain, quite stringent, risk-management requirements. As a result NCC's own risk-weighting was lowered, which makes clearing through it potentially less capital intensive for counterparties than OTC trading. Fitch also understands that NCC meets the preliminary criteria for inclusion in the list of systemically important financial institutions.
Although there is no track record of support, as NCC has never needed it, certain support mechanisms have been put in place by CBR, included unlimited USD/RUB swap lines, a collateralised liquidity facility and a direct repo line.
The CBR has not publicly stated its willingness or commitment to provide capital support to NCC, and in case of any solvency issues, Fitch expects that the CBR would turn to MOEX to recapitalise NCC in the first place. However, in Fitch's view, should MOEX itself be for any reason unable or unwilling to support NCC, the CBR would be highly likely to take whatever actions are required to ensure NCC's continued smooth operation.
KEY RATING DRIVERS: NCC'S VR
The upgrade of the VR reflects NCC's strengthened capital position following recent equity injection and earnings retention, major improvements in legislation including the proper close-out netting of failed market participants, limited risks arising from the introduction of new products, improved regulatory oversight and significantly reduced contingency risks related to MOEX. As a result NCC now achieves a 'BBB' Long-term IDR even without taking into account potential support.
Credit risk is moderate, as NCC's collateral levels provide sufficient coverage of potential replacement costs arising from counterparty defaults. The daily collateral margining with an ability to manually adjust collateral requirements in case of significant market volatility (occasionally used by management) further mitigates risks. In addition, recent legislative changes addressed previous concerns about NCC's potential inability to enforce collateral under derivatives transactions in case of a counterparty bankruptcy. Individual uncovered limits are small (e.g. do not exceed 1.2% of NCC's equity even for investment grade names).
NCC did not suffer any losses from counterparty defaults during the 2008 crisis, and during 2013 suffered only one small loss on a default by a broker due to it receiving dividends on traded securities prior to settlement (collateral requirements have then been changed to address such risks). New products, including 'T+2' settlement and CCP repo operations, are adequately managed and do not pose significant additional risk. NCC also plans to introduce cross-market netting across all products (this currently only applies for equity, bonds and repo markets) which will further reduce risks.
NCC's solid capitalisation was supported by a RUB9bn capital injection from the group in October 2013. Regulatory capital increased to RUB27.7bn at 1 November 2013, resulting in a capital adequacy ratio (N1) of 21.6%, comfortably above the regulatory minimum of 10%. Collective loss coverage funds totalling RUB3.6bn and robust earnings generation (RUB4.6bn net income in 9M13, annualised ROE of 39%) provide an additional cushion against potential stresses. Fitch estimates that the capital buffer could allow NCC to comfortably withstand a stress more severe than that of September 2008. Specifically, Fitch estimates that NCC could withstand the defaults of its largest 40 counterparties without requiring capital support.
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 proved to be countercyclical: NCC even reported an inflow of customer funding in the crisis of 2008 due to the loss of confidence among market participants, who became less willing to trade with each other directly.
Investment policy is very conservative, allowing investing in cash, high-rated bank placements and short-term (up to 1.5 year duration) bonds rated 'BB-' and above, which can be repoed with the CBR. As a result, customer accounts were 94% covered by available liquidity at end-3Q13.
Fitch's concerns about potential contingency risks for NCC from MOEX have considerably reduced because of the extinguishment of MOEX's RUB22bn put option (considered a liability) previously provided to former RTS shareholders (RTS was merged into MOEX in December 2011), which was exercisable if they had not been able to sell their shares through an IPO. However, as the IPO was successful, MOEX's equity was restored by this amount and was also supported by sound earnings (consolidated net income of RUB8.5bln in 3Q13). As a result MOEX's Fitch Core Capital/total assets ratio increased to 10.3% at end-3Q13 from a modest 1.2% at end-1H12.
Operational risks (mostly stemming from MOEX) have also moderated, as the group has been working on improving IT systems, which is reflected in increased availability ratio and reduced frequency and duration of IT disruptions.
NCC's IDRs will be upgraded if both Russia's sovereign rating is upgraded and either the SRF is revised upward or VR is upgraded. The IDRs would be downgraded if either Russia's sovereign rating is downgraded or both the SRF is revised downward and the VR is downgraded.
The SRF may be revised upward if the Russian sovereign is upgraded. Any failure or prolonged delay by the CBR/state to provide support, if needed, could result in a downgrade of the Support Rating and downward revision of SRF.
An upgrade of the VR would require an upgrade of sovereign rating and further improvement in the credit profile. Losses due to 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 NCC's VR.
The rating actions are as follows:
Long-term foreign and local currency IDRs: upgraded to 'BBB' from 'BBB-'; Outlook Stable
Short-term IDR: affirmed at 'F3'
Support Rating: affirmed at '2'
Support Rating Floor revised to 'BBB' from 'BBB-'
Viability Rating: upgraded to 'bbb' from 'bb+'
National Long-term rating: upgraded to 'AAA(rus)' from 'AA+(rus); Outlook Stable