Fitch Ratings-Moscow/London-24 February 2016: Fitch Ratings has affirmed National Clearing Centre's (NCC) Long-term foreign currency (FC) Issuer Default Rating (IDR) at 'BBB-', Long-term local currency (LC) IDR at 'BBB' and Viability Rating (VR) at 'bbb'. The LC IDR and the VR are one notch above the FC IDR and the Russian sovereign rating of 'BBB-'. The Outlooks on the Long-term IDRs are Negative. 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 the largest exchange in Russia. NCC is a central clearing counterparty (CCP) on foreign exchange (FX), securities, REPO, derivatives and commodities 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
VR, LC IDR AND NATIONAL RATING
The affirmation of the LC IDR reflects NCC's exceptionally strong credit profile in the context of the local market, based on its intrinsic strength, as reflected in its 'bbb' VR. The latter is driven by NCC's high resilience to potential losses due to strong risk management and controls, the largely short-term nature of its risk exposures, and robust solvency, which is further protected by extra buffers and a loss cap (with any excess loss to be shared among market participants). The VR also reflects strong liquidity, its countercyclical and very cheap funding base, and continued robust performance.
The Negative Outlook on the LC IDR reflects that on the Russian sovereign rating, as Fitch believes that NCC's credit profile is correlated with the domestic operating environment. Therefore the agency would most likely maintain a one-notch difference between NCC's LC IDR and the sovereign rating if Russia was downgraded.
Credit risk is moderate and is represented primarily by counterparty exposures, mostly to local banks and brokers. Their credit profiles have been pressured by the weaker operating environment (as reflected in our negative outlook for the Russian banking sector), but NCC mitigates this risk by prudent collateral management with respect to both upfront initial margins and daily mark-to-market adjustments. To protect itself from the tail risk of significant volatility, NCC can additionally increase collateral requirements in stress events (like the market turbulence in December 2014). Credit risk management is further reinforced by the sound close-out netting and cross default procedures.
NCC does not extend any uncollateralised exposures to market participants. At end-2015, NCC's collateral levels substantially exceeded the potential replacement costs that could arise from counterparty defaults. NCC did not suffer any losses from counterparty defaults during the 2008 crisis or in forced close-outs made since then, with the exception of one very small loss in 2013.
The investment policy is quite conservative, permitting holdings of cash, placements in highly-rated banks and investments in short-term (up to 1.5 year duration) bonds rated 'BB' and above. At end-2015, approximately 84% of the securities portfolio and 82% of bank placements had investment-grade quality. However, placements in Russian commercial banks (primarily state/foreign-owned) were a large 4.8x equity and holdings of Russian bank, corporate and sovereign securities comprised a further 2.5x equity. These represent potential risk in case of quite extreme stress scenarios in Russia, although Fitch believes management would take action to significantly reduce these exposures in case of a further deterioration in the domestic operating environment.
NCC's regulatory capital ratio stood flat at 13.5% at end-2015 compared to end-2014 despite robust internal capital generation (ROAE of 46% in 2015). This was mainly due to a reallocation of assets from (previously zero risk-weighted) placements in the CBR to current accounts in foreign and local banks and to a lesser extent to the securities portfolio. This was in turn driven by new CBR regulations, which increased the risk weighting of foreign-currency CBR placements and sovereign Eurobonds (from 0% to 100%) from 1 Jan 2016. Although NCC keeps liquidity primarily in highly-rated banks or assets, this nevertheless puts pressure on capitalisation, as even placements on current accounts with 'A' rated foreign banks are 20% risk weighted under local rules. At the same time, the regulatory changes on clearing counterparties introduced in 2015 excluded CCP operations (e.g. CCP repo) from the risk-weighted assets calculation.
Fitch estimates that the existing capital buffers could allow NCC to withstand the defaults of nearly all counterparties, unless these defaults were accompanied by unprecedentedly high intra-day market movements impairing the currently high collateralisation levels. Even under a very severe stress case (more severe than September 2008), NCC's buffers would be enough to absorb defaults of the largest nine counterparties (40% of the total exposure). The new default waterfall (i.e. procedure for allocating losses in case of counterparty failures) introduced in November 2015 further protects NCC's solvency by placing caps on losses for NCC (the combined cap for different markets is RUB6.5bn or 10% of end-2015 equity) with any excess losses to be shared among market participants. Collective loss coverage funds (funded contributions from market participants to absorb losses) totaled RUB4.5bn.
Robust earnings generation (RUB22.8bn net income in 2015 under local GAAP, ROE of 46%) provides an additional cushion. Although net interest income comprises about 75% of NCC's gross revenues, operating costs are still over 4x covered by clearing and settlement commissions, which ensures earnings stability regardless of interest rate swings.
NCC has no debt, and its liabilities consist primarily of interest-free accounts of trading counterparties (mainly used for pledging of collateral). Customer balances have proved to be countercyclical, as market participants prefer to trade more through NCC than with each other directly in times of stress. Customer funding increased 3.6x during 2014 and was stable throughout 2015. NCC's liquidity cushion is exceptionally strong, at RUB1.1trn as of end-2015 (of which about 80% was in foreign currency), covering over 100% of customer funds.
Operational risks (mostly stemming from MOEX) are moderate, as the group has been working on improving IT systems, which is reflected in an increased availability ratio and reduced frequency and duration of IT disruptions. The group also has prudent business continuity planning, which improves resilience to disaster and sudden blackouts.
The affirmation of NCC's National Ratings at 'AAA(rus)' reflects Fitch's view that the entity remains among the strongest credits in Russia.
NCC'S FC LONG-TERM IDR, SUPPORT RATING, SUPPORT RATING FLOOR
NCC's Long-term foreign currency IDR of 'BBB-' is constrained by Russia's Country Ceiling. The foreign currency IDR is driven by the VR, but also underpinned at this level by potential sovereign support, as reflected in the Support Rating Floor (SRF) of 'BBB-', in line with the sovereign rating.
Fitch views the propensity of the sovereign to provide support to NCC as high 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 CCP by the Central Bank of Russia (CBR), a designation which recognises NCC's special role and confirms its compliance with certain, quite stringent, risk-management requirements. In future, this status may result in a special legal/regulatory regime and/or supervision for NCC.
Although there is no track record of support, as NCC has never needed it, support mechanisms have been put in place by CBR, including unlimited USD/RUB swap lines, a collateralised liquidity facility, direct repo line and certain other instruments that should protect NCC from the impact of counterparty defaults. At the same time, during very severe stress NCC may be considered by the authorities as a possible tool to support market participants, as was the case in December 2014, when it transferred significant liquidity to a few state banks, although the provided support did not require any breach on NCC's credit risk limits/policies.
RATING SENSITIVITIES
IDRS, SUPPORT RATING AND SUPPORT RATING FLOOR
The Negative Outlook on NCC's Long-term IDRs reflects the potential for the ratings to be downgraded if Russia's sovereign ratings are downgraded and the Country Ceiling is lowered. A revision of the Outlook to Stable would require the same action on the sovereign ratings.
VR, NATIONAL RATING
Continued deterioration in Russia's economic environment, 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, potentially resulting in its LC IDR being downgraded to the level of its FC IDR.
The rating actions are as follows:
Long-term foreign currency IDR: affirmed at 'BBB-'; Outlook Negative
Long-term local currency IDR: affirmed at 'BBB'; Outlook Negative
Short-term IDR: affirmed at 'F3'
Support Rating: affirmed at '2'
Support Rating Floor affirmed at 'BBB-'
Viability Rating: affirmed at 'bbb'
National Long-term rating: affirmed at 'AAA(rus)'; Outlook Stable