Fitch Ratings-Moscow/London-11 February 2019: Fitch Ratings has affirmed Central Counterparty National Clearing Centre's (NCC) Long-Term Foreign-Currency (FC) Issuer Default Rating (IDR) at 'BBB-' with Positive Outlook. The agency has also affirmed NCC's Viability Rating (VR) at 'bbb' and Long-Tern Local-Currency (LC) IDR at 'BBB' with Stable Outlook. A full list of rating actions is at the end of this rating action commentary.
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 on foreign exchange, 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
The affirmation of NCC's VR reflects its exceptionally strong credit profile in the context of the Russia market, based on the entity's intrinsic strength. NCC is resilient 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 between market participants). The VR also reflects NCC's strong liquidity and robust performance.
NCC's VR is one notch above the Russian sovereign rating (BBB-/Positive), reflecting the view that NCC would probably retain its capacity to service its obligations even in case of quite severe sovereign and macroeconomic stress due to its sound risk management. Fitch would expect NCC to strengthen collateral requirements in case of heightened market stress. At the same time, NCC's credit profile is closely correlated with the domestic operating environment and with the sovereign credit profile.
Credit risk is well-managed and is represented primarily by counterparty exposures, mostly to local banks and brokers. NCC mitigates credit risks with prudent collateral management in respect to both initial and variation margins. Credit risk management is further reinforced by sound close-out netting and cross-default procedures.
In 1H18 NCC reported RUB1.7 billion as other operating expenses (3% of the Fitch Core Capital (FCC) at end-1H18 or 20% of pre-tax income for 1H18), which was a combination of a RUB0.9 billion provision on a legal case and a RUB0.8 billion loss due to an operational error that occurred as result of manual adjustments done during a defaulter's position closing in 1H18. The legal case provision was related to an arbitrage court decision on NCC's default management procedure in 2015 against a failed brokerage company. Fitch understands that in late 2018 NCC successfully appealed the court's decision and the company has good prospects of recovering the full RUB0.9 billion provision, subject to the decision of the supreme court.
NCC does not extend any uncollateralised exposures to market participants. At end-2018, NCC's collateral levels substantially exceeded the potential replacement costs that could arise from counterparty defaults.
NCC's 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-2018 approximately 72% of bank placements and 88% of securities portfolio represented investment-grade risk. Placements in Russian commercial banks (primarily state/foreign owned) were equal to 2x FCC and holdings of Russian bank, corporate and sovereign securities comprised a further 3.5x of FCC. These represent potential risk in case of extreme stress scenarios in Russia, although Fitch believes management would take action to significantly reduce these exposures in case of a sharp deterioration in the operating environment.
The FCC ratio was a sound 22% at end-1H18. The default waterfall (procedure for allocating losses in case of counterparty failures) further protects NCC's solvency by capping its losses. Under this framework, NCC's loss on counterparty defaults is limited to RUB9.5 billion (15% of FCC) with the excess loss to be covered by collective default funds (RUB7.2 billion) and the Moscow Exchange contribution to the default funds (up to RUB5 billion), available upon request. According to NCC's clearing rules, any remaining loss is shared among market participants.
NCC has no debt, and its liabilities consist primarily of interest-free counterparty trading accounts. Almost all assets are very liquid and fully cover customer accounts.
IDRs, SUPPORT RATING FLOOR AND SUPPORT RATING
The Long-Term LC IDR is equalised with NCC's VR. The Long-Term FC IDR of 'BBB-' is constrained by Russia's Country Ceiling. The Long-Term FC 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 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.
RATING SENSITIVITIES
NCC's Long-Term FC IDR would be upgraded if Russia's sovereign rating and Country Ceiling were upgraded, bringing the sovereign rating in line with the VR. The VR and Long-Term LC IDR are unlikely to be upgraded in the event of a sovereign upgrade, as a result of which they would become equalised with the sovereign rating. Relaxation of risk controls, repetitive or prolonged IT system outages and more regular losses relating to operational failures or capital deterioration could put pressure on NCC's VR.
The rating actions are as follows:
Long-Term Foreign-Currency IDR: affirmed at 'BBB-'; Outlook Positive
Long-Term Local-Currency IDR: affirmed at 'BBB'; Outlook Stable
Short-Term Foreign-Currency IDR: affirmed at 'F3'
Support Rating: affirmed at '2'
Support Rating Floor affirmed at 'BBB-'
Viability Rating: affirmed at 'bbb'