Fitch Ratings - Moscow - 29 August 2019.Fitch Ratings has upgraded Central Counterparty National Clearing Centre's (NCC) Long-Term Foreign Currency (FC) Issuer Default Rating (IDR) by one notch to 'BBB'. The agency has also affirmed NCC's Viability rating (VR) at 'bbb' and Long-Term Local-Currency (LC) IDR at 'BBB'. The Outlooks are Stable. 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 of the clearing participants.
Key Rating Drivers
The upgrade of the Long-Term FC IDR and upward revision of the Support Rating Floor (SRF) reflect an improvement of Russia's financial flexibility, and therefore stronger ability to provide support to NCC, as reflected by the upgrade of the Russian sovereign rating earlier in August.
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.
The affirmation of the VR reflects NCC's exceptionally strong credit profile in the context of the Russian market, based on the entity's intrinsic strength. NCC has a 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 between market participants). The VR also reflects NCC's strong liquidity and robust performance.
Fitch believes that NCC's intrinsic strength would likely correlate with the Russian operating environment and sovereign credit profile, as the company is largely exposed to the local economy and counterparty exposures might be vulnerable to an economic stress. However, such risks are reasonably mitigated by NCC's risk framework.
During 2018-1H19, NCC faced three unrelated operating loss cases. The first case related to litigation after a workout of a defaulted counterparty in 2015. NCC lost the initial arbitrage and created a RUB0.9 billion provision in 2018, but subsequently won an appeal in the Supreme Court and fully recovered the provision in 1H19. The second case that ended in a RUB0.8 billion expense in 1H18 relates to an operational error that occurred as result of manual adjustments made when closing a defaulted participant position. The third one, which may cost up to RUB2.4 billion, subject to potential insurance compensation, relates to grain market contracts, as NCC uncovered a shortage of grains in a few qualified elevators, which were supposed to be stored as collateral. In its 1H19 IFRS accounts, NCC recognised RUB2.4 billion of other operating expenses in relation to this case.
Although these expenses are not very significant relative to NCC's income and equity, it shows that the risk management framework, although advanced, is not free from occasional errors and slippages. Positively, NCC promptly made the necessary adjustments to its systems/processes to prevent similar risks arising in the future.
Generally NCC's asset structure is conservative, with clearing assets representing 76% of total assets at end1H19. These are mirrored by respective liabilities and the risk is managed through robust initial/variation margining. The remainder is composed of liquid assets, where NCC's investment policy is conservative, permitting holdings in cash, placements in highly-rated banks and investments in short-term bonds rated 'BB+' and above.
NCC's Fitch Core Capital (FCC) ratio was estimated at 180% at end-1H19, underpinned by low weights of clearing-related assets (equity/assets ratio was 2%). Regulatory capital requirements are also met with significant headroom with a N1ccp ratio of 149.4% at end-1H19, compared with the 100% minimum requirement. Moreover, the default waterfall mechanism (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 RUB10.1 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 commercial debt, and its liabilities consist primarily of interest-free counterparty trading accounts. Almost all assets are highly liquid and fully covered customer accounts.
NCC's 'F2' Short-Term IDR reflects sovereign support (in line with the sovereign's Short-Term IDR F2) in case of need. The risk of the sovereign paying its direct obligations ahead of providing support to NCC is limited, in our view, and there should be no impediments to the prompt flow of funds to NCC.
Rating actions on the IDRs and SRF of NCC will likely mirror those on Russia's sovereign ratings.
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.