It is more than 12 hours since DBRS, the Canada-based agency, placed its ratings for Italy, Spain, Ireland and Portugal under review with negative implications. So far the world hasn’t ended.
(*looks furtively outside*)
But it does give us an excuse to share something interesting about the way the European Central Bank’s rules work for accepting collateral in its liquidity ops.
OK — DBRS cited systemic implications from Greece for the four ratings reviews. The current ratings look like this (DBRS downgraded Spain earlier this month):
Italy – A (high)
Spain – A (high)
Portugal – BBB (low)
Ireland – A (low)
We mention the ECB because DBRS ranks alongside the Big Three as a source of ratings both for allowing assets as collateral, and for assigning them haircuts:
The role of DBRS here is always useful to remember when one of Moody’s, S&P or Fitch cut a eurozone sovereign’s rating and questions start up about how it affects margin calls etc at the ECB. Particularly when Spain is starting to fall into the BBBs, below the A-, ‘credit quality two’ level above. That would imply an extra 5 per cent haircut on Spanish sovereign bonds pledged to the central bank. (That’s not much, you could argue, but to cut a long story short the volatility of collateral value surely does matter more in the LTRO age.)
In fact JPMorgan’s Flows & Liquidity analysts looked at the issue earlier in May:
…for Italy to fall below the A- threshold the following downgrades would need to occur: Moody’s (1 notch), Fitch (1), and DBRS (3). For Spain to fall below the A- threshold: Moody’s (1), Fitch (2) and DBRS (3). I.e. DBRS keeps Italy and Spain rated A+, two notches higher than the other agencies, according to the ECB’s rules. Overall, one could argue that rating changes by DBRS are the most important for sovereign bonds held as collateral at the ECB, given current levels.
So now you know.
And now we can also point out that the ECB continues to waive minimum ratings requirements for Portugal and Ireland, so further ratings changes probably don’t matter that much for using them as ECB collateral. Italy and Spain are a different story. But so much vaster a presence do their bonds have in banks’ collateral pools, we wouldn’t be surprised if the ECB waived for them too if there really is a threat of them losing the A-threshold among all four agencies in the near future.
That’s what central banks can do, change the rules of the game.
Sorry to tell you that right at the end of the post.