PARIS/LONDON, March 07 (Fitch) Fitch Ratings has affirmed the
Mechanism's (ESM) Long-term Issuer Default Rating (IDR) at 'AAA'
with a Stable
Outlook and Short-term IDR at 'F1+'.
KEY RATING DRIVERS
The affirmation and Stable Outlook reflect the following key
ESM's ratings are underpinned by the strong level of support
provided by the 17
euro area member states (EAMS), reflected in the large amount of
capital subscribed (EUR620bn) and the high share (61.6%) of
provided by shareholders rated 'AA-' and above. If ESM operates
capacity, 92.3% of its debt would be covered by liquid assets
and the callable
capital of EAMS currently rated at least 'AA-'. However, the
quality of EAMS has declined since ESM inception. Over time,
this could result
in a weakening in the quality of support.
ESM's callable capital mechanism is stronger than that of other
development banks (MDBs). Capital can be called not only to
replenish capital in
the event of losses, but also to increase ESM's lending
capacity. To avoid a
default from ESM on its debt obligations, an emergency capital
unique among MDBs, has been established. It allows the ESM's
to call capital without approval of the governing bodies. The
commitment of EAMS
to provide callable capital is legally binding.
ESM benefits from a relatively high capitalisation ratio and the
that paid-in capital/reserves will always be equal to at least
outstanding debt. In the event that the ESM reached its EUR500bn
capacity limit, the equity-to-assets ratio would stand at 13.8%,
which is in
line with other 'AAA' rated European MDBs. As of end-December
2013, EUR64bn out
of the total subscribed capital of EUR80bn had been paid in,
with the balance to
be disbursed by April 2014.
Risk management guidelines are conservative, especially for
ensure that ESM will not suffer a cash shortfall in the event of
a default from
a borrower. Funds from the paid-in capital will not be lent and
will be used as
a liquidity buffer, which is expected to cover ESM's liquidity
needs for the
next 12 months. Investments in liquid assets are governed by
As of end-December 2013, the minimum rating requirement for
treasury assets is
ESM enjoys preferred creditor status (PCS) only junior to the
IMF, which reduces
sovereign credit risk and enhances recovery prospects in the
event of default.
PCS is clearly stated in the founding treaty of ESM, which is
unique among MDBs.
However, the PCS does not apply to the EUR41.3bn facility
granted by the
European Financial Stability Facility (EFSF; AA+) to the Spanish
was transferred to and replaced by the ESM financial assistance.
It does apply
to the EUR9bn financial assistance facility provided to Cyprus,
EUR4.6bn had been drawn as of end-December 2013.
These features offset the extremely high concentration of
constitutes ESM's main weakness. As of end-December 2013,
concentrated on only two sovereign borrowers, Spain and Cyprus.
ESM has no
concentration limit and all its financing could, in an extreme
concentrated on a single borrower.
Member states agreed in 2013 to extend ESM's mandate to Direct
Instruments (DRI), aimed at financial institutions in the
eurozone. DRI will
become operational once the Single Supervisor Mechanism has been
not before November 2014. In Fitch's view, capital injections
into banks, which
are inherently riskier than loans and not protected by PCS, will
ESM's intrinsic credit quality, making its IDR reliant on
support from EAMS.
The Stable Outlook reflects Fitch's assessment that downside
risks to the 'AAA'
rating are currently not material.
As DRI is implemented, the ability and willingness by EAMS to
support the ESM
will become more important to its rating than its intrinsic
considers support as currently commensurate with ESM's 'AAA'
rating thanks to
the specificity of the callable capital mechanism and the still
rating of EAMS despite past ratingrevious downgrades. However,
downgrades, particularly of a large highly-rated EAMS, would
pressure on ESM's IDR.
Fitch could adjust these rating sensitivities if the
implementation of DRI was
accompanied by significant credit risk mitigants that supported
strengths of the ESM, thereby making the rating less dependent
on support from
The ratings and Outlook are sensitive to a number of
- The ratings are based upon the assumption of ESM using its
capacity under the existing legislative framework.
- Fitch assumes that the risk of fragmentation of the eurozone
- Fitch assumes that no large EAMS will choose to leave the
eurozone and that
highly rated member states will remain committed to responding
to any capital
- With the exception of the introduction of DRI, Fitch expects
change in the overall mandate and operations of the ESM.
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Additional information is available at www.fitchratings.com.
Applicable criteria, 'Rating Multilateral Development Banks',
dated 23 May 2012,
are available at www.fitchratings.com
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