Training on SF, June 15–16

Methodology for Analyzing Relationships Between Rated Entities and Supporting Organizations Registered Outside the Russian Federation

1 Scope of methodology

This Methodology for Analyzing Relationships Between Rated Entities and Supporting Organizations Registered Outside the Russian Federation (hereinafter – the Russian Federation or RF) is used to evaluate and account for the influence that parent entities registered outside the Russian Federation have on creditworthiness of rated entities registered in Russia and representing both, financial and non-financial sectors.

Not being a comprehensive document, this methodology contains references to other ACRA (hereinafter, ACRA or the Agency) methodologies; in particular, to those for assigning credit ratings under the national scale. This methodology is inapplicable for ratings of regional and municipal authorities or small and medium-sized businesses.

Rated entities, whose standalone creditworthiness assessment (SCA) has to be adjusted depending on the influence that their foreign parent structures have on them, are regarded as rated entities under external foreign influence. This implies that creditworthiness of a rated entity, in addition to its standalone creditworthiness, is determined by both its significance for a foreign supporting institution (foreign SI) and the foreign SI’s influence on the operations and financial dealings of the rated entity. Furthermore, creditworthiness of rated entities under external foreign influence depends on their foreign Sis’ ability to provide them with extraordinary or, when necessary, use their resources to the benefit of other affiliates or shareholders.

The use of this methodology usually calls for a preliminary SCA calculation of a rated entity, for which purpose ACRA applies methodologies developed specifically for different types of rated entities, with possible adjustments for the influence of foreign SI.

If the Agency regards a rated entity as government-associated, with the latter’s support playing the most significant role for this rated entity, then, in order to account for external support, ACRA shall use the Methodology for Analyzing Relationships Between Rated Entities and the State.

This methodology shall be applied on a permanent basis until a new edition is approved by the ACRA Methodological Committee.

The credit ratings assigned according to this methodology shall be revised in compliance with the Federal Law of 13 July 2015 No 222-FZ On the Activities of Credit Rating Agencies in the Russian Federation, On the Amendment to Article 76.1 of the Federal Law ‘On the Central Bank of the Russian Federation (Bank of Russia)’ and the invalidation of certain provisions of legal acts of the Russian Federation, as well as in accordance with ACRA internal documents, but not later than 365 days past the date of the latest rating action.

In order to keep this methodology up to date, ACRA shall review and amend it in the following cases:

  • over three instances of deviation from this methodology while performing rating activities over the course of one quarter;
  • requirement for amendments based on the results of methodologies application monitoring conducted by the methodology group;
  • conflict between this methodology and Federal Law of 13 July 2015 No 222-FZ On the Activities of Credit Rating Agencies in the Russian Federation, On the Amendment to Article 76.1 of the Federal Law ‘On the Central Bank of the Russian Federation (Bank of Russia)’ and the invalidation of certain provisions of legal acts of the Russian Federation;
  • request for immediate revision of this methodology filed by the Compliance and Internal Control Service of ACRA.

ACRA shall review this methodology in accordance with its internal documents within one calendar year after the latest review date. A review may bring amendments to the methodology, or leave it unchanged until the next review.

Any deviation from this methodology in the course of its application shall be documented and disclosed on ACRA’s official website www.acra-ratings.ru simultaneously with a credit rating or a credit rating outlook publication and with an indication of reasons for such deviation.

If any errors that already affected or may potentially affect credit ratings and/or credit rating outlooks are detected in this methodology, ACRA shall conduct its analysis and review in accordance with the established procedure. Reports of each such instance and the updated versions of the methodology shall be submitted to the Bank of Russia in accordance with the set procedure. If errors discovered in this methodology may impact any previously assigned credit ratings, ACRA shall disclose such information on its official website www.acra-ratings.ru.

If the planned amendments to this methodology are significant and affect or may potentially affect the current credit ratings, ACRA shall do the following:

  1. file with the Bank of Russia and disclose on its official website www.acra-ratings.ru the full information about the planned changes to the current methodology, with an indication of reasons and consequences that such changes may entail, including impact on credit ratings assigned in accordance with this methodology;

  2. assess the need for revision of all credit ratings assigned in accordance with this methodology within six months after the latest amendment date;

  3. revise credit ratings within six months after the latest amendment date, if the review results identify a need for revision.

2 Methodology basic principles

One of the main criteria that call for SCA adjustments within the framework of this Methodology is the likelihood of a SI providing extraordinary support to a Rated Entity in the event of severe deterioration of the latter’s financial standing. Another criterion is the likelihood of the SI appealing to a Rated Entity for extraordinary support in the event of potential deterioration in the SI’s finances. Thus, SCA adjustments can be made both upward and downward.

When determining the maximum number of notches for possible SCA adjustment with regard to foreign influence, ACRA performs its own Country risk assessment of a foreign SI’s presence jurisdiction in comparison with the country risk of the Russian Federation.

When calculating the final SCA adjustment level, ACRA conducts supporting institution creditworthiness assessment (SICA) on the national and global markets, as well as analyzes the degree of relationship between a foreign SI and a rated entity.

A substantial SI’s stake in the share capital of a Rated Entity is not regarded as sufficient grounds for a rating adjustment.

The ceiling level of a Rated Entity’s creditworthiness estimate, accounting for foreign SI’s influence, shall be set at the level of the Russian Federation sovereign risk.

3. Analysis structure

Figure 1. Analysis structure for relationships between rated entities and supporting organizations registered outside the Russian Federation

* If it is impossible to determine the rated entity’s SCA, this methodology shall not apply.
Source: ACRA

4 Analysis procedure

4.1. Determining the group perimeter and identifying the supporting institution

The terms "group" and "group members" refer to the ultimate parent company and all of the entities, over which it has direct or indirect control. A group consolidation perimeter is reflected in the audited consolidated financial statements of the parent (holding) structure, along with their proportionate shares in joint ventures (individually or jointly controlled).

In most cases, ACRA interprets control as the ability to manage the financial and operating activities of a rated entity. Control can also be interpreted as the ability to manage a group member company’s development strategy and cash flows. In many cases, the key indicator of control is ownership of over 50% shares of the rated entity. However, control may potentially be exercised even if a parent company owns less than 50% of the voting stock (shares) and, on the contrary, control may potentially not be exercised even if the parent company owns more than 50% of the voting stock (shares).

Identifying the supporting institution

By supporting institution, ACRA means a company, which in case of necessity is likely to provide emergency support to a rated entity. In most cases, the supporting role is assumed by a parent or holding structure, although other options are possible. For example, in the course of the rating analysis, the status of supporting institution may be assigned to a major operating company that, being part the group, provides guarantees for a significant part of rated entity’s debt portfolio.

Supporting institution’s creditworthiness is assessed by ACRA rating analysts, but the Agency reserves the right not to publish the results of supporting institution creditworthiness analysis (SICA), while the SICA itself is not a credit rating.

If the Agency believes that the supporting institution is an entity registered outside the Russian Federation, while the rated entity is regarded as being under external foreign influence, the analysis must be performed according to current methodology. If ACRA considers the supporting institution as an entity registered in the Russian Federation, while the rated entity is regarded as the one influenced by a group, the analysis must be carried out according to the Methodology for Analyzing Member Company Relationships Within Corporate Groups.

4.2. Country risk assessment of a foreign SI’s presence jurisdiction

A Country risk assessment of a foreign SI’s presence jurisdiction relative to the country risk of the Russian Federation shall be performed based on ACRA’s Country Risk Assessment Register (CRAR).

CRAR includes an assessment of key country risks for jurisdictions, in which institutions supporting entities rated by ACRA operate. Country risk estimates are not credit ratings. ACRA CRAR is approved by an authorized body of the Agency and must be reviewed within 180 days after the date of its latest approval. CRAR is an internal ACRA document and is not subject to disclosure.

Country risk assessment factors

Country risk analysis is based on an assessment of the government and market infrastructure development level, national economic base, cross-border trade and financial flows, fiscal and monetary policies. The level of country risk characterizes the ability of resident companies to service and repay debt in foreign currency, as well as to provide cross-border support to their subsidiaries abroad.

The country risk is mainly influenced by the following:

  • institutional factor,
  • economic factor,
  • monetary factor,
  • debt factor,
  • capital flow regime factor.

Table 1. Country risk factors

Institutional factor

The institutional factor includes an analysis of state institutions and market infrastructure development in a country, an assessment of stability and continuity of economic policies, the coherence and consistency of law enforcement. For rated entities, the developed government and market institutions expand the opportunities to refinance debt, while a consistent economic policy coupled with a stable legal environment reduce risks of doing business in that jurisdiction, which in turn decreases costs of debt raising and servicing. This factor receives an expert estimate ranging from 1 (low level of institutions development) to 5 (high level of institutions development).

Table 2. Institutional factor

Economic factor

The economic factor evaluates the level of country’s economic development. The analysis includes an assessment of country’s wealth and the intensity of international trade as a source of foreign exchange proceeds. The indicators used are GDP per capita and exports per capita. A special attention is paid to debt burden of the economy. The latter is measured by the loans to GDP ratio. A bursting credit bubble leads to an increase in borrowing costs, which can dramatically slowdown economic growth, entail capital outflow from the country and negatively affect residents’ creditworthiness.

Monetary factor

The monetary factor includes an evaluation of monetary policy, which determines stability of the national currency and the exchange rate regime, as well as the extent of capital flow freedom. The monetary factor relies on such indicators as the inflation pace, the national currency dynamics and the current capital flow regime. A monetary policy that leads to higher inflation will inevitably entail national currency weakening or force the government to impose restrictions on capital flows. In both cases the country risk tends to increase, reducing the ability of residents to service and repay their foreign currency debts.

Debt factor

The debt factor takes into account the level of foreign currency debt of both, the government and the private sector (corporates, banks, individuals). This factor relies on government and non-government external debt to GDP ratios, which characterize the current and future needs of country’s residents pertaining to foreign exchange resources for debt repayment. Availability of resources to service external debt also matters and is measured by the gold and forex reserves to foreign debt ratio. The maximum value of this indicator is attributable to jurisdictions, whose currency is used on the global market as a reserve currency and whose residents have a wide access to global capital markets for refinancing, while multiplying ratios are applied to debt indicators of such jurisdictions. The ratio is an expert assessment depending on the ability of residents to issue debt denominated in the national currency on the foreign market.

The country risk assessment is formed by summing the weighted values of individual factors. The factor ratings are based on threshold values indicated in Table 2.

Table 3. Country risk matrix

Source: ACRA

Capital flow regime factor

A restriction on cross-border capital flows will make it impossible for a parent company to support its subsidiaries abroad. This indicator is evaluated at an expert level and shall equal 1 when capital flows are unrestricted, and shall stand at 0 in case of a moratorium on capital flows is imposed and any support from a foreign SI is ruled out. An introduction by a government of partial restrictions on the capital flows, depending on the strength of restrictions imposed, will place the indicator value between 0 and 1, based on an expert opinion. To account for the influence this factor has on the country risk level in a jurisdiction in question, the final assessment shall be multiplied by the adjustment factor.

In exceptional cases, when ACRA believes that a supporting institution is able to bypass its presence jurisdiction while delivering cash to a rated entity, the factor of capital flow regime is not considered during analysis.

A restriction on cross-border capital flows will make it impossible for a parent company to support its subsidiaries abroad. This indicator is evaluated at an expert level and shall equal 1 when capital flows are unrestricted, and shall stand at 0 in case of a moratorium on capital flows is imposed and any support from a foreign SI is ruled out. An introduction by a government of partial restrictions on the capital flows, depending on the strength of restrictions imposed, will place the indicator value between 0 and 1, based on an expert opinion. To account for the influence this factor has on the country risk level in a jurisdiction in question, the final assessment shall be multiplied by the adjustment factor.

In exceptional cases, when ACRA believes that a supporting institution is able to bypass its presence jurisdiction while delivering cash to a rated entity, the factor of capital flow regime is not considered during analysis.

Table 4. Capital flow regime

Procedure for country risk assessment of a foreign SI's presence jurisdiction

For determining the category of a foreign SI's presence jurisdiction, its estimated country risk is compared to the country risk estimate of Russia. If the country risk estimate of a foreign SI's presence jurisdiction exceeds the country risk estimate of the Russian Federation by more than 10 pps, but not more than 30 pps., the jurisdiction’s category is defined as moderately strong. If the country risk estimate of a jurisdiction exceeds the country risk estimate of the Russian Federation by more than 30 pps, the jurisdiction’s category is defined as strong. If the country risk estimate of a jurisdiction is below the country risk estimate of the Russian Federation by more than 10 pps, but not more than 30 pps, the jurisdiction’s category is defined as moderately weak. If the country risk estimate of a jurisdiction is below the country risk estimate of the Russian Federation by more than 30 pps, the jurisdiction’s category is defined as weak. If the difference between country risk estimates of a jurisdiction and the Russian Federation does not exceed 10 pps, the jurisdiction’s category is defined as corresponding to the one of the Russian Federation.

Foreign SI's presence jurisdictions are distributed between the levels listed below, based on subjective assessment of country risk by ACRA.

Strong jurisdiction (the risk level is significantly lower than the country risk of the Russian Federation). If a foreign SI's presence jurisdiction is placed in this category, the credit rating level of a rated entity shall be capped by the level of sovereign risk of the Russian Federation, provided a high creditworthiness assessment of the foreign SI. If the latter’s creditworthiness is estimated as insufficiently high, the parity with the sovereign risk of the Russian Federation shall not be attainable, and SCA adjustment shall be based on an expert assessment of the SICA.

The maximum SCA adjustment for a foreign SI registered in a given jurisdiction:

  • parity with the sovereign risk of the Russian Federation, provided a very high SICA level;
  • if the SICA is recognized as high, the rated entity’s SCA may be adjusted by up to five notches upwards the rating scale.

Moderately strong jurisdiction, or jurisdiction on par with the Russian Federation (the risk level corresponds to the country risk of the Russian Federation, or its deviation from the country risk of Russia is estimated as negligible). If a foreign SI's presence jurisdiction is placed in this category, this does not unconditionally imply an achievement of parity between rated entity’s final rating and the sovereign risk of the Russian Federation. SCA adjustments are made in accordance with the SICA and is capped by the level of creditworthiness of the supporting institution.

The maximum SCA adjustment for a foreign SI registered in a given jurisdiction:

  • if the SICA is recognized as moderate, high or very high, the rated entity’s SCA may be adjusted upwards by up to five notches.

Moderately weak or weak jurisdiction (the risk level is higher or significantly higher than the country risk of the Russian Federation). Placing a foreign SI's presence jurisdiction in this category, with a comparable or weaker SICA, determines the rated person’s SCA as the maximum attainable rating value. In case of a low SICA and a strong relationship of a rated entity with a foreign SI, a negative SCA adjustment is possible in order to account for the probability of the foreign SI turning for help to the rated entity.

The maximum positive SCA adjustment for a foreign SI registered in a given jurisdiction:

  • if the SICA is recognized as high or very high, the rated entity’s SCA may be adjusted upwards by up to two notches.

4.3. Maximum SCA adjustment assessment

The maximum SCA adjustment level of a rated entity is determined in accordance with Table 5, based on comparison of a SICA category with a foreign SI’s presence jurisdiction.

Creditworthiness assessment of a foreign SI registered in a foreign jurisdiction is made by ACRA in comparison with rated entity’s SCA and in accordance with the methodology applicable to a respective type of rated entities.

The SICA level of entities located in a foreign jurisdiction is determined on the basis of publicly available information and data provided by rated entities. In view of restrictions related to the specifics of a foreign jurisdiction analysis (complexity of assessing industry risks and regional operating activity aspects; impossibility or difficulty of making a comparison with other entities rated by ACRA; impossibility of assessment under the national rating scale of the Russian Federation), the result of creditworthiness analysis of a foreign SI shall be rendering of its SICA to one of the following categories (without making a more accurate estimate):

  • weak,
  • moderately weak,
  • neutral,
  • moderately strong,
  • strong.

Table 5. Maximum SCA adjustment assessment

Source: ACRA

4.4. Determining the degree of relationship between a rated entity and a foreign SI

To determine the direction and extent of adjusting the SCA of a rated entity, depending on creditworthiness of a foreign SI, the latter’s degree of relationship with the rated entity has to be determined.

The method of determining the degree of relationship between a foreign SI and a rated entity is similar to the approach described in the Methodology for Analyzing Member Company Relationships Within Corporate Groups.

ACRA identifies five degrees of relationship between a foreign SI and a rated entity:

  • Very weak,
  • Weak,
  • Moderate,
  • Strong,
  • Very strong.

The degree of relationship between a foreign SI and a rated entity is determined on the basis of such factors as:

  • Existence of legal ties,
  • Existence of contingent liabilities (including sureties and guarantees),
  • Strategic importance,
  • Operational integration.

4.5. Final credit rating assignment

Establishing parity between a final credit rating and the sovereign risk of the Russian Federation is allowed, if the foreign SI is considered very strong and its relationship with the rated entity is strong or very strong.

If the degree of relationship between a foreign SI and a rated entity gets lower, the SCA may be adjusted by up to five rating scale notches, with the maximum final rating level as a result of this adjustment being the parity of the final rating with the sovereign risk of the Russian Federation.

In certain cases, when the risk of funds redistribution from a rated entity to a foreign SI emerges and when the degree of relationship of these entities is assessed at least as moderate, a negative SCA adjustment is possible (for example, when the SICA is defined as low or very low, or the jurisdiction category is regarded as moderately weak or weak). ACRA does not limit the number of SCA negative adjustment notches in this case.

Table 6. SCA adjustment assessment

Source: ACRA

If a rated entity is not part of an identifiable foreign group, ACRA takes into account the instances of additional support from a foreign shareholder and/or companies owned by this shareholder. In case of absence of support precedents, the Agency may consider written statements by a foreign shareholder and/or companies owned by such shareholder expressing willingness to support the rated entity. If the Agency believes that the probability of such support is high, it reserves the right to adjust the SCA one notch up.

However, if ACRA sees a high probability of capital (liquidity) withdrawal from a rated entity by a foreign shareholder, the SCA may be adjusted one notch down.

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