Scope Ratings uses an innovative ‘mandate-driven’ rating methodology to rate supranational institutions, an approach which sets it apart from the Northern American credit rating agencies. Giacomo Barisone, head of public finance, and Alvise Lennkh, lead analyst for supranational entities, explain the distinctiveness of Scope’s rationale, exemplified by its recently assigned first-time rating of the European Investment Bank.

Scope Ratings has extended its coverage of European supranational entities. How does your approach distinguish itself from the methodologies of Northern American agencies?

GB: Scope is the first European credit rating agency to issue supranational ratings. Essential to our approach is the recognition that supranational institutions are not commercial entities, but rather international bodies owned and controlled by governments which provide them with financial resources, credibility, regulatory frameworks and liquid capital markets to raise funds to support government policies.

AL: Strong shareholders therefore signal to market participants that the supranational’s debt securities are likely to benefit from an institutional framework that ensures liquidity and market acceptance, for instance, via preferential regulatory treatment, eligibility for central bank operations and listings on well-established securities exchanges. This is why our analysis starts with an assessment of the key shareholders rather than the strength of the institution’s balance sheet.

Why is this distinction important?

GB: In case of financial distress, a supranational institution’s ultimate recourse to honour its obligations is not necessarily its own balance sheet, but the ability and willingness of its shareholder governments to provide additional support, including emergency loans or a (pre-cautionary) capital increase, should the institution have exhausted its own financial reserves. Highly rated shareholders with political commitment to the institution provide a strong form of support and investor assurance given their inherent capacity to provide additional financial resources in case of need.

AL: In our view, an institution with strong shareholders can afford to have a relatively weaker balance sheet, whereas a supranational with weak shareholders necessarily requires a strong balance sheet for a high rating assessment. Our methodology follows this rationale by defining strong shareholder support as a sufficient condition for strong creditworthiness, while intrinsic financial strength is a necessary condition for supranationals owned and controlled by weak shareholders.

In this context, how do the ratings of the EIB’s shareholders stack up?

AL: The governments of Europe’s seven largest economies – France (AA/Stable), Germany (AAA/Stable), Italy (BBB+/Stable), the UK (AA/Negative), Spain (A-/Stable), Belgium (AA/Stable) and the Netherlands (AAA/Stable) – account together for around 83% of the EIB’s capital. These sovereigns constitute the EIB’s key shareholders with a weighted-average rating of AA-. Under our approach, highly rated shareholders on their own warrant a high rating for the supranational institution they own, though strong operations, including liquidity buffers, access to ECB funding, excellent asset quality and sustained profitability provide further uplift, and therefore buffers, to the EIB. We assigned a first-time rating of AAA with Stable Outlook on 15 November.

Can you give a specific example of the interdependence between the EIB and its shareholders?

GB: Yes. The very existence of supranational institutions is based on the premise that their activities enhance the policy goals of their shareholders. The EIB is a good example. The bank’s project appraisals assess how each one contributes to EU and member-country economic development. As the EU’s policy agenda changes, so does the EIB’s loan exposure. The mandate is not to maximise profits but to finance projects that support policies which is why we place a higher weight on the ability to finance these projects through the cycle rather than the quality of the assets themselves.

AL: Indeed, the decision last week by the EIB board - that is, its government shareholders - to change EIB energy lending to bring it in line with climate goals, shows that the EIB ultimately finances the policies at the discretion of the EU. With the decision to align its energy-sector financing with the goals of the Paris climate accord, the EIB is at the centre of the EU’s environmental agenda and energy policy.

Is the UK’s planned exit from the EU a potential challenge for the EIB?

AL: Yes and no. Brexit may result in a reduction of the quality of the EIB’s callable capital. If the UK exits, callable capital of shareholders rated AA- or above would drop to around EUR134.0bn from EUR 148.1bn currently. Even allowing for the EIB’s replacement capital plans and capital increases from Poland and Romania, we estimate the EIB’s shock-absorption capacity would fall to around 30.3% from the current 33.2%. The bank would have fewer shareholders rated AA- or above for extraordinary capital support, which would result in a weaker assessment of the bank’s shareholder concentration. However, our analysis shows that even without the UK as a shareholder, the EIB has significant buffers to retain its AAA/ Stable rating.