DBRS Publishes Final Methodology on Rating Sovereign Governments
Sovereigns, GovernmentsDBRS, Inc. has released the 2017 update of its Methodology “Rating Sovereign Governments.” This Methodology presents the criteria on which sovereign ratings are based, and is effective as of November 27, 2017. As noted in the October 10th Request for Comment, these refinements may have an impact on the ratings of Argentina, Brazil, Colombia, Mexico, and Turkey, most likely affecting the local currency issuer rating. Details regarding any affected ratings will be published soon hereafter. No other rating changes are anticipated from its adoption. While some changes have been made to the text and tables for clarification, no material changes were made to this version as a result of the comments received during the Request for Comment period.
Highlights of the updated sovereign methodology include:
• An enhanced Sovereign Scorecard;
• An updated approach to determining when a sovereign’s foreign and local currency issuer ratings should differ;
• A new section explaining the applicability of sovereign issuer ratings to different types or classes of debt securities issued by the same sovereign;
• A new appendix that discusses the impact of sovereign ratings on other DBRS ratings.
The updated methodology includes several refinements to the sovereign scorecard, which are discussed in greater detail in Appendix A. Reflecting DBRS’s experience with the scorecard, optional indicators have been removed, and the number of sub-factors and indicators has been slightly reduced. Some indicators and thresholds have undergone minor recalibrations to better reflect DBRS’s rating approach. Notwithstanding these changes, the overall purpose and use of the scorecard remains the same: to help inform the analysis of each building block and to facilitate peer comparison.
The relevant quantitative and qualitative considerations that may cause DBRS to assign ratings that deviate from the scorecard results also remain broadly unchanged. Consequently, the refinements to the scorecard are unlikely to have an immediate effect on outstanding ratings. Nonetheless, the refined scorecard does alter the relative ranking of some sovereigns and could have an impact on ratings over the longer term. Going forward, DBRS rating reports will provide additional transparency regarding the overall results of the scorecard and the main considerations that factor into rating committee decisions.
Additionally, the updated methodology revises the approach used to determine whether a differential between foreign and local currency issuer ratings is warranted. As the macroeconomic fundamentals and financial sophistication of emerging market countries have improved over recent decades, the basis for differentiating the risk between these two issuer ratings has diminished. In investment grade emerging market sovereigns, in particular, increased reliance on local currency debt issuance and the frequent participation of international investors in these local markets appear to have reduced the likelihood of selective defaults favoring local currency debtholders. While emerging markets with weak or deteriorating fundamentals may face material foreign exchange constraints that increase the risk of a foreign currency default, local currency defaults have been at least as common among rated sovereigns in recent decades. Accordingly, the basis for a differential between local and foreign currency issuer ratings has gradually diminished for most DBRS-rated sovereigns.
This updated methodology also incorporates a more detailed approach to the application of a sovereign’s issuer ratings to different types or classes of its securities. It discusses those types of debt where a sovereign’s issuer rating may not be applicable, including in post-default situations.
A new appendix to the methodology summarizes the main channels through which sovereign ratings may influence other DBRS ratings. The appendix builds on previous analysis published by DBRS and seeks to provide additional transparency regarding the impact of sovereign, macroeconomic, and country risk on other DBRS ratings.
DBRS received some comments on its methodology during the request for comment period, but respondents requested confidentiality and the comments will not be published. Comments received were generally focused on certain scorecard metrics and their relevance to the analysis of specific sovereigns. Respondents also sought clarification on whether specific considerations relevant to monetary policy and financial stability were incorporated into the analysis. DBRS inserted and edited a few phrases to clarify the impact of these considerations on sovereign ratings.
DBRS criteria and methodologies are publicly available on its website www.dbrs.com under Methodologies.