Bankers in Scandinavia Dealt Blow by ESMA in Ratings Clampdown

Scandinavian bankers, brokers and issuers are wondering how to respond to warnings from the European Securities and Markets Authority that the region’s method for awarding shadow corporate debt ratings is in breach of existing rules.

The Swedish Securities Dealers Association convened a meeting at 10 a.m. local time on Tuesday to discuss the ramifications of not using ratings scales after its members were told by ESMA that only registered raters can do so. At the same time, the list of Scandinavian banks dropping their credit ratings scales is growing.

“I don’t think anybody anticipated that it would happen this quickly,” Babak Houshmand, a portfolio manager at Carnegie Fonder AB in Stockholm, said by phone. “They’re fixing something that’s not broken.”

At the Stockholm-based association, the view is that the shadow ratings model used in Scandinavia is key in providing “financing for small and medium-sized companies, which is a market that the European Commission wants to grow,” Kerstin Hermansson, head of the association, told Bloomberg.

But there are signs that the industry is assuming there’s no point in fighting ESMA. Nordea Bank AB, Scandinavia’s biggest, said last week it will discontinue the use of a ratings scale to summarize credit quality in investment research. The bank said it came to that conclusion after ESMA “strongly indicated that the use of a scale” is only “reserved for registered credit rating agencies” such as Moody’s, S&P and Fitch.

On Monday, Danske Bank A/S said it was following Nordea after “feedback” from ESMA. Scandinavia’s second-largest bank said the European regulator had indicated the practice wasn’t allowed for non-registered raters. On Tuesday, Svenska Handelsbanken AB joined the group of lenders to drop ratings scales, with immediate effect, spokesman Mats Olsson told Bloomberg.

The development threatens to hurt a region in which small businesses and investors have relied on banks for shadow ratings, which are often provided free of cost by local analysts prized for their familiarity with the market. A ban such as the one threatened by ESMA could seriously impede liquidity, increase systemic risk and disrupt the entire market, Mikael Busch, head of credit research at Swedbank AB, said earlier this month.

There are some who point out that the industry’s practice of awarding shadow ratings has a checkered history. Sindre Stoeer, managing director at the Norwegian Securities Dealers Association, says banks were caught pumping up companies whose bonds they were poised to sell, in what was a clear conflict of interests. Yet he also notes that such practices are a thing of “the past,” stopped by the raft of rules imposed since the financial crisis and by industry efforts to police itself.

Norwegian companies may be the hardest hit by the withdrawal of ratings scales, according to Thomas Hovard, Danske’s head of credit research. While all Nordic industries have been rated, “Norwegian asset-heavy industries -- for example, offshore -- and commercial real estate, make a relatively large part of the markets,” he said.

For now, it looks like banks need to find a new way to provide credit research to issuers and investors. Danske says it will work with market participants and the authorities to come up with alternative models. Swedbank is also looking into other frameworks if ESMA imposes a full ban, Busch said.

But Houshmand at Carnegie warns that the change could make it “harder” for banks to “hold on to mandates. Their relative edge will disappear.”

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