Association fédérative internationale des porteurs d'emprunts russes (AFIPER)
34 avenue du Maréchal Leclerc, 63110-Beaumont, FRANCE.
www.afiper.org
DG Internal market and services, unit G3
Via electronic mail.
Tuesday, September 2nd, 2008.
Comments from Association fédérative internationale des porteurs d'emprunts russes (AFIPER) to DG International market and services'
Consultation on a draft Directive / Regulation with respect to the authorisation, operation and supervision of credit rating agencies (CRAs).
AFIPER ID number: 1243413348-68______
Dear Sirs,
AFIPER thanks the Commission for initiating the above consultation.
In March 2008 I signed a response to CESR's consultation on the role of credit rating agencies in structured finance, which I presented in the name of Collectif pour la reconnaissance du défaut de paiement russe, because AFIPER had no legal existence at the time. In the covering letter I wrote:
"Holders of defaulted sovereigns welcome the recognition, in the wake of the subsequent market turmoil, by regulatory bodies and investors worldwide, of the necessity to closely scrutinize the credit rating process for potential conflicts of interest.
They are, however, concerned to see that this scrutiny is mainly limited to potential conflicts of interest in the rating process of structured products, when other conflicts of interest have also been and are presently at work and influence the ratings of sovereign issues worth hundreds of billions of dollars."
We strongly believe that the problem of potential conflicts of interests is endemic to CRA activity as a whole and that the necessity for CRAs to "comply with exacting regulatory requirements to make sure ratings are not tainted by the conflicts of interest inherent to the ratings business" (as per Commissioner McCreevy's statement) applies to the entire range of products rated by CRAs, and not only structured products - even if the necessity for robust measures has only been acknowledged in the wake of the current crisis, which is clearly linked to structured products.
We note that the scope of the present consultation is not limited to the rating of any specific product but covers rating activity in its globality.
And that includes sovereign ratings, which is why we particularly welcome the opportunity to comment as per the following documents.
In addition we would be delighted to provide any documentary evidence to support our statements and further assist the Commission and other interested parties should they so require.
Yours truly,
Eric SANITAS
President
1. PRELIMINARY STATEMENT
AFIPER fully supports the main objective of the Commission proposal, which is "to ensure that ratings are reliable and accurate pieces of information for investors".
We take the point that the proposals "aim at ensuring the highest professional standards for rating activities" and that "they do not intend to interfere with rating methodologies or rating decisions which will remain the sole competence and responsibility of CRAs".
Our comments will therefore not be provided with the aim of obtaining that the Commission enforce upon CRAs the obligation of attributing a default rating to defaulted sovereign issuers (although we believe they clearly need to be attributed default ratings).
Rather, they will be provided with a view to ensuring that ratings:
· Are not tainted by potential conflicts of interest.
· Provide reliable and accurate pieces of information for investors.
It is compliance with the proposed rules that will naturally bring about the appropriate ratings to be attributed to all categories of issuers and issues.
We do however need to provide some background information on the reasons which brought us to comment in the first place, in order for readers to be aware of the specific potential pitfalls and problems which must be addressed in the matter of rating sovereign issuers.
Which is why prior to actually commenting of the Commission's proposal we shall provide some background on the AFIPER claim and discuss in some detail the inexplicable investment grade ratings attributed to the Russian Federation, the possible implications as to how and why they have been attributed, and also consider the effect the attribution of default ratings would have had on the financial performance of the CRAs.
2. BACKGROUND ON AFIPER
AFIPER is a French "association" of holders of defaulted bonds issued or guaranteed by the Russian state prior to 1917, formed in order to enforce full and complete settlement of their claims against the Russian Federation.
In 1917 the Bolsheviks overthrew the Romanov imperial regime to instate their own government which in 1918 unilaterally repudiated the previous government's foreign debt. As a consequence, since 1918 the defaulted bonds held by AFIPER members, due in the twentieth century, have been serviced in neither interest nor principal.
Despite Russian representations to the contrary, this default has not been resolved and no agreement has been reached with any bondholder.
Over the years many different groups have been formed to represent the interest of holders of defaulted Russian bonds.
AFIPER was created in Paris on May 31st 2008. Although it is registered in France, it is open to defaulted bondholders regardless of they nationality or country of residence.
3. BACKGROUND ON VALIDITY OF CLAIMS AGAINST THE DEBTOR.
The overthrown Romanov imperial regime was succeeded by the Bolshevik government and the Soviet Union and within it the Russian Soviet Federative Socialist Republic which gave way to the Russian Federation.
3.1. The claim in international law.
Each of the above governments benefited from international recognition; and by virtue of the internationally accepted successor government doctrine of settled international law the Russian Federation is bound by the obligations of its predecessor governments.
3.2. Intergovernmental Franco-Russian agreement (27.05.1997).
In 1997 the French and Russian governments signed an agreement whereby they mutually agreed to abandon their claims on debts to each other arising prior to 1945. As an overall compensated settlement for these mutual intergovernmental claims the Russian Federation paid the French government US$400 million.
Private bondholders took no part in negotiating the agreement, were not a party to its signature, and gave no representative mandate to the French government.
We underline the following facts:
· French citizens are not party to the agreement, which is between the two signatory states only.
· The Russian Federation has never made any payment to a holder of defaulted Russian bonds.
· The agreement specifically states that it does not imply acknowledgement of any debt whatsoever covered by the agreement.
It must lastly be noted that bondholders are in possession of the said bearer bonds, which would not be the case if they had been redeemed. Despite the above, the Russian Federation's position is that the matter of pre-1917 debt to French citizens is settled by the agreement.
3.3. The claim in French law.
The unacceptable Russian position has been successfully challenged by defaulted bondholders and France's highest administrative court the Conseil d'Etat has repeatedly found (21.02.2003, 31.03.2003, and 02.02.2004) that the 1997 intergovernmental agreement could not be opposed to private bondholders, whose rights against the Russian federation remain intact.
This fact has been explicitly referred to by Mr. SARKOZY in a 2007 written statement, and in more recent public and written statements by Mme. Lagarde, the French ministre de l'Economie.
Any limitation that might affect the validity of the claims is regularly interrupted by actions from bondholders.
3.4. Validity and amount of bondholders' claim.
3.4.1. By virtue of both international and internal french law (as per 3.1. and 3.3.), the defaulted bondholders' claim against the Russian Federation remains valid, and its settlement remains a full obligation of the Russian Federation.
3.4.2. On the basis of independent valuations, AFIPER's estimate of the global amount of monies owed to french defaulted bondholders is in excess of EUR 100 billion.
3.5. Enforcement.
In French courts bondholders are confronted with the Russian Federation's sovereign immunity. Therefore, despite the validity of the claim, creditors have no means of enforcing payment.
Creditors are in the situation, well know to practitioners of international law but not to the general public, of every private holder of certain defaulted sovereign bonds, whereby the validity of the claim is recognised by all - except the debtor - yet claimants have no access to the appropriate judicial forum.
4. BACKGROUND ON AFIPER DISPUTE WITH THE CRAs.
The only means of enforcing payment in the above circumstances (3.5.) is to prevent the debtor from accessing alternative sources of capital until he has settled existing obligations. This would have been achieved if the Russian Federation had been attributed a default rating as its position clearly justifies.
But the attribution of investment grade ratings has closed this only exploitable avenue.
The leading CRAs have been served notice of:
· The validity of the defaulted bondholders claim against the Russian Federation.
· The fact that the defaulted bonds have been serviced in neither interest nor principal since 1918.
· The absence of any willingness to pay on behalf of the defaulted debtor.
· The falsity of Russian public accounts which do not mention, and therefore dissimulate, liabilities to bondholders (see image below).
Despite this constructive notice the main CRAs rate the Russian Federation investment grade. It has therefore been allowed access to capital with no incentive to settle its prior obligations.
As a consequence, bona fide investors cannot make good on their valid claims, and suffer a prejudice worth more than one hundred billion Euros (as per 3.4.2.).
4.1. Inexplicable discrepancies.
At AFIPER we have carefully examined the rating methodologies of two leading CRAs, and we have found inexplicable discrepancies between their published methodologies and rating definitions on the one hand, and the Russian Federation's actual attributed ratings on the other.
4.1.1. MOODY'S.
4.1.1.1. Moody's definition of a foreign currency bond default:
"Government Local Currency and Foreign Currency Bond Ratings.
The meaning of default:
Moody's defines default as any missed or delayed disbursement of interest and/or principal. We include as defaults distressed exchanges in which: (1) the issuer offers bondholders or depositors a new security or package of securities that amount to a diminished financial obligation (debt with a lower coupon or par amount, or a less liquid deposit either because of a change in maturity or currency of denomination or required credit maintenance facilities); and, (2) the exchange has the apparent purpose of helping the borrower avoid default. Moody's also classifies as a default event those situations in which an issuer delays payment for credit reasons even when payment is ultimately made within the grace period provided for in an indenture or deposit agreement."
(In "A Guide to Moody's Sovereign Ratings", August 2006 accessed on 09.08.08)
4.1.1.2. "Willingness to repay is key to sovereign credit analysis".
"Any credit analysis must take into account not only a debtor's ability -- but also its willingness -- to repay. Determining a country's ability to repay is in the end not a very difficult task. (...) The real question is -- what level of resource mobilization are governments willing to undertake in order to repay their debts? In the end, willingness to repay is the key to sovereign credit analysis." (...)
(In "Sovereign Risk: Bank Deposits vs. Bonds", October 1995, accessed from "Moody's rating methodologies" on 09.08.08)
It must be noted here that despite constructive notice of Russia's refusal to acknowledge its financial obligations (as per 4.), Moody's inexplicably wrote about the Russian Federation that
"The government's improved willingness and ability to meet its debt servicing obligations is matched by its improved willingness and capacity to increase tax collections and close tax loopholes."
(08.08.05 Moody's press release)
and again that
"Clearly, the Russian government has exhibited a very strong willingness and ability to pay (and even to pre-pay) its own debt obligations."
(July 2008 special comment entitled "Moody’s Refines Views on Russian Federation Quasi-Sovereign Corporates")
4.1.1.3. Moody's issuer rating definitions.
"Long-Term Obligation Ratings
Moody’s long-term obligation ratings are opinions of the relative credit risk of fixed-income obligations with an original maturity of one year or more. They address the possibility that a financial obligation will not be honored as promised. Such ratings reflect both the likelihood of default and any financial loss suffered in the event of default.
Moody’s Long-Term Rating Definitions:
Aaa / Obligations rated Aaa are judged to be of the highest quality, with minimal credit risk.Aa / Obligations rated Aa are judged to be of high quality and are subject to very low credit risk.
A / Obligations rated A are considered upper-medium grade and are subject to low credit risk.
Baa / Obligations rated Baa are subject to moderate credit risk. They are considered medium-grade and as such may possess certain speculative characteristics.
Ba / Obligations rated Ba are judged to have speculative elements and are subject to substantial credit risk.
B / Obligations rated B are considered speculative and are subject to high credit risk.
Caa / Obligations rated Caa are judged to be of poor standing and are subject to very high credit risk.
Ca / Obligations rated Ca are highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest.
C / Obligations rated C are the lowest rated class of bonds and are typically in default, with little prospect for recovery of principal or interest.
Note: Moody’s appends numerical modifiers 1, 2, and 3 to each generic rating classification from Aa through Caa. The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category.
Issuer Ratings
Issuer Ratings are opinions of the ability of entities to honor senior unsecured financial obligations and contracts. Moody’s rating symbols for Issuer Ratings are identical to those used to indicate the credit quality of long-term obligations."
(In "Moody's rating methodology handbook", February 2004, accessed 09.08.08)
4.1.1.4. Discrepancy between Russian Federation's actual Moody's rating vs. its rating if attributed according to Moody's published rules: