With the spread of financial turmoil, the importance of accurate risk rating tools has been brought to the forefront. Melodie Michel reports.

In these uncertain times, changes in the world’s political and economic landscape are hard to keep up with. This has prompted risk rating agencies to develop a number of new products to help trade finance providers better assess the sovereign risks surrounding deals.

Richard Green, head of political risk and structured credit at Marsh, explains that updating and sharing ratings on an almost daily basis has become crucial in order to keep clients informed on what could threaten their investments. “There is a demand for more updated and broader information in country risk ratings; a tool that can really help clients analyse their country risk exposures more scientifically, and more importantly to spot the trend,” he tells GTR.

Spotting the trend is exactly what Marsh has tried to do by teaming up with American risk analysis provider Maplecroft. The insurer now offers an online platform allowing its clients to access the information that they want directly with a member’s code. The platform features indices and up-to-date analysis in terms of regulatory and legal risks, political environment and human rights issues, as well as an overall ranking.

“The problem with these tools in the past is that they’ve been quite slow to respond to events. This system is very dynamic in the sense that the information on there changes almost daily and therefore you could get a good view of what’s going on every day and how the countries are progressing or deteriorating from a political risk perspective,” Green says.

“We were looking forward to more dynamic country risk analysis tools. We recognise that we don’t have the resources to do it ourselves in-house so we went looking for a specialist firm in that area and it made sense for us to team up with Maplecroft.”

Other technology providers are also working towards updating information instantly, with several of them launching early warning tools in the past few months. Altana’s Riskalert enables financial services professionals to select which institutions they want to monitor in a list of 1,200 entities worldwide, including sovereign, corporate and financial institutions.

Based on credit default swap (CDS) observation, it sends alerts via email as soon as warning triggers are reached, and allows users to view real-time updates through an online dashboard.

Altana founder and chief investment officer Lee Robinson says: “We are in a credit crisis. To lack updated market information on credit insurance is an invitation for failure. CDS spreads are regarded as the best measure of current and short-term outlook of unexpected events and have proven to do so in periods of crisis. Given the current uncertain state of the European economy, it is more important than ever to have timely financial indicators.”

Short-term vs long-term outlook

IHS has gone one step further, with a short-term risk rating tool that works alongside the firm’s medium-term solutions, making it easier for bankers to assess their exposures. Jan Randolph, director of sovereign risk at IHS, explains to GTR how the company surveyed the need for short-term rating systems and found that comparability with medium-term solutions was key.

“If you look at Standard and Poor’s and Fitch’s short-term ratings, you will see that they have hardly moved over the last five years, which is incredible given what’s happened in the world since 2007. It’s not absolutely clear what the short-term ratingis supposed to measure in terms of risk.

“The other thing we noticed is that their short-term ratings are unrelated to their medium-term ratings, so they have a completely different methodology and toolbox and cannot be compared. Our ratings are scored in a similar way in terms of adding risk, but because they come from the same toolbox and the same underlying methodology in scoring systems, in essence they are comparable and that is of great value.

“What this is telling the bank is that some countries that have a clear risk in the medium term actually have very good short-term rating. That should open the possibility of investigating or contemplating the continuation of short-term business,” Randolph says.

The IHS short-term rating system is based on 60% liquidity factors and 40% relational factors, whereas the medium-term tool is based on a 30% liquidity, 20% solvency and 50% relational ratio. Six liquidity tests are used: external liquidity gap, external current account, import cover in months, interest service ratio and risk spreads, banking system, and external foreign-exchange cover over short-term debt.

“They can either score 0.5 or 10 so there is no splitting hairs here. Either there’s a clear risk or there’s not, and if there’s a clear risk it is either significant or highly significant. The risk score 5 or 10 is equivalent to a rating notch, so if you move from 5 to 10 it’s a single notch downgrade equivalent,” Randolph explains.

The model also analyses relational factors, such as compliance to International Monetary Fund (IMF) and World Bank requirements, or links with surrounding countries, which can often drive liquidity, particularly in emerging markets. “Whether a country is meeting its policy targets, for example, is very important for the continued support of the IMF, and that becomes an important liquidity support in the country, which then becomes useful for banks engaging in trade finance because they know there’s liquidity there.

“Relations with creditors are important, but we also look at whether the country has any friends if it encounters a stress period. The eurozone is a classic example at the moment, where the likes of Greece, Ireland and Portugal have used their European membership for liquidity support.

“Others may not have access to these bailouts, particularly if they’re not members of the eurozone. It almost gets political. For example, Cyprus has been able to tap Russia for support loans and so has Belarus from time to time, but that’s linked to the relationship between Putin and Luchenko, and it’s not always clear what the support conditions are,” adds Randolph.

Finally, the solution looks at average payment delays in days, which could be an indicator of the emergence of credit risk or foreign exchange shortages.

As a result, IHS has produced a ranking of countries that have the biggest short-term/medium-term divergence. Algeria, the Philippines and Cape Verde are at the top of the list, followed by Egypt, Lebanon and Iraq, and IHS suggests that although long-term investment might not be recommended, short-term business is still sound in these countries.

New fears

Overall, the rating industry has realised the need to adapt to a fast-changing risk environment, and strived to provide accurate new solutions. “They recognise the fact that they have to be more responsive and provide more dynamic ratings and that’s what the major agencies are trying to do,” says Green.

But there is no time to rest for rating tool providers, as customers express more emerging concerns about civil unrest and nationalisations. As Green points out, investors are increasingly worried about the wave of nationalisations observed in Argentina, Mongolia and Indonesia, and that is something that risk rating agencies could look to address in the future.

“In the wake of the global financial crisis, and with the perception that many people have that capitalism has failed miserably, there has been a swing to the left, towards more socialist governments around the world. It is quite appropriate for socialist governments to say that national natural resources are not there to be exploited by foreign firms and with governments coming in having that agenda, it’s natural that clients who invest heavily in those countries have some concerns about their assets.
So there is a heightened concern about nationalisation, the likes of which we haven’t seen for quite some time,” Green adds. GTR

Natural catastrophes

Property and casualty insurer Ace has also launched new products in the past few months, including a mapping tool to evaluate natural catastrophe exposure. The company came up with the idea after a long string of global catastrophes in 2011, which highlighted the vulnerability of companies’ operations to supply chain interruptions.

Using information on earthquake, storm and flood risk, along with information provided by clients, the Ace Cat Web Platform provides an online colour-coded global map showing geographical risks. Satellite imagery can then be used to provide more detailed risk assessments, and the platform features past and current global natural hazard activity using the US Geological Survey.

Derek Talbott, Ace’s executive vice-president, explains: “Last year a number of disasters, from the Japanese earthquake and tsunami to the Thai floods, underlined the importance for every business of understanding the risk exposures they face from increasingly global and ever more complex production and supply chains.

“By pinpointing accumulation hot spots, companies can better assess the strengths and weaknesses of their supply chains and Ace can more easily work with them to develop the right programmes to manage the risks.”