The loss of the double A of French debt could force certain institutional investors to sell their French bonds, their internal rules requiring them to only hold AA- at least.
Unimportant financial agency notes. Until now, the opinions of S&P, Fitch and Moody's on the quality of French debt seemed largely ignored by institutional investors.
The loss of its double A last June did not cause a surge in borrowing rates for France on the markets, on the contrary. The 10-year French OAT saw its yield decline between June and July, falling well below 2%.
While the country awaits this Friday the new opinion from the S&P agency which could once again downgrade the French rating, will the same causes produce the same effects?
This time nothing is less certain. A further drop in the rating would indeed increase French debt from AA- to A+. The signature from France deemed so far “high quality” would be considered by the agency to be “upper average quality”.
“Often the impact of a downgrade is insignificant because investors in the markets were already aware of the problems of the country concerned and already took them into account to determine the interest rate required on its bonds,” recalls Eric Dor, director economic studies at IESEG.
But when a downgrade causes the rating to move to a lower category that triggers automatic threshold effects on the country's bond demand, then there are increases in the interest rate.”
The A+ that changes everything?
Institutional investors such as pension funds, UCITS, insurance companies or other banks are subject to internal management rules. For a certain number of them, the holding or purchase of bonds rated below the double A threshold is thus prohibited.
The Experts: Debt, will S&P downgrade France's rating? – 29/11
“The downgrading of France's public debt to category A would therefore imply net sales of its bonds on the markets, and then a sharp drop in demand, explains Eric Dor. This would automatically lead to an increase in the rate of return required on bonds issued by France.”
An effect which may have already occurred last July when Japanese investors sold a very high amount of 8 billion euros of OATs following the loss of the AA.
In other words, more than the agency's opinion as such, the agency's rating can have an automatic consequence on the positions taken by investors.
Another similar threshold effect could also occur with banks. The latter are in fact required by regulation to hold a certain amount of equity. Requirement reinforced in 2010 by the Basel III agreement which requires banks to hold a certain amount of capital as well as a percentage of quality, risk-free capital.
However, sovereign bonds rated from double A are considered risk-free. Which is no longer the case for those who only have one A.
“The risk coefficient applied to sovereign bonds is 20% for ratings A- to A+, explains Eric Dor. So a downgrade of France's rating to A+, or less, would cause an increase in the risk-weighted assets of the banks that hold them, and therefore an increase in the minimum capital requirements of these banks.”
By maintaining the same amount of French bonds, certain establishments could thus automatically fall below the required capital threshold.
The most exposed British banks
The consequence is that certain establishments would react by purchasing less French public debt, which would lead to an increase in the rate of return required on the markets.
It remains to be seen what proportion of these threshold effects and this loss of attractiveness would be on the colossal French OAT market, the total amount of issuance of which (the State's financing requirement) should be around 300 billion euros in 2025.
The French debt, the amount of which peaks at 3,200 billion euros, is 9.2% held by French banks. The majority (55%) is in the hands of foreign investors. According to the Bank for International Settlements (BIS), British banks hold the largest amount (124 billion euros), ahead of the Japanese (112 billion), the Americans (43 billion) and the Germans (33 billion).
