Bangkok--28 Nov--Fitch Ratings
In November 2011, Fitch's Corporates rating team met with a number of investors in Hong Kong and Singapore, where its approach to rating state-owned entities (SOEs) was frequently discussed.
Fitch's approach to rating corporate (non-financial institution) SOEs in Asia Pacific follows its "Parent and Subsidiary Rating Linkage" (PSL) criteria, where the strength of legal, operational and strategic links between the sovereign and the SOE are analysed to determine the likelihood of support by the sovereign and thus any rating linkage. The level of government ownership, in itself, does not drive rating linkage, but may inform Fitch's assessment of the operational and strategic ties.
Where the standalone rating of an SOE is stronger than that of the government, the rating of the SOE is likely be constrained to that of the sovereign, unless there is an effective legal ring-fence to prevent the government extracting cash from the SOE. An example of this is China National Petroleum Corporation ('A+'/Stable), constrained at the level of the sovereign, despite a 'AA' standalone credit strength.
In the more common situation where the standalone credit profile of the SOE is weaker than that of the government, the SOE is rated on a top-down basis (that is, by notching its rating from that of the sovereign) if legal, operational and strategic ties between the government and SOE are strong. If, overall, legal, operational and strategic ties are deemed to be less than strong, Fitch rates the SOE either on a standalone basis, or by notching up from the standalone for implied government support, if the agency believes that the sovereign might provide some tangible support at a time of financial distress.
Normally, the top-down rating approach is applied if the SOE is strategically very important to the government, is seen as an important policy tool (particularly if tariffs are set by government at an uneconomic level), and/or it has received, or is receiving, subsidy or equity funding from the government. Strong legal ties, such as a sovereign guarantee of SOE debt or the existence of cross-default clauses linking SOE debt with sovereign debt, would be strong evidence, for a top-down rating approach. However, even in their absence, an SOE can be rated on a top-down basis, even equalised at the level of the sovereign, if strategic and operational ties are strong enough.
Examples where the top-down approach is taken with equalisation of the SOE's ratings with the sovereign include: Korea Electric Power Corp. (KEPCO, 'A+'/Positive) and Korea Gas Corporation (KOGAS, 'A+'/Positive) where the government maintains full control over management and operations and where there is a very high reputational risk to the government in the case of default; PT Perusahaan Listrik Negara (Persero) ('BB+'/Positive) and PT Pertamina (Persero) ('BB+'/Positive) in Indonesia and the government-owned Indian downstream oil and gas businesses all of which receive cash from the government through subsidies and/or public service obligation receipts; India's Power Finance Corporation ('BBB-'/Stable) and Rural Electrification Corporation ('BBB-'/Stable) which have a clear policy role in funding the strategically important power sector; and the Queensland government-owned electricity companies, ENERGEX Limited, Stanwell Corporation Limited and CS Energy Limited (all 'AA+'/Negative), whose funding is provided by related party loans from the Queensland state treasury.
In some cases, the legal, operational and strategic ties between the government and the SOE are strong enough to rate the SOE on a top-down basis but not strong enough for equalisation. Typically, these SOEs will be either strategically less important (and therefore of lower priority should support be rationed) or have a weaker record of government support than those SOEs with equalised ratings. Examples of where Fitch follows this approach and rates one notch down from the sovereign are: Korea District Heating Corporation ('A'/Positive) which the agency assesses to be less strategically important to the government than KEPCO and KOGAS; and China Petroleum & Chemical Corporation (Sinopec, 'A'/Stable) which has a weaker history of receiving sovereign support than, for example, a government-owned Indian downstream oil and gas business such as Indian Oil Corporation ('BBB-'/Stable).
A change in the rating of the parent sovereign entity will usually cause a corresponding change to the credit ratings of a top-down rated SOE. For bottom-up rated SOEs, Fitch rates on a standalone basis or notches up from the standalone rating to factor in implied government support - normally just one notch, occasionally two, and rarely three. Changes in either the operating or financial performance for these SOEs are the main factors driving movements in their ratings, often with the value of support (ie notching) remaining constant.
For SOEs rated on a bottom-up basis, the notching up provided may increase if a sufficient deterioration in their operational or financial performance occurs which changes the perceived or actual level of support from their sovereign parent. At the extreme this could result in a switch from bottom-up to top-down, if there was sufficient change in strategic priority or tangible support from a sovereign, although this is very rare. Conversely, if operating and financial performance of the entity improves consistently, there may become a point at which the entity reaches a natural ceiling for its industry sector. As it approaches this point, up notching for sovereign support may start to compress and then eventually disappear. Fitch's individual sector credit factor reports illustrate what it considers to be natural rating ranges (and ceilings) for different corporate sectors.
Typically, SOEs which benefit from a notch or more of government support on a bottom-up basis will be less strategically important than top-down rated SOEs, either due to their size or their sector, or they will have weaker operational links, for example more commercial operations or less government oversight. SOEs operating in a commercial environment where government influence is minimal, that is, where Fitch does not expect the government to support the SOEs during a period of distress, will be rated on a standalone basis.
Examples of providing a bottom-up notch for government support include CNOOC Limited (CNL, 'A'/Stable) and the Chinese thermal independent power producers (IPPs). CNL is not rated top-down because it is significantly less integrated into the Chinese national oil and gas infrastructure than top-down rated Sinopec and is much more exposed to commercial international oil pricing than Sinopec, whose revenue is very dependent on government-regulated pricing. Nevertheless, Fitch believes that CNL is strategically important enough to the sovereign to warrant a notch up from its standalone rating, evidenced by its monopoly on offshore production sharing contracts and the financial and political assistance received from the government during the CNOOC group's attempted acquisition of Unocal in 2005.
The Chinese thermal IPPs operate in a strategically important sector but are relatively small compared to China's overall electricity capacity, and their level of government ownership is lower than some regional SOE peers. These thermal IPPs are stretched financially but have not been receiving significant support from the government. Nevertheless, their role in electricity generation is important enough to warrant a single notch for government support.
The agency plans to release an updated report on its rating approach for all SOEs in Asia Pacific by mid-January 2012.