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Euroclear Bank S.A

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Euroclear Bank S.A Euroclear Bank S.A. Primary Credit Analyst: Thierry Grunspan, Paris (33) 1-4420-6739; [email protected] Secondary Contacts: Yulia Kozlova, CFA, London +44 207 176 3493; [email protected] Giles Edwards, London (44) 20-7176-7014; [email protected] Table Of Contents Major Rating Factors Rationale Outlook Profile: Largest European Securities Settlement Franchise Support And Ownership: Majority Owned By Users Strategy: Deepen Relevance To Clients Through More Efficient And Expanded Post-Trade Services Risk Management: A Vital Discipline And Key Strength Accounting: Analysis Of Both Bank And Group Profitability: Improved Efficiency Capital: Sustained Strong Ratios Expected Related Criteria And Research WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 22, 2014 1 1354795 | 301084691 Euroclear Bank S.A. Major Rating Factors Strengths: Counterparty Credit Rating • Crucial role in supporting Euroclear's leading franchise in international AA/Stable/A-1+ securities markets. • Strong risk management and regulatory framework. • Very low risk profile. • Strong capitalization and limited leverage. Weaknesses: • High operational risk inherent in settlement and custody activities. • Dynamic operating environment, requiring constant adaption to mitigate potential threats and leverage opportunities Rationale The ratings on Belgium-based Euroclear Bank S.A. reflect Standard & Poor's Ratings Services' view of its "core" status to ultimate parent Euroclear plc (Euroclear), and the crucial role that it maintains in the international securities markets. The ratings also reflect the strong and dynamic risk management framework, the Euroclear group's very low risk profile, and the strong regulatory framework under which it operates. While apparently well-managed, we consider high operational risk to be inherent in the settlement and custody business. Euroclear Bank is one of the world's largest providers of cross-border settlement services, covering domestic and international bonds, equities, and investment funds. In addition to securities settlement, the bank continues to focus on related activities such as asset servicing, securities lending and borrowing, collateral management, money transfer, and ancillary banking services. In addition to the bank's role as one of the two leading international central securities depositaries (CSDs), the Euroclear group also operates the national CSDs for many countries in north-west Europe. Euroclear reports that it covers 57% (by value) of debt and equity securities issued by European Union issuers, and provides access to 90% of securities worldwide. It held €24.2 trillion in client assets at end-2013. Although Euroclear's client assets are about double those of Luxembourg-based competitor Clearstream group, we see the two as very close peers, given their hegemony as the leading international CSDs and broadly comparable financial strength. Euroclear operates in a dynamic regulatory and competitive environment. We believe that it is protected to a large degree by its strong franchise, high barriers of entry, and we see no current initiatives that pose a conclusive threat to its leading position. However, to maintain this position Euroclear continues to innovate and adapt, for example in response to rising client demand for global collateral management services and, over the medium term, from the European Central Bank's planned Target2 Securities (T2S) initiative. While we see Euroclear as relatively well-positioned to deal with the prospective loss of some of its settlement revenues and the more competitive environment that T2S could well bring, we see currently it as an at-best neutral development for Euroclear. In our view, the EU CSD directive is unlikely to constitute a serious threat to Euroclear's current business model because we WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 22, 2014 2 1354795 | 301084691 Euroclear Bank S.A. expect that it will continue to allow a CSD to undertake both depositary/settlement activities and related banking activities. As a largely user-owned infrastructure provider, Euroclear is not a profit maximizer, but it does seek to generate a level of profitability that is satisfactory to its stakeholders. Euroclear's reported business metrics for 2013 showed growth in all areas, including a 5% year-on-year rise in client assets, a 6% rise in securities transaction settled, and a 12% rise in average daily collateral outstandings. Earnings followed the trends evident in the preceding year: that is, a slight rise in fee income, interest income continuing to be held back by super-low central bank interest rates, and solid cost management disciplines. Together, these combined to push reported operating profit to €353 million from €328 million the year before. We expect that Euroclear will see further traction in its major growth opportunities in the current and next financial years: notably from collateral management, expanding links into emerging markets, and growing funds-related activity. However, given our expectation of no strong and sustained rebound in market activity, a likely persistent very low interest rate environment, and now limited scope for further reductions in total operating expenses, we see only modest scope for profit growth in 2014 and 2015. But, equally we would expect any reduction in underlying profitability to be modest. The operational risk inherent in the settlement and custody business is high, but we consider it well-managed by Euroclear. Euroclear Bank settles transactions in commercial bank money and faces sizable inherent intraday liquidity risk. However, we consider this risk to be substantially mitigated, aided by the delivery-versus-payment approach to settlement and associated processes, the bank's sizable liquidity resources, and its solid and stable customer franchise. While the bank cannot entirely avoid taking unsecured exposure to counterparts, we consider credit risk incurred in related banking services to be low, due in large part to the short duration of credit facilities granted, their generally highly secured nature, and the group's conservative investment policy. The low risk profile of Euroclear Bank and the wider group contributes to both maintaining very strong regulatory capitalization. Euroclear reported a 48% Basel II Tier 1 ratio at end-2013 on a consolidated basis. While Euroclear maintained its dividend payout ratio at 40% in 2013 and undertook a share buyback in mid-year, there was no change in its capitalization from the year before. We consider that Standard & Poor's risk-adjusted capital (RAC) framework offers some insight into the capitalization of Euroclear, which is a regulated banking group. Based on this measure, we view the group's capitalization as a supportive factor, even at this high rating level. The RAC ratio at year-end 2013 was 17.3%, and we expect no significant change in future. The group's only structural debt arises from the hybrid instrument issued by a subsidiary of Euroclear Bank and guaranteed by it. There is now just €98 million nominal remaining after the bank completed a tender offer for €196 million nominal in 2012. The instrument is not Basel III-compliant and has a 2015 call date. Reflecting the vital role that it plays for the group, the material size of its capital base in a group context, and its continued strong contribution to group earnings, we consider Euroclear Bank to be "core" to Euroclear under our group ratings methodology. As a result, we equalize the ratings on Euroclear Bank with the "aa" group credit profile (GCP). Until February 2014, we were applying our November 2013 criteria on rating companies above the sovereign as WWW.STANDARDANDPOORS.COM/RATINGSDIRECT AUGUST 22, 2014 3 1354795 | 301084691 Euroclear Bank S.A. Belgium was lower rated than Euroclear Bank. Our analysis suggested that Euroclear's business and financial drivers were relatively uncorrelated with the fortunes of the Belgium government and the domestic economy, and that a sovereign default was a relatively remote possibility. Belgium is now rated AA/Stable/A-1+, in line with the bank, so this criteria is no longer of immediate relevance to our rating on Euroclear Bank. Outlook The stable outlook reflects our view that Euroclear's creditworthiness is likely to remain resilient. We expect that it will maintain its low risk profile, satisfactory underlying profitability, strong capitalization, and a leading position in settlement and associated post-trade activities, despite a highly competitive environment and structural changes in the European securities industry. We could lower the rating if Euroclear's business or financial profile was to deteriorate materially. This could result from a marked deterioration in the group's very strong market position or its profitability, an increase in its risk appetite, or from a material increase in financial leverage. While we consider this exceptionally unlikely, it could also result from a revision of Euroclear Bank's group status (from the current "core" status to Euroclear). We consider an upgrade unlikely at this time, given the already high rating and the potential challenges to the group's business model and competitive position arising from initiatives such as T2S. Nevertheless, we could raise the rating if we expected that the group was able to materially strengthen its already very strong business profile, for example because earnings were rising as a result of it materially deepening its franchise among an ever-widening
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