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French Pension Move Eases Burden, But Challenges Remain.

The French government's recent announcements on pension reform are a credit-positive step that will ease immediate pressure on the country's pensions system, though they do not fully address the underlying fiscal burden of an ageing population, Fitch Ratings says.

The measures are planned to help finance the funding gap of the private pension system, which is expected to reach EUR7.6bn by 2020.

Among key measures announced last week is a rise in employee and employer pension contributions by a total of 0.6 percentage points over the next four years - although the government's pledge that total social contributions will not increase suggests cuts will have to be made elsewhere.

Other measures include postponing the inflation-indexation of the basic pensions from 1 April to 1 October each year and increasing the contribution period required to earn a full pension by 18 months, to 43 years, between 2020 and 2035.

The proposals are expected to yield EUR7.3bn by 2020. Additional savings after 2020 will yield EUR2.7bn by 2030 and EUR 5.4bn by 2040, when the private pension system is expected by the government to be in balance.

The estimates are sensitive to unemployment and growth assumptions. In light of this, a steering committee will be created to make recommendations if there are significant discrepancies between observations and the baseline scenario, based on a yearly assessment of indicators provided by the Pensions Orientations Council.

The measures will be put through parliament in late September/early October. Fitch does not expect any major changes to the draft proposals.

There are no major moves to bring public sector pensions, which are expected to be in deficit by EUR8.7bn in 2020, in line with the private sector.

Including this, along with the general pension scheme and the supplementary regimes, the total pension system funding gap - barring any further reforms - is set to rise to an estimated EUR20.7bn by 2020 and then stabilize at around EUR27bn by 2040, from around EUR14bn in 2011.

However, the public sector pension scheme will be affected by the announced rise in the social contribution rates, the increase in the contribution period length, and the postponement of the inflation- indexation of pensions. However, no official numbers are available yet on the impact of the reforms on the total pension system deficit.

Furthermore, the proposals do not encompass additional reforms, such as those proposed by the European Commission in May. These included increasing minimum and full-pension retirement ages, adapting indexation, and reviewing the numerous exemptions to the general pension scheme.

Therefore, the latest announcements, on their own, do not appear to be sufficient to remove persistent deficits and make the French pension system sustainable in the long-run.

In common with most advanced economies, the rising proportion of elderly people in the French population will put pressure on public spending in the future, although the projected increase in the fiscal cost of an ageing population is lower in France than in many European and OECD peers.

This reflects more favorable demographics and pension reforms over the last decade. Public pension expenditure as a share of GDP will increase by 0.5pp for France from 2010 to 2060, according to a European Commission report last year. This compares with the 2.0pp average for the Eurozone and 2.6pp for Germany.

When we reviewed France's rating in July, we did so in light of the government's fiscal consolidation plans, which took into account the impact of the then-unspecified pension system reforms on the social security balance.

Our review assumed that the French government would stick closely to its plans. The pension reform announcement therefore does not materially change any of our fiscal assumptions. We expect France's headline deficit to fall to around 1% of GDP by 2017, from 4.8% in 2012.

The pension reforms are consistent with the gradualist approach the government has taken in other areas since it took office, such as competitiveness and labor market reform. The impact of these reforms on the economy and public finances is uncertain.

We rate France 'AA+' with a Stable Outlook.

Cal Transit Union Exemption Will Save Billions in Grants

California will soon pass legislation proposed by Governor Brown to exempt unionized transit workers in the state from pension reforms, Fitch Ratings believes. The state's transit agencies would lose billions of dollars in federal grants if this legislation is not adopted quickly.

Earlier this year, the U.S. Department of Labor put a hold on transit grants to the state as conflicts arose between the California Public Employee Pension Reform Act of 2013 (PEPRA) and federal laws that protect transit workers' collective bargaining rights. Governor Brown's administration argued against the Department of Labor's position for months, but relented subsequently.

Fitch believes the risk of losing these federal grants is highly remote, as we noted in our recent affirmation of the rating on Santa Clara Valley Transportation Authority, CA's sales tax revenue bonds. The legislation is likely to pass as Democratic majorities rule both state houses and the political risk in voting against it is significant.

Fitch rates the following nine local transit agencies, as well as the state of California. Federal grants support transit operating budgets in many jurisdictions and typically provide a large share of capital funding. Up to 20% of the operational budgets of the authorities we rate are derived from federal grants. Adoption of the legislation in California would end the current freeze on federal transit grants and prevent potentially disruptive additional cuts.

Contra Costa Transit Authority

Los Angeles Metropolitan

Transportation Authority

Orange County Local Transportation


Riverside County Transportation


San Bernardino County

Transportation Authority

San Francisco Bay Area Rapid

Transit District

San Francisco County Transportation


Santa Clara Valley Transportation


Sonoma-Marina Area Rail Transit


In our view, most transit authorities outside of California do not face similar risks as most other states have already exempted their transit workers from similar pension reforms.

Level and Mix of G-SIFI Debt Buffer Key

Rating Variables

The level and mix of gone-concern loss-absorbing capacity (GLAC) to be proposed by the Financial Stability Board for global systemically important financial institutions will be the key rating variables, Fitch Ratings says.

If it is sufficiently large and met with junior debt, it could prove positive for senior debt default risk because it would increase the possibility of restoring a bank's viability without hitting senior debt.

This week the FSB said it would prepare proposals by end-2014 so that G-SIFIs in resolution would have adequate loss-absorbing resources to recapitalize at a level that promotes market confidence and meets regulatory capital requirements.

It is unclear whether only subordinated debt would count towards the GLAC or whether unsecured senior debt eligible for bail-in can be included, as is possible under the UK's primary loss-absorbing capital proposals, for example.

In the US, where the Fed and FDIC are developing rules on minimum holding company debt requirements, holding companies issue substantial amounts of group senior and subordinated debt, all of which may qualify as GLAC.

The clearest beneficiaries of holding company debt and GLAC rules among US G-SIFIs will be depositors in operating banking subsidiaries. Assuming GLAC has to be met with debt securities, the requirement will be positive for all G-SIFI depositors.

But it is unclear how the G-SIFI requirement might interplay for EU global systemically important banks (G-SIBs) with the minimum eligible liabilities and own funds requirement and write-down of capital instruments provisions in the EU's Bank Recovery and Resolution Directive proposals, for example, or with GLAC-like policies in jurisdictions such as the UK and Switzerland.

In countries where the bank resolution agenda is well entrenched, we believe bank capital management may increasingly focus on secondary capital buffers as well as primary common equity-based measures.

This is already the case in Switzerland, where the two large global banks have to build loss-absorbing junior debt and equity up to 19% of their risk- weighted assets (RWA) over the next five years.

G-SIBs may look to cover their GLAC requirement with junior debt to improve protection for senior unsecured creditors, but investor appetite for significantly higher levels of junior debt has yet to be tested and may prove insufficient.

The location for GLAC within group structures also has to be determined. The positioning of the buffer will vary depending on the preferred approach to resolution: a "single point of entry" through the parent or holding company will presumably require the GLAC to be at that level, making its mix neutral to creditors of subsidiaries; a "multiple point of entry" approach will logically require the GLAC to be issued by a group's material subsidiaries, making its mix more important for senior creditors. We expect some shifts in the location of junior debt when these details are clarified.

GLAC requirements could be tiered for the G-SIBs, like the five buckets for common equity capital buffers. GLAC principles could also be adopted more broadly by national supervisors for their domestic systemically important banks.

Levels of junior debt vary across the banking industry. For example, we estimate a sample of the largest European banking groups held junior debt securities on average equivalent to around 6% of RWA at end-2012. But the level of the potential secondary capital buffer varied from around 2% to as high as 11%.

Equity conversion of junior debt in mid-to-high single digit percentages of RWA would have been sufficient to restore viability to many high-profile banks in the most recent crisis.

For example, the RBS public sector bailout was 6%-8% of RWA, depending on treatment of its (unused) asset protection scheme; for Commerzbank 6%, KBC Bank 4%, Lloyds 4% and UBS 2%.

The cost of recapitalizing several European banks, notably in Spain and Ireland, has exceeded these levels, and expectations around viable core equity solvency levels for G-SIFIs are now higher than before.

But measures to reduce idiosyncratic and systemic bank risks - such as Basel III and, in the euro area, Banking Union - ought to reduce the likelihood of such spectacular bank failures in future.

China's Securitization Reforms Have a Long Way to Go

China's State Council announced several measures last week, which could signal an intensifying commitment to developing its securitization market, says Fitch Ratings. These include steps to boost market liquidity, broaden the investor base, and enhance regulatory and risk controls.

However, Fitch feels that rapid development will remain inhibited in the short term. This is for three crucial reasons.

First, the market remains structurally fragmented by the existence of two securitization frameworks in China - the Credit Asset Securitization (CAS) scheme and the Specific Asset Management Plan (SAMP) - which are governed by different regulatory authorities.

Furthermore, the authorities apply different guidelines on the two frameworks with respect to eligible originators, underlying assets, and the investor base.

Second, legal enforceability and bankruptcy-remoteness in SAMP transactions remain unclear. This stems from an absence of comprehensive rules on the transfer of asset title for various (underlying) asset types under the SAMP framework.

Third, the government remains cautious about the pace of development of the securitization market. This is because the authorities would like to see the market develop at a steady pace while still retaining control over the risks of securitization.

The recently announced measures are still significant. Notably, the proposal to allow securitized products to be traded on stock exchanges would boost liquidity. It would not only facilitate a real-time market- based pricing of these products, but also raise the number of investors and provide a wider selection of investment options.

Moreover, the proposal to limit stock exchange-traded securitization notes to "high quality" assets would facilitate a relatively stable portfolio performance.

Thereby, it would also potentially enhance funding options for participating banks (originators of the underlying assets), and provide at least an incremental benefit to balance-sheet flexibility.

Finally, the State Council's intention to strengthen control over the securitization market makes sense in that it would enhance oversight of related authorities, improve current laws and regulations, as well as standardize and tighten product guidelines. In turn, these should support investors' confidence in - and the overall liquidity of - the securitization market.

What these measures will not do is facilitate any meaningful risk transfer from the banking system. Unless quotas are lifted dramatically, the small size of China's securitization market (less than 0.1% of total assets) means any attempt at "cleaning up" the country's banks by a large-scale transfer of NPLs could be problematic - given problems with pricing such assets and the potential for overwhelming what is a fledgling market.

Fitch does not currently rate any securitized debt in China. The agency feels that the recent statements from the State Council, while lacking greater detail, are of considerable significance. However, this does not go far enough to radically alter the size or structure of the securitization market - nor does it carry any huge near-term implications for China's overall financial system.

Modest U.S. Wireless Consolidation Expected

The largest four wireless operators in the U.S., pro forma for pending acquisitions, now account for nearly 92% of total U.S. wireless subscribers, according to Fitch Ratings.

We expect only modest consolidation going forward as few material targets remain when operators and spectrum holdings are considered. Fitch believes it is virtually certain that the Federal Communications Commission (FCC) would materially restrict any consolidation among the top four U.S. wireless operators.

In the near term, it seems likely that DISH will make a wireless strategy move within the next few months. Many expect that DISH's move will be associated with T-Mobile. Activity around DISH could be the most significant near-term wireless industry consolidation event.

In the midterm, the 578 MHz-698

MHz TV spectrum auction could occur around 2015-2016. We base that expectation on the time lag of previous auctions coupled with delays associated with pending changes with the FCC commissioners.

This auction potentially represents the largest single acquisition event for the industry over the foreseeable future. It also seems likely that usage of some or all of the Light Squared L-band spectrum will be achieved within the next couple of years through either partnering or acquisition.

The long-term future for regional or small wireless operators is uncertain at best. Due to lack of scale, these operators will continue to face difficulty in remaining competitive with the large nationwide operators. Fitch believes that these operators will eventually be acquired by larger wireless operators.

Regardless of the time horizon considered, the consolidation of the wireless industry is nearing an end and future competitive positioning will rely on operating strategies rather than on mergers and acquisitions.

This should result in steadier financial trends, although changes in competitive position will take longer to achieve in this consolidated and maturing marketplace.

MMFs Expected to Embrace Fed Reverse

Repo Facility

A new reverse repurchase agreement (repo) facility under consideration by the U.S. Federal Reserve may prove attractive to money market funds (MMFs) and help offset the diminishing supply of eligible short- term securities, according to Fitch Ratings.

The repo facility, as proposed, would be an appropriate investment for rated MMFs and would be exempt from Fitch's normal counterparty limits.

While the Fed has expressed an interest in this facility, there has been no indication of when this tool would be implemented, if at all.

The U.S. Federal Reserve's minutes from its recent July 30-31 meeting discussed establishing a fixed-rate, overnight repo facility wherein market participants, including certain MMFs, would be eligible to lend cash to the U.S. Federal Reserve on an overnight basis, collateralized by securities held by the U.S. Federal Reserve.

The repo facility is an additional tool for the U.S. Federal Reserve to manage a reversal of its quantitative easing program and money market interest rates by lending securities for a set period of time in order to withdraw cash from the banking system.

This facility could provide much needed supply of short-term, liquid investments for money market funds, as traditional banking counterparties are reducing the amount of available short-term repo in response to regulatory pressures and structural changes in the repo markets.

Fitch's current MMF rating criteria caps repo exposures backed by government and agency securities at 25% for counterparties rated 'A' or better.

However, given the essentially risk- free nature of the U.S. Federal Reserve as counterparty and the preliminary terms of the structure, participation in this program would not be subject to this 25% limit.

The program would expand MMFs' investment opportunities in light of constrained asset supply and offer a high quality, liquid investment option.

Malaysia's Fiscal Policy Shift Faces a Tough Road Ahead

Malaysia's measures, announced yesterday, to lower fiscal subsidies and limit import-intensive investment are a strong statement of the government's intention to stem pressure on the sovereign credit profile from deteriorating public finances (as reflected in the Negative Outlook assigned to the 'A-' rating in July 2013).

The measures are consistent with Fitch Ratings' fiscal projections, and are credit-neutral over the near term. Further steps to improve fiscal sustainability and long-term macroeconomic stability could see the ratings revert to Stable Outlook.

The fuel subsidy reduction is a first, small, step ahead of possible additional measures to shore up public finances. Projected near-term fiscal savings from the 20 sen/liter hike in the price of subsidized fuel products are MYR1bn in 2013 (0.1% of GDP) and MYR3bn (0.3% of GDP) in 2014.

Fitch was already factoring in a net 1ppt of GDP reduction in government expenditure in its fiscal projections for the period to 2015, so these measures in themselves do not significantly alter the agency's analysis.

The timing of yesterday's announcement seems responsive to heightened global market volatility brought on by impending Fed tapering and greater investor scrutiny of vulnerabilities in emerging markets.

A more calibrated pace of public investment prioritizing non-import- intensive projects should limit the risk of near-term fiscal overruns as well as lower the likelihood of the current account slipping into a deficit. We estimate that Malaysia's current account surplus will fall - sharply - to 3% of GDP this year after averaging 11% over 2009-2012.

However, the fundamental driver of the narrowing current account surplus has been the widening public sector deficit, drawing attention to the health of medium-term public finances. Effective fiscal consolidation in the next 12 months will by no means be easy. This is for two reasons: First, the Malaysian economy is undergoing a terms-of-trade shock, with the prices of key commodity exports falling sharply. In this environment, expenditure restraint could raise downside risks to our GDP growth forecasts of around 5%, year- on-year, in 2013-2014.

If this were to materialize, slowing growth could also lower tax receipts, making it that much more difficult to achieve the medium-term government deficit target of 3% of GDP by 2015.

The second reason is that the political position of the ruling coalition has weakened following the May election. This means the government is likely to continue to encounter difficulties in implementing far-reaching, and much delayed, revenue-enhancing reforms such as the Goods and Services Tax (GST).

The upshot is that the corrective fiscal measures, announced yesterday, are too small to alter the Negative Outlook on Malaysia's 'A-' sovereign rating.

Sustained reform implementation, if accompanied by structural measures to broaden the revenue base, could make a difference to the sovereign's credit profile. But such an intensification of reforms that can also withstand potential growth headwinds is not on the cards at present.
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Publication:Cambodian Business Review
Geographic Code:1U9CA
Date:Oct 31, 2013
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