The European Stability Mechanism and European Financial Stability Facility received Aa1 ratings with stable outlook from Moody’s, while the UK's creditworthiness was under pressure. Pexels

The European Stability Mechanism and European Financial Stability Facility received Aa1 ratings with stable outlook from Moody’s, while the UK's creditworthiness was under pressure. Pexels

According to a report published by the credit ratings agency this week, the ESM’s credit strengths include the political and financial support of its shareholders, substantial paid-in capital and a strong mechanism in place to call additional capital.

The agency adds that its key strengths are “its very strong capital position and low leverage”, its very high capital adequacy and very high liquidity.

“The ESM's rating is more closely correlated with that of its largest shareholders than is the case for most other multilateral institutions, given that their economic and financial links are strong,” Moody’s said, adding that a ratings upgrade would most likely require rating upgrades of its large shareholders.

“Conversely, a deterioration in the creditworthiness of significant member states could cause downward pressure on the ESM's rating. Indications of waning political support would also be negative, although Moody's considers this scenario to be unlikely.”

Similarly, a second report found the EFSF debt rating was closely linked to that of its guarantors. Moody’s vice president and report co-author Rita Babihuga-Nsanze said:

“The creditworthiness of the guarantors is high and all of EFSF's outstanding issuances are fully covered by guarantees of Aaa and Aa-rated guarantors.”

Like the ESM, an upgrade of the EFSF's rating would could only happen if there were “rating upgrades of guarantors that represent a significant share of the guarantee pool while a deterioration in the creditworthiness of significant guarantors, particularly a multi-notch downgrade of France's rating as the lowest rated of the large guarantors, could exert downward pressure on the EFSF's ratings.”

UK creditworthiness under pressure

A separate Moody’s report highlighted that the UK’s creditworthiness was under pressure as a result of Brexit-related uncertainty, increasing political and fiscal risks. Moody’s issued an "Aa1 negative" annual credit analysis, saying that pressure came from Brexit-related uncertainty; prompting a rise in political and fiscal risks.

“The outlook could be returned to stable if a trade arrangement with the EU is reached that would limit the economic impact from exit,” the report suggested.

But it warned the UK sovereign rating could also be downgraded if negotiations with the EU suggest that the government might not be able to preserve core elements of the UK's current access to the EU single market.

“Continuously higher budget deficits than expected and further delays in reversing the rising public debt trend would also be negative for the rating. A more medium-term driver for a rating downgrade could emerge if the role of Sterling as a reserve currency were significantly diminished or lost,” the report said.