Rating agencies risk exposing investors to “yet another unsound investment product” by lax standards in their definitions of bonds, according to investment boutique Kames Capital.
The warning comes after a new security was issued by HSBC and rated as an investment grade bond by both Moody’s and Fitch. It is described by Moody’s as a “high-trigger additional Tier 1” security.
Gregory Turnbull-Schwartz, a fixed income manager at Kames, questioned the classification, claiming it was closer to an equity than a bond. He cited documentation for the security that said interest payments were “discretionary” and “the issuer may cancel interest payments in whole or in part, at any time”.
Turnbull-Schwartz said: “In terms of repayment, it says ‘the securities have no scheduled maturity’. In our view, a piece of paper that says that you have no right to receive interest payments and no right to receive your money back is not a bond. It is more akin to a receipt from a charity describing your donation.”
He said HSBC was “good credit risk” but described the documentation issued with the new security as “troubling”.
Both Moody’s and Fitch have rated the security as an investment grade bond, which Turnbull-Schwartz claimed was “a far stretch”, and accused the agencies of having “rolled over on their backs like the love-struck puppies they were prior to the financial crisis”.
The classification of the security as a highly-rated bond could also result in it being added to bond indices, making it harder for fixed income managers to avoid investing in it, Turnbull-Schwartz added.
“If that were to happen, the rating agencies would have effectively colluded in getting yet another unsound investment product stuck into people’s retirement funds,” Turnbull-Schwartz said. “Let’s hope the regulators are doing their job behind the scenes and that these do not end up in indices despite the rating agencies’ current lax approach to the matter.”
When contacted by CIO, both Moody’s and Fitch defended their stance and insisted their processes took the security’s characteristics into account.
Rebecca O’Neill, head of communications at Fitch, said the security had been rated five “notches” below HSBC’s standard credit rating of AA- “in line with our rigorous published criteria, which has been consistent over the last several years”. She said the rating took into account the potential for the security to convert into an equity, as well as “non-performance risk”.
O’Neill admitted the securities attracted “divergent opinion” but said they were “of great interest to market participants”.
“Fitch’s criteria, ratings, and research reflect the fundamentals of the banks that issue the securities, the varied features and risks of the securities, and the clearer regulatory focus on ensuring subordinated debt and hybrids are loss-absorbing,” she said.
In a statement, Moody’s said it had rated the security as Baa3, “our lowest investment grade rating, recognizing the unique nature and features of these securities when compared to traditional bonds”.
It added: “The Baa3 rating reflects HSBC’s creditworthiness, the bank’s most recent capital equity tier (CET) 1 level, as well as our views on how the firm may manage this CET level in the future. Investors in these securities—which are not uncommon—are always made aware of their undated nature and the contingent capital terms of the instrument.”
HSBC was approached for comment but had not responded at the time of publication.