Is it time for credit ratings on Malta’s corporate bonds?

The Maltese bond market has never seen a default but nobody really knows how risky some of its bonds are.

Central bank governor Alexander Demarco was asked about local capital markets at a conference launching the bank’s annual report.

He floated the idea of risk ratings for companies on the bond market, saying there needs to be more awareness of the risks involved in investing in capital markets, especially in private corporate bonds.

When a person buys a corporate bond, they are lending money to a company and trusting that it will pay them back, with interest, years down the line. However, without a credit rating, there is no independent, standardised way of knowing how likely that company is to keep its promise.

Demarco later explained to Times of Malta that a standardised credit scoring system would confront three structural issues in the market: the absence of external credit ratings, limited market liquidity and inconsistent interpretation of credit quality.

“This initiative would enhance transparency in risk classification, improve price discovery, broaden access for institutional investors and strengthen confidence in domestic bond issuances,” he said.

In practice, that would mean clearer risk labelling for investors, more accurate pricing and a market that is more attractive to larger professional investors, not just members of the public.

Discipline

Demarco added that the system would also reinforce market discipline by providing companies with clearer visibility on how their financial health affects their ability to repay investors, which would then encourage more efficient capital structures and higher quality disclosure ahead of a bond issue.

The central bank governor has plenty of ideas on how this could take form. Ratings could come from a fully independent private rating style agency or they could be part of a framework embedded within the listing and approval process of the Malta Financial Services Authority (MFSA).

However, he acknowledged that directly assigning scores by the regulator itself may raise concerns on the institutional independence and the perception of implicit regulatory endorsement.

Demarco also suggested a more balanced approach, whereby the MFSA defines and publishes a standardised credit risk classification while the actual assignment of scores would be carried out by accredited, independent third-party providers, either local or foreign.

He said the methodology should combine quantitative and qualitative factors, as well as structural credit enhancements and forward-looking risk factors.

The methodology could also be publicly disclosed, except for detailed weightings, internal thresholds and calibration mechanics, to preserve integrity and reduce the risk of score optimisation.

Status quo

Financial commentator Paul Bonello agrees with the idea of credit ratings in the local bond market. He said the investing public tends to be shallow in its analysis of the bond market, focusing more on coupon rates rather than underlying risk. Meanwhile, brokers tend to concentrate on their commission.

Financial literacy overall tends to be weak in Malta, he noted. The investing public tends to be older in age and hoping to make some low-risk gains.

“In reality, some bonds are riskier than shares,” he said.

Few companies on the Maltese bond market have a credit rating from an international agency. One of those companies is Bank of Valletta. Its chairman, Gordon Cordina, agrees with the governor’s credit-rating suggestion but with some caveats.

“I’m in agreement if this can be done at a reasonable cost and with full assurance of independence of rating companies from companies that are rated and their competitors. These may be especially difficult challenges given the relatively small sizes of markets and businesses in Malta but the ideas are very much worth exploring.”

Others are more sceptical. An industry insider said that requiring companies to obtain credit ratings would help investors to make more informed decisions but he sees significant pushback from companies being forced to pay up to €100,000 a year to maintain a credit rating. He does not believe it is realistic to require a micro company looking to raise as little as €20 million to spend hundreds of thousands over the life of the bond, especially when so many bonds are oversubscribed.

The bond market came under scrutiny last year after it appeared that several companies were facing financial pressure. Times of Malta had reported that companies, ranging from real estate firms MIDI and Central Business Centres to retailers Dizz Group and maritime sector operators Mediterranean Maritime Hub and Yacht Lift Malta, faced financial pressures ahead of scheduled bond repayments.

At the time, Labour backbencher Edward Zammit Lewis asked the finance minister whether measures are in place to mitigate the impact of a bond default on markets and investors.

Finance Minister Clyde Caruana responded that defaults are an inherent part of investing in capital markets and form part of the general risk that investors accept when investing in bonds.

At this stage, credit ratings for local issuers might be more of a pipe dream than a policy in the making. However, financial stakeholders are increasingly eager to discuss ways to make the bond market more appealing and safer for ordinary investors.