BlackRock and State Street adjust rules to maintain European sovereign debt positions, Eurozone's "golden position" in jeopardy.

Several top asset management companies globally are modifying their investment rules to avoid forced selling of French government bonds. According to sources, a fund with a size of 1 billion euros (approximately 1.2 billion dollars) managed by the BlackRock Group, as well as a product with a size of 2.89 billion euros managed by the BNY Mellon Group, have recently stopped using an index with strict AA credit rating standards as a performance benchmark. This allows them to maintain their positions in French government bonds even if France's credit rating is downgraded below that threshold. This proactive adjustment has already shown results. Last Friday, S&P Global Ratings suddenly downgraded France, causing the largest bond-issuing country in Europe to lose its average AA rating among the three major rating agencies. This will force other funds with strict investment standards to sell French government bonds. "Adjusting the related index is in response to the explicit demands of clients," a spokesperson for BlackRock Investment Management said. A spokesperson for BNY Mellon declined to comment. Moody's Ratings will conduct a new evaluation of France's credit rating this Friday. Currently, Moody's rates France at Aa3 (the lowest AA rating in its system) with a stable outlook. In September of this year, Fitch Ratings downgraded France's credit rating from AA- to A+. France is not the only issuer facing rating pressure, and most funds can still invest in its government bonds. However, France's outstanding bond size is close to 3 trillion euros, and if some funds are forced to sell due to regulatory restrictions, they will need to significantly adjust their asset allocation, while other funds may also be selling at the same time. This will not only incur high trading costs but also lead to portfolio concentration on a few issuers, potentially not benefiting clients. Lessons from Belgium BlackRock's ETF timely adjusted its rules to successfully avoid the impact of France's rating downgrade. The trigger for this action was in June when Belgium's rating was downgraded by Fitch to A+, forcing BlackRock to sell Belgian government bonds. The fund's previous performance benchmark (provided by S&P Global Index Services) clearly stated that if a bond is rated A+ or lower by any major rating agency, it "will be removed at the next index review." This standard is stricter than other index methods, which usually use average ratings from multiple agencies. Therefore, BlackRock had to reduce its holdings of long-term Belgian government bonds. The risk posed by France was greater: the country's government bonds accounted for close to one-third of the fund's portfolio. Within weeks of Belgian bonds being removed from the index, BlackRock found a solution. On July 18th, S&P Index Services proposed lowering the minimum credit rating requirement for the benchmark index to BBB, while also drawing up a list of eligible countries to ensure that the index composition remains consistent with the state before Belgian bonds were removed. The proposal was later approved and officially implemented at the end of September during the index review. Now, even if France's rating is further downgraded in the coming months, its bonds can still remain in the index, while Belgian bonds have also returned to the fund's holdings. In a letter to ETF investors, BlackRock stated that this rule adjustment will avoid "increased turnover of index constituents and decreased index diversification." Customized Solutions On the other hand, a fund under the BNY Mellon Group, the "Euro Core Treasury 10+ Year Bond Index Fund," previously tracked the ICE BofA 10+ Year AAA-AA Euro Government Index. However, the fund documents show that in June this year, the fund switched to a "custom index" compiled by the Intercontinental Exchange Inc. Custom indices have rules and standards specified by clients, different from the universal public benchmark indices. As of the end of September, French government bonds accounted for 39% of the holdings in this BNY Mellon fund. Other institutions in the market took action even earlier, excluding France from rating requirements. Shift in Market Sentiment Indeed, despite the recent rating downgrade, French government bonds are still firmly in the investment-grade category, which is a crucial threshold in bond fund investment standards. Mara Dobrescu, Senior Director of Morningstar's Fixed Income Strategy Ratings, pointed out that for a few investors with AA rating standards, forced selling may create opportunities for other funds to absorb French government bonds at a "discounted price." However, if France's rating is further downgraded, the greater impact may be seen in global investor sentiment. For years, foreign investors have favored French government bonds: they offer higher yields than German government bonds, better credit quality, and less volatility compared to Italian government bonds. Some analysts have suggested that "France may fall behind other eurozone issuers, losing its long-held 'golden position' among eurozone government bonds - it is this position that has long attracted global investors." "The cost will be a structurally higher government bond yield."