The Impact of Complex Organizational Structures on Credit Ratings
GICP expert view / 9 July, 2024
The structural design of an organization influences its credit rating and overall creditworthiness. Financial institutions (FIs) may choose to adopt complex organizational structures and intragroup dynamics for a range of reasons such as tax efficiencies and cost optimization. However, whilst these strategies can yield financial benefits, they also introduce several risks and challenges that impact credit assessments.
Utilizing Brazil as a case study, in the report ‘What Investors Want to Know: Can Complex Organization Structures Have a Negative Effect on Ratings of Brazilian Financial Institutions?’, Fitch Ratings highlights some of the key organizational factors influencing an institution’s credit rating.
To read the full report, follow this link. Please note that a Fitch Ratings account may be necessary to access the report.
Organizational factors influencing credit ratings:
Tax optimization
- Where companies may build complex structures primarily for tax efficiency, these arrangements can constrain financial analysis due to their unconventional nature and potential opaqueness. The intricacy and ownership dynamics often hinder the clear assessment of risks.
- Tax-efficient structures may attract increased regulatory scrutiny, leading to potential disputes and penalties from tax authorities, which can negatively affect credit ratings.
Financial transparency
- The lack of transparency and limited visibility into operations and financial transactions raises concerns about their true nature and implications, making it difficult for credit rating agencies to accurately evaluate the organization's financial health.
- Fitch Ratings refrains from rating entities that exist solely for tax and accounting purposes without fundamental economic operations, underscoring the importance of transparent financial practices.
Regulatory environment
- A regulatory framework is positive in that it requires issuers to comply with a minimum set of requirements on leverage, credit risk provisioning and corporate governance.
- For fintechs and other entities operating outside regulatory frameworks, remaining unregulated is not viewed negatively in terms of credit. However, Fitch Ratings considers that regulation provides a level of oversight and standardization that enhances creditworthiness.
- Offshore vehicles and entities based in favorable tax jurisdictions reduce financial statement transparency, complicating the evaluation of credit profiles and associated risks.
Operational performance
- Some diversified conglomerates designate a single company within the group as the cost center, often resulting in weak financial performance for that entity. This can detract from the overall creditworthiness of the group.
- Practices such as asset sales and intragroup debts can serve as indirect methods of support to bolster revenues or reduce leverage. While these strategies can improve short-term financial metrics, they may obscure the true financial condition and sustainability of the organization.