Editor’s note: NeuGroup’s online communities provide members a forum to pose questions and give answers. Talking Shop shares valuable insights from these exchanges, anonymously. Send us your responses: [email protected].
Member Question: “I am exploring whether doing a ‘mini-credit assessment’ (similar to Moody’s model) is a meaningful exercise and a value-add change to our current policy, which is to treat all subsidiaries as created equal for the purposes of determining our credit rating for intercompany loan borrowing rates (i.e., a few notches below [the parent’s] credit rating).
- “I am interested in what other member companies are doing in this space to determine the interest rates for intercompany borrowings in the absence of an external credit rating.”
Peer answer: “Our credit spread is based on the ‘risk profile’ tier we assign an entity to. The tier is based on the nature of entity activity and the country they operate in. We use, for example, the [Allianz Trade] country risk rating to define country risk.
- “[Allianz Trade] risk rating methodology combines three variables:
- ‘The Macroeconomic Rating (ME), based on the analysis of the structure of the economy, budgetary and monetary policy, indebtedness, the external balance, the stability of the banking system and the capacity to respond effectively to (emerging) weaknesses.
- Structural Business Environment Rating (SBE) measures the perceptions of the regulatory and legal framework, control of corruption and relative ease of doing business.
- The Political Risk Rating (P), which is based on the analysis of mechanisms for transferring and concentration of power, the effectiveness of policy-making, the independence of institutions, social cohesion, and international relations.’
“The operational risk of the entity is generally contemplated in the country risk rating, using logic similar to Moody’s.
“Scale
- Revenue: Sales in lower risk markets are less sensitive to surprise changes in country regulation.
“Business Profile (Pharma)
- Product and Therapeutic Diversity: Lower risk markets tend to have better patient reimbursement and improved price predictability.
- Geographic Diversity: Lower risk markets tend to have broader market segmentation (e.g., private market vs. government reimbursement only), plus better market intelligence.
“Patents and Pipeline
- Patent Exposures: Lower risk markets tend to have better patent protection in place with better legal systems to ensure protection.
- Pipeline Quality.
NeuGroup Insights: Paul Dalle Molle, a NeuGroup senior executive advisor, added: “When I was a banker, we helped a few multinational companies answer this question. That effort was driven out of our credit ratings advisory team and focused on providing a framework for a company to systematically categorize all its global entities. The big initial question is how granular you want your analysis to be, and what you are trying to solve for.
- “One of the biggest motivations we found was the need for the CFO and treasurer to show business unit leaders that they had a systematic approach that was fair and that was part of an overall capital allocation policy. Accounting and tax also liked this approach because it helped insulate the company from future accusations of transfer pricing manipulation.
- “The companies that were most interested in this had already established the basic principle that their subsidiaries around the world did not have the same degree of risk and that therefore they needed some ways to differentiate them for internal cost-of-capital calculations and intracompany borrowing rates in order to achieve something approaching ‘arms-length’ pricing.
“Five vectors stood out:
- Country risk: For this, companies adopted risk categories from rating agencies or specialized risk consulting companies.
- Ownership: 100% vs. joint ventures.
- Type of funding: the debt/equity mix, taking into account how local laws treat parent loans (in some countries they are automatically considered as equity).
- Source of funding (internal or third-party): On the question of granularity, our clients got very granular whenever joint venture partners and/or third-party funding was involved, but otherwise kept the analysis relatively light and easy to manage.
- Type of affiliate company: e.g., manufacturing, distribution, R&D, intellectual property, sales, etc.”
