Abstract：Fitch Ratings has affirmed IG Group Holdings PLC's (IG Group) and IG Markets Limited's (IG Markets) Long-Term Issuer Default Ratings (IDR) at 'BBB-'. The Outlooks are Stable.
Fitch Ratings - London - 21 Sep 2021: Fitch Ratings has affirmed IG Group Holdings PLC's (IG Group) and IG Markets Limited's (IG Markets) Long-Term Issuer Default Ratings (IDR) at 'BBB-'. The Outlooks are Stable.
IG Markets' rating is equalised with that of IG Group, in line with the 'common ratings' approach of Fitch's Non-Bank Financial Institutions Rating Criteria. This is because IG Markets is very large relative to IG Group and highly integrated in management, capital management and systems, resulting in highly correlated credit profiles.
IG Group's and IG Markets' Long-Term IDRs reflect IG Group's good profitability, low leverage, robust capitalisation and well-established franchise, which offsets a narrow business scope as principally a provider of retail derivatives for non-institutional clients in the UK and select international markets. Fitch views risk controls as adequate for IG Group's activities, but risks associated with the group's concentrated business scope currently constrain the ratings at 'BBB-'.
IG Group is a leading provider of OTC leveraged trading products, mainly in the form of contracts for difference (CFDs), to retail clients. Its revenue is derived primarily from the UK, where it is listed. It also has a presence in Europe, North America, Africa, Asia-Pacific and the Middle East and operates through the IG, tastytrade, IG Prime, Spectrum, Nadex and DailyFX brands The strategic direction of IG Group is to diversify the current business scope and, if executed successfully, this would be positive for its credit profile.
IG Group substantially achieved its target of growing revenues from its 'significant opportunities' markets by GBP100 million one year ahead of schedule, which has led management to define a new set of medium-term strategic targets. These targets are a 5%-7% per annum growth of core market revenue (with financial year to May 2022 to be the base year) and a 25% - 30% per annum growth in revenue of high potential markets, which mainly consist of the exchange-traded derivatives businesses.
tastytrade, Inc. (tastytrade), a US-based brokerage group primarily servicing retail customers trading and investing in listed futures and options which IG Group acquired in 2021, is included in the high potential markets. If execution is successful, this would improve business-model diversification, with a significant increase in global revenues coming from the US market, in addition to the non-OTC business lines generating a significantly larger proportion of revenues. IG Group's addressable market would also increase, mainly via tastytrade's focus on the US listed options and futures market.
Fitch expects the regulatory backdrop for IG Group to stabilise in the medium term, as around 93% of its OTC leveraged revenue is derived from countries that have already imposed leverage restrictions, but the group's retail focus exposes it to heightened regulatory risk. Key jurisdictions have implemented a number of regulatory restrictions aimed at reducing the risk that retail clients can assume when trading OTC leveraged products. Notably, ESMA restrictions led to a significant decline in IG Group's revenue in FY19. Restrictions by Australian Securities and Investments Commission (ASIC) in FY21, which were expected, will have a more moderate impact on revenue. The principal source of this regulatory risk is concern about customer product suitability and is reflected in our ESG score of 4 for 'Exposure to Social Impacts'.
The retail-trading sector has shown strong growth over 2020 and so far in 2021, as a result of the high levels of market volatility arising from the coronavirus-pandemic disruptions, and IG Group on-boarded a record number of clients in FY21. Management believes that a significant proportion will be retained as active clients as attrition rates for these clients are following historical patterns. This could indicate a structural shift of retail-investment patterns post-pandemic.
In the traditional OTC business, IG Group acts as counterparty to client trades and nets off trades internally (“internalises”) before hedging externally. Net trading revenue is derived from client income (commissions, spread and funding costs) less the trading-book cost (IG Group's losses/gains on client trades net of their hedging losses/gains). The OTC business model relies on client income exceeding the trading-book cost and net trading revenue is therefore dependent on client-trading volumes generating sufficient client income and also minimising external hedging costs by increased internalisation. IG Group has a critical mass in most of its markets, which allows it to benefit from economies of scale and to reduce external hedging costs.
As part of the exchange-traded derivatives model, IG Group is not counterparty to client trades and revenue is generated mainly through royalty and platform fees. Fitch expects this business line to become a larger part of IG Group's business over the medium term.
Direct market risk is a feature of IG Group's business model as it offers an instant execution service for clients and thereby accepts residual market risk before hedging externally. We believe that this risk is adequately managed as IG Group has consistently generated a significant amount of net trading revenue and has maintained its client income-to-net trading revenue ratio at a fairly stable level. Profitability, as measured by EBITDA to revenue, is strong at 57% for FY21 (FY20: 52%).
Credit risk is mitigated by retail clients having negative-balance protection in some jurisdictions as well as by IG Group's collateral requirements and close-out monitoring process. Furthermore, financial institution counterparties are largely highly rated.
The current scope of IG Group's business model is a constraining factor, primarily due to the limited product range (OTC products generate over 90% of revenue) and size of addressable higher-value client base. Revenue also inherently depends on market trading conditions, which can affect earnings stability. Fitch views positively the progress made by management to deliver on the strategic objectives set out in 2019, notably, growing the core OTC-market business, increasing revenue from Japan and developing the exchange-traded derivatives business lines. Although the recent volatile market conditions played a large part in boosting revenue, IG Group had shown good momentum towards achieving these objectives prior to the pandemic.
Operational risk is material for IG Group and platform problems could have significant impact on its reputation and revenue. Fitch views operational-risk management as robust and, despite some incidents during FY20 and FY21, this is assessed in the context of extremely high levels of trading and account applications.
IG Group has modest leverage and sound capitalisation, which adds stability to its overall credit profile with gross debt to EBITDA of 0.2x at FYE21 (FYE20: 0.3x). The acquisition of tastytrade was largely funded by equity but IG Group increased debt in June 2021 via a new GBP150 million term loan. Pro- forma for the tastytrade acquisition gross debt to EBITDA increases to around 0.6x, which is still modest.
IG Group's total capital ratio has declined after the tastytrade acquisition created a significant amount of goodwill, but remains comfortably above the regulatory requirement of 19.9% and internal management buffers.
IG Group holds a significant amount of liquid assets of over GBP1 billion at FYE21. However, the majority is restricted, due to operational and regulatory reasons, and unrestricted liquidity amounted to around GBP600 million at FYE21. Broker margin requirements are the largest liquidity requirements for IG Group, in particular, the initial margin requirement, which can be volatile and varies depending on the level of internalisation, the product mix of hedging positions as well as hedging brokers' perceived credit risk of IG Group. Fitch views that while IG Group's liquidity risk can be material, it is managed adequately with stress-testing forming part of IG Group's liquidity planning. Additionally, IG Group has available committed revolving credit facilities of GBP125 million.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
The scope of IG Group's current business is a constraint on the rating. Increased diversification of products offered and the client base and clear franchise gains could lead to an upgrade, providing there is no material increase in its risk appetite or deterioration of financial metrics. In particular, a more meaningful franchise in products not directly correlated with IG Group's dominant CFD business line and further regional diversification with a decreased reliance on the UK market would be credit-positive.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A worsening regulatory environment for IG Group, which results in a material reduction in profitability, although not expected by Fitch, would be rating-negative, in particular if it affects its UK home market and/or multiple markets simultaneously. Indications that the tastytrade acquisition materially increases IG Group's exposure to regulatory or litigation risk would also be viewed negatively.
Franchise reduction and increasing concentration of the business lines and client base would be negative for IG Group's ratings, as would an increased risk appetite or evidence that the current risk controls prove insufficient to contain market, credit or liquidity risks. Inability to successfully integrate tastytrade in risk reporting and risk management would also weigh on the ratings.
A significant adverse reputational or operational event damaging IG Group's franchise or financial strength could also be rating-negative. Similarly, sustained and material deterioration of IG Group's financial metrics, which could arise as a result of client-income generation being lower than is needed to offset the corresponding trading P&L or from a significant increase in debt or initial margin requirements, would also put pressure on IG Group's ratings.
A material increase in double leverage, as calculated by Fitch, (in particular if sustainably in excess of 120%) might have a negative rating impact.
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579
The principal sources of information used in the analysis are described in the Applicable Criteria.
IG Group has an ESG Relevance Score of '4' for Exposure to Social Impacts reflecting regulatory risk regarding customer product suitability, in particular, ESMA's recent restrictions on products sold to retail clients and similar restrictions from ASIC. These have a negative impact on the credit profile, and are relevant to the rating[s] in conjunction with other factors.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.
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