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Metal Bashing: European Steel Is Going Through The Mill (Again)

Metal Bashing: European Steel Is Going Through The Mill (Again)

The business cycle has soured for European steel producers after nearly three years of decent to strong performances. Prices for basic products such as flat and hot rolled coil (HRC) as well as margins and EBITDA are back at the weak levels of first-quarter 2016 (see chart 1). Worse, a rapid rebound looks unlikely given the outlook for broadly softening demand. As EBITDA halved, S&P Global Ratings downgraded smaller, lower-rated and European-focused companies such as Schmolz + Bickenbach AG and Ferroglobe and revised the outlook on the rating to negative on global player ArcelorMittal.

We see difficult current market dynamics and longer-term structural challenges for the European steel industry. Even if the prevailing clouds disperse, the path to actual and metaphorical blue skies for European steel is strewn with not just environmental hurdles, but cost disadvantages, limited industry consolidation, and the mixed and impermanent benefits of EU tariffs to limit cheap imports.

Here, S&P Global Ratings outlines its base case outlook and assumptions for Europe's steel industry, excluding Russian producers whose credit fundamentals and performance are distinct, in the context of global and regional trends. Russian producers typically have stronger margins and are less exposed to European dynamics. We consider how an alternative downside scenario for the European industry could evolve. Noting recent transactions and the implications of curtailed consolidation and, beyond the next 18 months, we emphasize the environmental challenges the industry faces, then summarize rating flexibility for European steel makers.

Chart 1


EU steel companies: our base case

We see 2019 as a trough year for the European steel industry, with demand expected to contract by up to 2%. During the year, S&P Global Ratings revised downward its estimation for GDP and demand, mirroring the concerns about a trade war: Our projection is now 1.2%. According to our economists, growth in Europe will remain weak in 2020 with our current forecast at 1.1%, leading to a muted recovery with demand for steel increasing by up to 0.5% (chart 2).

Globally, and particularly in China, the picture isn't always as weak as in Europe. Chinese demand and balances are holding up for now, even if growth is slowing. But U.S. pricing and margins have softened after a tariff-related boost at the start of 2019.

Chart 2


Turning to end-user industries, we see a mixed picture. Construction remains broadly supportive. However, manufacturing industries are experiencing softness and the auto industry is weak. The European market continues to be the soft point, and in the first six months of 2019 sales of new vehicles fell by 7.9%, according to the European Automobile Manufacturers Association.

Chart 3


Globally, after reaching record high spreads in 2018, we now see lower margins in most regions. Margins in Europe saw deeper drop, propelled by the soft demand from automakers as well as high input prices for iron ore and coal. The current spreads (HRC minus BOF cash cost) are similar to levels last seen in the downturn in late 2015. Margins have also contracted due to changes in the flow of steel products globally following the implementation of Section 232 in the U.S. More recently, given the general negative business sentiment in the continent, customers started putting short-term orders and consuming their inventory. This limits demand visibility.

Credit metrics this year for European players will likely be influenced more by lower earnings and cash flow than debt movements (in many cases, working capital inflows covered for the weaker cash flows from operations and even more). In 2020, improved profitability, self-help measures such as disposals, and further working capital release should result in a decrease in leverage compared with this year.

The weak demand and the different trade barriers in place, we have an unusual situation where prices for European steel products are below those for Chinese export products and U.S. products. While we witnessed some mismatch between Europe and the U.S. in the past, the current mismatch between Europe and China is a new phenomenon.

At this stage, we haven't see material capacity curtailments in Europe, but those will need to come earlier than later. In June 2019, ArcelorMittal announced an annual capacity curtailment of 4.2 million metric tons (Mt) in second-half 2019, compared with its original plan. At the moment, some of the steel plants that are subject to the curtailment are still in operation.

However, we are slightly optimistic about the margins in 2020, some capacity reduction, trade barriers, and generally below-average inventories (see the World Steel Association forecast in chart 2) may provide a floor to steel margins. On the other hand, high input prices (for iron ore, coking coal, and electricity) are not easy to pass onto customers, especially if apparent steel demand (production plus imports minus exports) is less robust.

Chart 4


The automotive industry will remain a key driver for any recovery

Globally, the high-growth years of the auto industy are behind us. In 2018, the global auto industry grew by 2.2% in 2018 (compared with 4.9% in 2017), and in 2019 may shrink by 2%-3%, without an obvious recovery in 2020 (see "Global Auto Sales Will Stay In The Slow Lane For At Least The Next Two Years," published on Sept. 17, 2019).

Because steel demand from the automotive industry in Europe is about 21% of demand for steel in Europe (construction is about 35%, mechanical engineering 15%, and energy 11%), the region's currently weak sales of new light vehicles will continue to hurt European steel producers. In the first half of 2019, sales of new vehicles fell by close to 3%, and we expect them to be flat year on year this year and next. For light vehicle assembly we see a much gloomier picture in Europe, with a contraction of about 1% in 2019 and little recovery in 2020.

In our view, the European industry faces many risks, including the European economic slowdown and customers who are delaying the purchase of new cars, a potential shift of production in case of Brexit, trade negotiations between the EU and the U.S., and weakening demand for luxury cars in China (see "Is the auto industry driving EU steel sheet demand towards a cliff?" CRU, March 26, 2019). Each factor is dampening demand for steel, but together they represent a key threat for steel producers with exposure to the automotive industry and a secondary threat for other steel producers.

In the scenario of no new trade agreement between the U.S. and Europe, resulting in the U.S. applying 25% tariffs on European car imports to the country, we project EBITDA could drop 15% overall for the six major European carmakers (see "Trump's Tariffs Could Hurt EU Carmakers--Not The Economy," published on March 26, 2019, on RatingsDirect.) In 2018, the EU exported 1.2 million passenger cars to the U.S. (about 8% of the EU's total production).

Of all of the factors we mentioned above, moving production out of Europe and back to Japan by Nissan, Honda, and Toyota would most likely to have the biggest impact on the steel industry in Europe. Japanese carmakers produced about 1.4 million cars in Europe last year, which is equivalent to about 0.6 Mt of steel production or slightly less than 1% of all European steel production. Honda has already decided to close its U.K. facility by 2022 and move the production back to Japan (representing about 90 kilotons (kt) of steel). Japanese carmakers currently have three plants in the U.K.

EU steel companies: our downside scenario

Lower economic growth in Europe, and potential recessions in other parts of the world, will increase the chances of a downside scenario materializing. We estimate a 0.5% drop in the EU's GDP could lower demand for steel by 2.0%-2.5%. For example, if GDP in 2020 were to decline by close to 0.5%, compared with our current base case of 1.2%, this would lead to a contraction by another 2% in the demand for steel products in Europe. Under our downside scenario, negative global trends may play a greater role.

Such downside could be triggered or sustained by one or a combination of the following:

  • A slowdown in European construction. So far it has remained strong, but construction sentiment is past its peak, according to our economists (see "Europe's Housing Markets Lose Speed As The Economy Weakens," published on Sept. 24, 2019).
  • A recession in the U.S., the probability of which has increased to 30%-35% recently.
  • A hard Brexit.

Under our downside scenario, we don't expect profitability in 2020 will fall below the the trough level seen in 2019--which stemmed from a "perfect storm" of negative variables that are unlikely to repeat--but it would remain at the current level or a notch above.

Credit metrics play an important role under this scenario, but are not the only driver for the ratings (see Table 2). We expect the current low rated companies to report weak credit metrics this year, and their challenge in a "no improvement" scenario would be managing future debt maturities and ability to access the capital market. This could lead to distressed exchange offers and, ultimately, defaults. That said, more solid companies may further use their financial levers to steer away from negative rating actions.

Global trade wars and protectionism

In our view, the escalation in the trade wars between the U.S. and rest of the world continues to cast a long shadow over the global economy and is modifying the existing flow of products among countries.

The EU imported 29 Mt of finished steel in 2018, of which 15 Mt came from the Commonwealth of Independent States (CIS) and Turkey, 12 Mt from Asia, 0.2 Mt from North America, and 0.8 Mt from South America. Most were flat steel (75%). On the other hand, the EU exported 20.6 Mt of finished steel, of which 7.6 Mt went to the CIS and Turkey, 3.6 Mt to Asia, 2.8 Mt to Africa, and 5.4Mt to North America. Trade flows show that the U.S. is a main market for steel production (net exports of 4.6 Mt), while the CIS, Turkey, and Asia are the biggest importers. In this respect, any barriers between Europe and the U.S. will hurt European demand for steel.

Different regions' attempts to protect domestic steel production have already changed the global flow of materials, making it more difficult to predict the winners and the losers. For example, the introduction of Section 232 in the U.S. in 2018 resulted in a 12% increase in finished steel coming to Europe, according to industry body Eurofer. On the other hand, exports of steel to the U.S. from Germany declined by 6% in 2018.

In reaction to the Section 232 announcement in the U.S. and the EU's view that the redirection of metals into the Continent is "seriously threatening EU steelmakers," the EU in January 2019 approved safeguard measures for steel effective Feb. 4, 2019, for a period of three years. The measures allocate a specific quota to each country to export steel to Europe. Imports above the quota are subject to 25% tariffs. The new measures should provide the steel industry the necessary protection against anti-dumping. However, European steelmakers argue that the regulator was too slow to react to the changing landscape and that the measures are insufficient to relieve mounting pressure on the industry.

Almost eight months after implementation of the safeguard measures, we do not see the benefits. In fact, the European steel industry looks, at best, as vulnerable and weak as it was in the last downturn in 2015. According to preliminary EU figures for the first half of the year, the quotas for plates, rebar, and rod were filled quickly, with China and South Korea already reaching 100%, and when aggregating all export countries, 74% of the quota was already met by the end of June.

This said, we don't see Section 232 as the root cause of the current situation in Europe. Since 2000, the European steel industry has become less competitive, resulting in a downward trend of shrinking capacity, and more recently moving from the status of being a net exporter to being a net importer. From 2009 to 2012, the EU exported about 750-1,000 Kt of steel, whereas today it has to deal with excess imports of about 500 Kt a year.

The EU competition authorities have said no to industry consolidation

In 2018, the steel industry announced a series of mergers and acquisitions, and for a while it seemed that the landscape for the European steel industry was going to change, becoming more concentrated and potentially less volatile. In practice, the EU did not approve many of the transactions, or they included some significant offsetting actions, such as disposals.

We understand the European regulator is less focused on the creation of regional champions, which would be able compete better globally, and more on ensuring a competitive environment in Europe. This is in contrast to policy in China, for example, regarding China Baowu Steel Group, and also some recent moves in the U.S. (see "U.S. Steel Corp. Outlook Revised To Negative On Debt-Financed Big River Acquisition; Ratings Affirmed," published on Oct. 1, 2019). However, we note that because roughly half of global steel is made in China, with the EU-28 and the U.S. each producing less than 10%, a consolidated player outside of China could have regional clout, though limited global pricing power. The largest producer, ArcelorMittal, contributes about 5% to global production.

Table 1

Partial Consolidation: Mergers And Acquisitions Involving European Steelmakers 2018-2019
Details Execution?
ArcelorMittal – Ilva In June 2017, ArcelorMittal offered to acquire Italy’s biggest steel company for total proceeds of $1.8 billion. In the past few years, Ilva suffered from financial and environmental issues that resulted in reduced steel production (about 6Mt compared to a nameplate of about 10Mt). As part of the transaction, ArcelorMittal is planning to make material investments, aiming to increase the production level, comply with the environmental requirements, and unlock synergies with its other European assets. Yes. The transaction was completed in November 2018. Due to competition concerns in certain key markets, and the potential power concentration, the EU conditioned the acquisition by divestment of equivalent steel capacity in Europe. To address European Commission's concerns, ArcelorMittal sold assets with equivalent capacity to Liberty Steel.
ThyssenKrupp-Tata Steel merger In June 2018, ThyssenKrupp proposed a joint venture with Tata Steel Europe, creating the second largest player in Europe with crude steel capacity of more than 20Mt. Some of the benefits of the proposed merger were: consolidating the fragmented steel industry in Europe; optimizing production; and unlocking synergies of about €400 million-€500 million a year and more. The merger would also fit into the general financial policies of the parents, streamlining the corporate structure and reducing leverage. No. In June 2019, the European Commission rejected the merger request. The main argument was the possible diminishing of competition in certain key markets. We think that the merger is unlikely to take place in the short term. As of today, we think companies are unlikely to submit another application for a merger, and each of the companies will look into the implementation of other cost-cutting initiatives.
Schmolz and Bickenbach acquiring Ascometal In January 2018, Schmolz and Bickenbach offered to acquire assets from Asco Industries for €195 million. The transaction represents a sales volume of more than 450kt per year and is complementary to the vertically integrated value chain of S+B. It also creates a new European leader for quality and engineering long steel products, with some gains from high utilization rates. Yes. The transaction was completed in February 2018. We understand that the merger between the two companies is ongoing. However, the benefits will come much later than previously assumed.
Nippon acquiring Ovako In March 2018, Nippon Steel & Sumitromo Metal Corporation (NSSMC), offered to acquire Ovako Group AB for €770 million. The acquisition adds 788kt of production capacity with revenue of about €743 million to NSSMC. Ovako will sharpen NSSMC's standing in sales and production of special steel in Europe. Yes. The transaction was completed in June 2018.
Aperam acquiring VDM Metals In April 2018, Aperam offered to acquire VDM Metals for €440 million. The transaction would have merged the two leading nickel alloy producers in Europe. No. The companies terminated the transaction in December 2018 after the EU raised some concerns regarding the lack of competition in specific segments. Going forward, Aperam is likely to put more focus on organic growth.
Liberty Steel acquiring certain assets from AM In October 2018, Liberty House offered to acquire ArcelorMittal Dudelang S.A. and certain other finishing lines in Belgium for €740 million. We understand that the final structure was quite different from the original transaction, taking into account the regulator’s objective to have a long-lasting player, without a too aggressive capital structure. This transaction is part of the conditions set by the European Commission for the approval of the acquisition of Ilva through ArcelorMittal. Yes. The transaction was completed in June 2019.

In our view, execution of the merger between Tata Steel and Thyssenkrupp and the acquisition of Ilva by ArcelorMittal could have been a game changer for the industry, especially in the production of flat products, since it would have allowed companies to better contend with the competitive imports (see charts 5 and 6 to see how the industry make-up could have changed).Over the past decade, imports to the continent increased to 20% in 2018 from 12%-15%.

Potential consolidation between Thyssenkrupp and Tata Steel, including what they estimated as annual cost savings of between €400 million-€500 million, would allow a combined company to better compete with imports, as well as improve its export capabilities. We understand that the companies aren't likely to approach the regulator again, after failing to receive a greenlight in the past.

Moreover, the downturn put ArcelorMittal in a less favorable position, with recently acquired Italian assets (Ilva) underperforming and dragging on the results of its European division. As a result, the potential synergies coming from the transaction will be further delayed.

Chart 5


Chart 6


How much flexibility do companies have to cope with a potential downturn?

Table 2

Do European Steelmakers Have Sufficient Headroom To Cope With The Current Downturn?
Rating Threshold for a downgrade 2019 base case 2020 base case Comments


BBB-/Negative FFO to debt <25% in 2020 <20% About 25% A negative rating action is likely if the very harsh steel market conditions persist in Europe and also in the US, and the company is unable to deleverage. Under our base case we assume: --EBITDA below $6 billion in 2019 with a recovery to about $7.0 billion-$7.5 billion in 2020. --Despite weak profitability, the company can generate positive free cash flow, allowing reduction of absolute debt, and over time to build some headroom for the rating. --Deleveraging is further supported by the company’s latest $2 billion divestment program.

Schmolz + Bickenbach AG

B-/Watch Neg No signs of support from its shareholders or core banks >10x >8x Under our current base case, the company's capital structure is becoming unsustainable and the company faces a likely covenant breach in the second half of the year. According to our calculations, S+B will need to reduce its debt by a few hundred million euros to adjust its capital structure to the currently weak environment in Europe, which it cannot achieve without the support of its shareholders and core banks.

Constellium N.V.

B/Stable Debt to EBITDA >6.0x together with negative FOCF <6.0x 5.0x Compared to other metal producers, healthy demand for Constellium's products across its different divisions is supporting the improvement of the company's results. We expect it to deleverage in 2019 and 2020, building some headroom for the existing rating.


BB+/Stable FFO to debt <45% >60% >60% In the last few years, the company set an objective to deleverage its balance sheet. This resulted in a several positive rating actions. As of today, the company has material headroom under the rating, which could further increase as its deleveraging plans continues and as it continues working on improving its product offer and cost structure.

Groupe Ecore Holding

B/Stable Adjusted debt to EBITDA >6.5x or DCF turning negative 5x-6x 5x-6x Low industrial activity in France since the beginning of the year resulted in lower availability of scrap, translating into lower EBITDA. That said, the company’s relatively low cost structure and limited capex needs should ensure positive FOCF, supporting a modest decrease in its debt position.

Ferroglobe PLC

CCC+/Negative Initiating a distressed exchange offer >10x >6.5x Under our base case we expect a recovery in Ferroglobe’s markets that will support a neutral free cash flow in 2020. However, if the currently weak market conditions in Europe persist and the company doesn't show some offsetting factors such as working capital inflows or other divestments, we could envisage a scenario that includes a distressed exchange offer. We could also consider a default on the current revolving credit facilities as the company is likely to breach the financial covenants. That said, we see this scenario as less likely.

Environmental steel

China has its "Blue Skies" policy, but environmental legislation and the regulation of greenhouse gases and other pollutants also has a strong focus in Europe. European steel producers are disadvantaged compared with global peers because of stricter regulatory EU and country frameworks that raise costs and penalize certain assets. EU foundries are often older on average and have a high share of blast furnaces (BOF; 58.5%) compared with electric arc furnaces (EAF; 41.5%) in 2018. This compares with a 67% production share of EAFs in both Turkey and the U.S., Canada, and Mexico, although China is even more heavily weighted to BOFs. Then too, weak performance handicaps a company's ability to upgrade or invest in more efficient technologies.

The production of steel is extremely energy intensive, whether starting from iron ore or scrap. In addition, production using coke in blast furnaces releases large amounts of carbon dioxide, nitrogen oxide, and particulates into the air. Eurofer notes that about 50% of EU steel production comes from recycled steel scrap used in BOFs or EAFs. In terms of efficiency, EU producers are understood to be reaching the thermodynamic limits of current processes (see chart 7). Some players, such as Liberty House Group, part of London-based GFG Alliance, plan to build or use renewable sources of energy to reduce their carbon footprint.

Another important trend is the shift toward EAFs, especially EAF mini-mills, which generally have a lighter environmental impact, to gradually replace BOFs. For example, a typical BOF requires close to 2,000 kilowatt-hours (kWh) of energy per ton, while EAFs will use about 450 kWh. For example, a BOF generally discharges more than 2,000 kilos of CO2 per ton, compared with 600 kilos of CO2 for a mini-mill.

Chart 7


Given that the world continues to use and increase demand for steel, BOF are going to stay with us for some time. This raises the question of whether it is possible to make steel without coal. Players are looking into alternatives with a smaller carbon footprint. One of the current alternatives is the use of direct reduced iron (DRI) or sponge iron. In this process, natural gas replaces coal, producing a pig iron (with 90%-94% iron content) that an EAF can use for feedstock. The use of DRI could reduce total energy consumption by 40%-50%. However, re-engineering and adopting new technologies is not cheap. We believe that companies will continue to devote a sizable portion of their annual capital spending to improve energy efficiency and reduce emissions, but the pace will vary by company and region, depending on local regulation and profitability of the steel industry.

European steelmakers could become less competitive if other countries don't follow Europe's green agenda

As of today, Europe is taking the lead in adopting tighter standards for CO2 emissions, aiming for reductions of 50% by 2030 (compared to 1990 levels), and reaching carbon neutrality by 2050. Steel players on the Continent already need to comply with CO2 quotas, making them slightly less competitive than their Asian peers. In anticipation of future reforms, which will further reduce CO2 allowances, we recently saw a hike in EU carbon prices, reaching €28/ton. In our view, unless Europe develops a carbon border tax, making sure each ton consumed in Europe is subject to the same environmental standards and associated costs, European steelmakers stand to suffer from a structural disadvantage.

Related Research

S&P Global Ratings' research
  • S&P Global Ratings Cuts Copper And Zinc Price Assumptions And Lifts Those On Nickel And Gold, Oct. 9, 2019
  • Low Growth And Lower Rates: The Eurozone In 2020, Sept. 26, 2019
  • Europe's Housing Markets Lose Speed As The Economy Weakens, Sept. 24, 2019
  • Low Business Investment Is Weighing On German Economic Growth, Sept. 18, 2019
  • Global Auto Sales Will Stay In The Slow Lane For At Least The Next Two Years, Sept. 17, 2019
  • Trump's Tariffs Could Hurt EU Carmakers--Not The Economy, March 26, 2019
Other research
  • Is the auto industry driving EU steel sheet demand towards a cliff? CRU, March 26, 2019

This report does not constitute a rating action.

Primary Credit Analysts:Elad Jelasko, CPA, London (44) 20-7176-7013;
Simon Redmond, London (44) 20-7176-3683;
Secondary Contact:Andrey Nikolaev, CFA, Paris (33) 1-4420-7329;

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