According to Zhitong Finance APP, several leading global asset management firms are modifying their investment rules to prevent forced sales of French government bonds. Insider sources reveal that a €1 billion (approximately $1.2 billion) fund managed by State Street and a €289 million product by BlackRock have recently stopped using strict AA credit rating standards for their benchmark indexes. This adjustment allows them to maintain their holdings in French bonds even if the country’s credit rating is downgraded and falls below this threshold. The proactive adjustments have already shown results. Last Friday, S&P Global Ratings unexpectedly downgraded France's rating, causing the largest bond issuer in Europe, France, to lose its average AA rating across the three major rating agencies. This downgrade will compel other funds with stringent investment standards to sell French government bonds. "The adjustment to benchmarks is in response to clear client demands," stated a spokesperson for State Street Investment Management. A BlackRock spokesperson declined to comment. Moody's Ratings is due to conduct a new evaluation of France's credit rating this Friday, with its current rating at Aa3 (the lowest tier of its AA level) and a stable outlook. In September, Fitch Ratings had already downgraded France's credit rating from AA- to A+. France is not the only issuer facing rating pressure; however, most funds can still invest in its bonds. With nearly €30 trillion in outstanding bonds, if some funds are forced to sell due to rule limitations, significant adjustments to asset allocation will be necessary, potentially leading to other funds also engaging in sell-offs. This could not only incur high transaction costs but also concentrate portfolios among a few issuers, ultimately jeopardizing client interests.

A recent lesson from Belgium highlights the need for timely adjustments, as BlackRock's exchange-traded fund (ETF) successfully circumvented the impact of France's rating downgrade by quickly changing its rules. This proactive step was taken following Fitch's decision in June to lower Belgium's rating to A+, which forced BlackRock to sell Belgian bonds. The previous benchmark explicitly stated that if any bond received a rating of A+ or lower from any major rating agency, it "would be excluded in the next index adjustment." This standard was stricter than other index methods, which typically use an average of ratings from multiple agencies, thus forcing BlackRock to reduce its holdings in Belgian long-term government bonds. The risk from France is even greater, as its bonds make up nearly one-third of the fund's portfolio. Within weeks of Belgian bonds being removed from the index, BlackRock found a solution. On July 18, the S&P index division proposed lowering the minimum credit rating requirement for the benchmark index to BBB, while also creating a list of eligible countries to ensure the index's composition remained consistent with the situation prior to Belgium's bond exclusion. This proposal was subsequently approved and came into effect during the index adjustment at the end of September. Now, even if France's rating is further downgraded in the coming months, its bonds can remain within the index; simultaneously, Belgian bonds have also been reinstated in the fund's holdings. BlackRock informed its ETF investors that this methodology adjustment would prevent "increased turnover and reduced index diversity."

On another front, State Street's “IUT Euro Core Treasury 10+ Year Bond Index Fund,” which was previously tracking the ICE BofA Euro Government 10+ Year AAA-AA Index, has switched to a "custom index" compiled by Intercontinental Exchange Inc. as of June this year. The rules and standards for the custom index are specified by clients, differing from the one-size-fits-all approach of generic public benchmark indexes. As of the end of September, the proportion of French bonds in the State Street fund reached 39%. Other institutions in the market took even earlier action to exclude France from stringent rating requirements.

While market sentiment is indeed shifting, French government bonds remain firmly within the investment-grade category, a key threshold for bond fund investment standards. Mara Dobrescu, Senior Director of Fixed Income Strategy at Morningstar, noted that for a handful of investors with AA investment standards, forced sales could create opportunities for other funds to acquire French bonds at attractive prices. However, if France's rating is further downgraded, the larger impact may manifest in the sentiment of global investors. For years, foreign investors have favored French bonds due to their yields being higher than German bonds, coupled with superior credit quality and a lesser degree of volatility compared to Italian bonds. Analysts suggest that "France could fall behind other eurozone issuers and lose its historically held 'golden position' in eurozone government bonds—this position has long attracted global investors." The cost of this decline will be a structural rise in government bond yields.