EBA欧洲银行-JC-DP-2014-01-Discussion-Paper-on-Use-of-Credit-Ratings-by-Financial-Intermediaries_35页_698kb

Summary of the Discussion Paper: The Use of Credit Ratings by Financial Intermediaries (Article 5(a) of the CRA Regulation)

Core Content

This Discussion Paper, published by the European Supervisory Authorities (ESAs) on 23 December 2014, addresses the use of external credit ratings by financial intermediaries and aims to reduce sole or mechanistic reliance on these ratings. It outlines the regulatory context, international developments, and responses from Supervisory Competent Authorities (SCAs) to a questionnaire on the topic.

Main Objectives

• To gather feedback on the use of credit ratings and alternative methods of creditworthiness assessment.
• To provide SCAs with an opportunity to complement their responses to the questionnaire.
• To allow supervised entities to provide feedback on their contractual reliance on credit ratings and their use of alternative assessments.

Key Information

1. Regulatory Context

• Article 5b(1) of the CRA Regulation (as amended by CRA3) prohibits ESAs from referring to credit ratings in guidelines or technical standards where such references could lead to sole or mechanistic reliance.
• SCAs are responsible for monitoring the use of credit ratings in investment policies and encouraging mitigation of their impact.
• The Joint Committee (JC) of the ESAs has been tasked with developing guidelines to reduce contractual reliance on credit ratings.

2. International Developments

a. Financial Stability Board (FSB) Principles and Roadmap

• The FSB endorsed principles in 2010 to reduce reliance on credit ratings, aiming to mitigate pro-cyclicality and systemic risk.
• A roadmap was published in 2012 to accelerate the implementation of these principles.
• The peer review highlighted uneven progress in removing references to credit ratings and the need for alternative creditworthiness standards.
• The FSB encourages national authorities to focus on internal credit risk assessment practices.

b. IOSCO Committee 5 on Investment Management

• IOSCO published a consultation report in 2014 on good practices to reduce reliance on credit ratings.
• Investment managers use credit ratings for:
  • Assessing the creditworthiness of issuers.
  • Selecting eligible collateral.
  • Evaluating the financial health of counterparties.
• The report recommends:
  • Developing internal credit assessment processes.
  • Using credit ratings as one element among others in the internal process.
  • Establishing a framework for the use of external ratings, including procedures for downgrades and ensuring a sufficient understanding of methodologies.

c. Basel Committee on Banking Supervision (BCBS)

• The BCBS is revising the securitisation framework, proposing a hierarchical approach to capital requirements:
  • Internal ratings-based approach (if approved).
  • External ratings-based approach (if permitted).
  • Standardised approach (if neither is applicable).
• The focus is on reducing reliance on external ratings while maintaining risk sensitivity and comparability.

d. US Securities and Exchange Commission (SEC)

• The SEC removed references to credit ratings from its Rule 15c3-1, encouraging the use of alternative creditworthiness assessment methods.
• Brokers may consider factors such as:
  • Credit spreads.
  • Internal or external credit risk assessments.
  • Default statistics.
  • Inclusion in indices.
  • Enhancement and priorities.
  • Price, yield, and volume.
  • Asset-class specific factors.
• The rule also specifies that if a security does not trade in a ready market, a 100% haircut must be applied.

e. AFM Report on the Use of Credit Ratings

• The AFM conducted a study on the use of credit ratings in the Netherlands, identifying that:
  • Credit ratings are still widely used but not the sole source for investment decisions.
  • They are used to determine investment bandwidth and in the selection of eligible counterparties.
  • Smaller market participants rely more on credit ratings, while larger institutions have more robust internal models.
  • Mitigating controls, such as grace periods and replacement of downgraded instruments, are used to prevent the cliff effect.

Key Viewpoints

• Sole or mechanistic reliance on credit ratings is discouraged, as it can lead to systemic risks and pro-cyclicality.
• The development of alternative standards is crucial for reducing reliance on credit ratings.
• Internal credit risk assessment is encouraged, with the use of credit ratings as one of many tools.
• Harmonisation of supervisory approaches across the EU is necessary to ensure consistency.
• Challenges include the need for robust internal processes, the complexity of alternative methods, and the impact of investor regulations.

Next Steps

• The Discussion Paper is open for comments until 27 February 2015.
• The evidence gathered will be used to draft the JC guidelines on reducing reliance on credit ratings.
• ESMA will issue a Consultation Paper in H1 2015 with a summary of responses and a first draft of the guidelines.
• The final guidelines are expected to be adopted by the JC by Q3 2015 and then ratified by the ESAs.

Conclusion

The ESAs aim to reduce the reliance on external credit ratings by financial intermediaries through coordinated guidelines and encouraging the use of internal assessment processes. The paper provides a comprehensive overview of international efforts and national practices, highlighting the need for alternative methods and harmonised supervision.

Annex 1 - Questions

Annex 1 contains a list of questions directed at financial market participants and SCAs to gather further insights on the use of credit ratings and potential alternatives.