Welcome to the February 2010 edition of the Basel ii
Compliance Professionals Association (BCPA)
newsletterDear
Members,
Today we will discuss the meeting of the Group of Central Bank
Governors and Heads of Supervision,
the oversight body of the Basel Committee
on Banking Supervision (10
January at the Bank for International Settlements).
A fully calibrated set of standards will be developed by the end of
2010
to be phased in as financial conditions improve and the economic
recovery is assured
with the aim of implementation by the end of 2012.
We will
also discuss a paper with some very important
definitions and developments:
Basel Committee on Banking Supervision, The Joint Forum -
Stocktaking on the use of credit ratings
We will
also answer a question:
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Contents 1. Risk Professionals
2. Compliance Professionals
3. Sarbanes Oxley Professionals
4. Basel ii Professionals
5. Solvency ii Professionals
6. Hedge Funds Professionals
7. Members of the
Board of Directors
Group of Central Bank Governors and Heads of Supervision reinforces
Basel Committee reform package
11 January 2010: The Group of Central Bank Governors and Heads of
Supervision,
the oversight body of the Basel Committee
on Banking Supervision,
met on 10 January at the Bank for International Settlements.
It welcomed the substantial progress of the Basel Committee to
translate the Group's September 2009 agreements into a concrete
package of measures, as elaborated in the Committee's 17 December
2009 Consultative proposals for
Strengthening the resilience of the banking sector and the
International framework for liquidity risk measurement, standards
and monitoring.
Governors and Heads of Supervision requested the Committee to
deliver a fully calibrated and finalised package of reforms by the
end of this year.
President Jean-Claude Trichet, who chairs the Group, emphasised that
"timely completion of the Basel Committee reform programme is
critical to achieving a more resilient banking system that can
support sound economic growth over the long term."
Central Bank Governors and Heads of Supervision welcomed the Basel
Committee's focus on both microprudential reforms to strengthen the
level and quality of international capital and liquidity standards,
as well as the introduction of a macroprudential overlay
to address procyclicality and systemic risk.
They also provided guidance and noted the importance of
making progress in the following key areas:
Provisioning:
It is essential that accounting standards setters and supervisors
develop a truly robust provisioning approach based on expected
losses (EL).
Building on the Basel Committee's August 2009 Guiding Principles for
the replacement of IAS 39,
a sound EL provisioning approach should achieve the following key
objectives:
1) Address the
deficiencies of the incurred loss approach without introducing an
expansion of fair value accounting
2) Promote adequate and more forward looking provisioning through
early identification and recognition of credit losses in a
consistent and robust manner
3) Address concerns about
procyclicality
under the current incurred loss provisioning model
4) Incorporate a broader range of credit information, both
quantitative and qualitative
5) Draw from banks' risk management and capital adequacy systems and
6) Be
transparent and subject to appropriate internal and external
validation by auditors, supervisors and other constituents So-called
"through-the-cycle" approaches
that are consistent with these principles and which promote the
build up of provisions when credit exposures are taken on in good
times that can be used in a downturn would be recognised.
The Basel Committee
should translate these principles into a practical proposal by
its March 2010 meeting
for subsequent consideration by both supervisors and accounting
standards setters.
Introducing a framework of countercyclical capital buffers:
Such a framework could contain two key elements that are
complementary.
First,
it is intended to promote the build-up of appropriate buffers at
individual banks and the banking sector that can be used in periods
of stress.
This would be achieved through a
combination of capital conservation measures, including actions to
limit excessive dividend payments, share buybacks and compensation.
Second,
it would achieve the broader macroprudential goal of protecting the
banking sector from periods of excess credit growth through a
countercyclical capital buffer linked to one or more credit
variables.
Addressing the risk of systemic banking institutions: Supervisors
are working to develop proposals
to address the risk of systemically important banks (SIBs).
To this end,
the Basel Committee has established a Macroprudential Group.
The Committee should develop a menu of approaches using continuous
measures of systemic importance to address the risk for the
financial system and the broader economy.
This includes evaluating the pros and cons of a capital and
liquidity surcharge and other supervisory tools as additional
possible policy options such as resolution mechanisms and structural
adjustments.
This forms a key input to the Financial Stability Board's
initiatives to address the "too-big-to-fail" problem.
Contingent capital:
The Basel Committee is reviewing the role that contingent capital
and convertible capital instruments could play in the regulatory
capital framework.
This includes possible entry criteria for such instruments in Tier 1
and/or Tier 2 to ensure loss absorbency and the role of contingent
and convertible capital more generally both within the regulatory
capital minimum and as buffers.
Liquidity:
Based on information collected through the quantitative impact
assessment, the Committee should flesh out the details of the global
minimum liquidity standard, which includes both the 30-day liquidity
coverage ratio and the longer term structural liquidity ratio.
Central Bank Governors and Heads of Supervision will review concrete
proposals on each of these topics
later this year.
They endorsed the Committee's approach to extensive consultation on
and comprehensive assessment of the proposed reforms, covering both
the impact on the banking sector and the broader economy, before
arriving at a final calibration of the minimum level of capital and
the buffers above the minimum at the end of this year.
They stressed that
the aim of the new global standards
should be to
achieve a better balance between banking sector stability and
sustainable credit growth.
President Trichet noted that "the Group of Central Bank Governors
and Heads of Supervision will provide strong oversight of the work
of the Basel Committee during this phase, including both the
completion and calibration of the reforms."
The fully calibrated set of standards will be developed by the end
of 2010
to be phased in as financial conditions improve and the economic
recovery is assured
with the aim of implementation by the end of 2012.
This includes appropriate phase-in measures and grandfathering
arrangements for a sufficiently long period to ensure a smooth
transition to the new standards.
Basel Committee on Banking Supervision, The Joint Forum
Stocktaking on the use of credit ratings - June 2009
Introduction
A. Background In its report to the
G7 titled Report of the Financial Stability
Forum on Enhancing Market and Institutional Resilience, the
Financial Stability Forum (FSF) requested the Joint Forum to
conduct a stocktaking of the uses of external credit ratings by
its member authorities in the banking, securities and insurance
sectors.
The request also suggested that authorities
review whether their regulations and/or supervisory policies
unintentionally give credit ratings an official seal of approval
that discourages investors from performing their own due
diligence.
To implement the FSF request, the Joint Forum Working Group on
Risk Assessment and Capital (JFRAC) prepared and circulated to
member authorities a questionnaire on the use of credit ratings in
their jurisdictions.
The questionnaire was designed to elicit information regarding
member authorities’ use of credit ratings in legislation
(statutes), regulations (rules), and/or supervisory policies
(guidance) affecting, or generated by, such authorities
(collectively, LRSPs).
he questionnaire requested information on the definitions (either
internal or via crossreference to an external source) of “credit
ratings,” “credit rating agencies,” or any related terms as well
as any references to specific credit rating agencies in LRSPs.
Member authorities were also asked questions regarding the usage
of credit ratings and/or references to credit rating agencies (or,
in either case, related terms) in their LRSPs, including an
explanation of what each LRSP was designed to accomplish and the
purpose of using credit
ratings in the LRSP.
Finally, the questionnaire asked member authorities to describe
their assessments, if any, of unintended implications of such
uses, in particular, whether the use of credit ratings has had the
effect of implying an endorsement of such ratings and/or rating
agencies or discouraging investors from performing their own due
diligence.
JFRAC received a total of 17 surveys from member authorities,
representing 26 separate agencies from 12 different countries, as
well as five responses describing international frameworks.
This report is intended to serve as a stocktaking of member authorites’ use of credit ratings.
This stocktaking is based entirely on the responses received from
member authorities in response to the questionnaire circulated by
JFRAC and, with the exception of the descriptions of international
frameworks prepared by member authorities, does not address the
use of credit ratings in any other jurisdictions.
The report is not intended to be, and should not be construed as,
an expository discussion of how credit ratings are developed, what
information they are intended to convey, or how and by whom they
are regulated. Furthermore, the report does not express any
viewpoint regarding the quality, accuracy, or any other subjective
evaluation of credit ratings and does not take any position on the
appropriateness of member authorities’ use of credit ratings.
Pursuant to the FSF mandate, the questionnaire circulated to
member authorities solicited their individual views on potential
unintended consequences of their use of credit ratings in LRSPs (ie,
the appearance of a “seal of approval”). In preparing their
responses to this portion of the questionnaire, member authorities
were not expected to conduct any independent research on the
issue, but instead simply to convey their broad impressions and
preliminary views.
As such, the summary of these views in this report should not be
construed as a definitive survey of member authorities’ positions;
the report expresses the range of viewpoints expressed by member
authorities on the issue of the unintended consequences of the use
of credit ratings in LRSPs and takes no independent position on
the subject.
Key terms used
Several key terms that are used throughout this report bear
mention.
The two most significant related terms for subsets of “credit
rating agencies” are
“nationally recognised statistical rating
organisations” (NRSROs),
which are regulated by the United States
Securities and Exchange Commission (US SEC), and
“external credit
assessment institutions” (ECAIs), a term set forth in the Basel II
framework.
The term “NRSRO” is defined in United States (US) legislation and
is limited to credit rating agencies that have applied for and
been granted registration by the US SEC.
This statutory definition of NRSRO is cross-referenced extensively
in US regulations as well as in the Canadian Securities
Administrators’ national instrument relating to the
Multijurisdictional Disclosure System (MJDS).
Almost half of the respondents referenced the term “ECAI,” with
several specifically referencing the Basel II framework and/or the
Committee of European Banking Supervisors (CEBS) “Guidelines on
the recognition of External Credit Assessment Institutions” (CEBS
Guidelines) as the source for that term.
While the amended Basel II framework sets forth criteria to be
used by national supervisors for the “recognition” of ECAIs, it
does not contain a
definition of the term.
Consistent with that framework, the Capital Requirements Directive
(CRD) that implements the Basel II framework in the European
Union (EU) does not define an ECAI, but instead sets forth
criteria for the recognition of eligible ECAIs.
A small minority of respondents indicated that their LRSPs include
an explicit definition of the term “ECAI.”
For instance, under the Australian prudential standards, an ECAI
is defined as “an entity that assigns credit ratings designed to
measure the creditworthiness of a counterparty or certain types of
debt obligations of a counterparty.”
The majority of respondents indicated that their
legislation (statutes),
regulations (rules), and/or supervisory policies (guidance) -
LRSPs
reference
specific credit rating agencies.
All but one of those respondents mentioned Moody’s Investors
Service, Standard & Poor’s Ratings Services, and Fitch Ratings.
Several respondents indicated that the individual credit rating
agencies listed in their LRSPs are formally reviewed on a regular
basis, in some cases on a fixed schedule (ie, annually or every
five years).
Several others noted that the Basel II and/or CEBS designation
procedures for ECAIs also applied to the removal of the ECAI
designation.
In addition, a number of respondents indicated that their LRSPs
naming individual credit rating agencies could be amended through
their jurisdiction’s standard legislative or regulatory process.
Finally, the Markets in Financial Instruments Directive (MiFID),
an EU law designed to provide a harmonised regulatory regime for
investment services, defines the term “competent rating agency”
for that specific purpose as an entity that “issues credit ratings
in respect of money market funds regularly and on a professional
basis and is an eligible ECAI within the meaning of Article 81(1)
of Directive 2006/48/EC.”
Basel Framework
Basel II serves as the foundation for the use of credit ratings in
a significant number of member jurisdictions.
These jurisdictions have implemented the Basel II framework into
their domestic LRSPs to varying degrees, with most appearing to
have incorporated the substantial elements of the framework into
their domestic LRSPs.
As alluded to above, the EU implemented Basel II via the CRD,
which applies to both banks and investment firms.
Uses of credit ratings
As described in greater detail below, credit ratings are generally
used in member jurisdictions for five key purposes:
(a) determining capital requirements;
(b) identifying or classifying assets, usually in the context of
eligible investments or permissible asset concentrations;
(c) providing a credible evaluation of the credit risk associated
with assets purchased as part of a securitisation offering or a
covered bond offering;
(d) determining disclosure requirements;
and (e) determining prospectus eligibility.
In general, the member authorities that responded to the survey
reported a greater use of credit ratings in their LRSPs covering
the banking and
securities sectors than in their LRSPs for the insurance sector.
A. Capital
1. Banking and securities sectors
This category features the broadest application of the use of
credit ratings.
Member authorities from every jurisdiction submitting responses
indicated that their LRSPs contained provisions using credit
ratings for the purpose of determining net or regulatory capital,
and more LRSPs are applied to capital requirements than to any
other category of use.
Credit ratings were generally used in those LRSPs as a means of
mapping credit risks to capital charges or risk weights.
A related use for ratings in LRSPs is the determination of margin
rates; for example, certain sovereign bonds and debentures may be
subject to lower margin rates as a result of receiving investment
grade ratings.
In the Basel II framework, external ratings are used for the
purpose of enhancing the risk sensitivity of the framework, for
example, by being incorporated into assessments of the credit
quality of an exposure or creditworthiness of a counterparty – and
thus the imposition of capital requirements.
External ratings are primarily used under the standardised
approach for credit risk,10 but also to risk-weight
securitisations exposures.
The different uses of external ratings generally correspond to
probability of default treatments under the standardised
approaches, and to situations where the use of internally
generated ratings is impossible or difficult given, for instance,
the lack of statistical data for securitised products.
In most cases, for member jurisdictions that have incorporated the
Basel II framework, the external ratings that can be used for the
purpose of determining regulatory capital are limited to those
provided by rating agencies recognised by national supervisors as ECAIs.
Supervisors assess whether these criteria are fulfilled and aim at
identifying rating agencies that issue ratings that are
sufficiently sound and robust to warrant using them to determine
the appropriate regulatory capital levels. Supervisors are also in
charge of articulating the
conditions and details for the use of ratings (eg, in the EU, for
the mapping of external ratings to the regulatory risk-weights or
credit quality steps).
All members of the EU have implemented the CRD, which implements
the Basel II framework for both banks and investment firms.
Within the EU, the decision as to whether or not to recognise an ECAI is within each member’s discretion, although the “joint
assessment
process” set forth in the CEBS Guidelines is designed to achieve a
consistent approach among EU member states.
In Australian LRSPs for authorised deposit-taking institutions,
mappings of credit ratings are used to calculate regulatory
capital risk weights for certain credit risk and securitisation
exposures, as set out in the Basel II framework.
In Canada, all banks have implemented the Basel II framework and
hence external ratings are used to assess the credit risk of an
exposure.
In Japan, credit ratings issued by Designated Rating Agencies (DRA)
are used to estimate market risks and counterparty risks for the
purpose of calculating the capital adequacy ratios for securities
companies.
Japan also noted that for calculating the capital adequacy ratios
for banks and other deposit-taking institutions, credit ratings
issued by ECAIs are used subject to the Financial Services Agency
(JFSA) ordinance under the Banking Act.
In the United States, which features the most widespread use of
credit ratings in LRSPs that establish capital requirements in the
securities and banking sectors, the use of credit ratings for
capital purposes is almost exclusively restricted to those issued
by credit rating agencies
designated as NRSROs through the US SEC’s registration process.
2. Insurance Sector
In the European Union, the existing insurance and reinsurance
directives do not contain any provisions that place reliance on
credit rating agencies.
There is no explicit credit risk charge for the solvency margin in
the Solvency I framework.
The solvency margin in the Solvency I framework is not the sum of
different capital charges related to different risks, but a single
capital charge calibrated to reflect all the risks an insurance
company faces.
Nevertheless, the importance of credit quality is taken into
account in the rules applying to asset allocation; but they are
not based on the use of credit ratings.
For instance, Article 24 of Directive 2002/83/EC establishes rules
for investment diversification without any reference to credit
ratings.
An insurance company must diversify the assets that cover its
liabilities towards policyholders and limit its investments in
certain asset classes as a percentage of total liabililties.
However, a number of member jurisdictions’ national laws
implementing the investment rules of the current Solvency I
Directives do refer to, or place reliance on, ratings in order
to determine whether a certain asset is authorised or eligible to
cover technical provisions.
Moreover, in a number of member jurisdictions, (re)insurance
undertakings are required, as part of their internal reinsurance
policy, to pay special attention to the financial strength of
their reinsurers, using ratings as a proxy.
For example, in the Netherlands, when pension funds reinsure their
assets, they must maintain buffers to cover the risk of the
reinsurance company defaulting on its obligations.
The size of these buffers depends on the credit spread of the
reinsurance company.
As a gesture to the sector, on its website, De Nederlandsche Bank
publishes credit spreads that (smaller) pension funds can use when
they cannot obtain market data.
In the United Kingdom, the Insurance Prudential Sourcebook
provides a table with “listed rating agencies” (A.M. Best Company,
Fitch Ratings, Moody’s Investor Service, Standard & Poor’s Ratings
Services), including credit rating descriptions and “spread
factors.”
With regard to insurance capital resources requirements,
credit ratings from these firms are used in determining assumed
spread stresses.
In the United States, insurance regulators require bonds and
preferred stocks to be reported in statutory financial statements
in one of six National Association of Insurance Commissioners (NAIC)
designations categories that denote credit quality.
If an accepted rating organisation (ARO) has rated the security,
the security is not required to be filed with the NAIC’s
Securities Valuation Office (SVO).
Rather, the ARO rating is used to map the security to one of the
six NAIC designation categories.
The NAIC designations are primarily designed to assist regulators
(as opposed to investors) to monitor the financial condition of
their insurers.
Finally, in light of the impact that the credit market crisis had
on the credit ratings of the financial guarantors and the bonds
they insure, the NAIC announced that the SVO will be issuing
“substitute” ratings for some municipal bonds. In doing so, the
NAIC will be assessing the creditworthiness of the municipality
that issued the debt.
These credit ratings will be used to determine the risk based
capital charge for the security.
The insurance regulators indicated that the proposal will
“decouple” the NAIC rating from the rating agency process.
In Canada, a significant portion of an insurer’s capital
requirement (especially for a life insurer) arises from its
exposure to credit risk.
This component of the overall insurer capital requirement is
determined using asset default factors.
For rated short term securities, bonds, loans and private
placements, these factors are based on the rating agency grade.
In its life insurer capital guideline, the Office of the
Superintendent of Financial Institutions (OSFI) states that:
“A company must consistently follow the latest ratings from a
recognized, widely followed credit rating agency.
Only where that rating agency does not rate a particular
instrument, the rating of another recognized, widely followed
credit rating agency may
be used.
However, if the Office believes that the results are
inappropriate, a higher capital charge would be required.”
Further, in Canada, asset default factors for preferred shares,
where rated, are based on the rating agency grade.
For financial leases where rated, and the lease is also secured by
the general credit of the lessee, the asset default factor is
based on the rating agency grade.
Other examples of the use of credit ratings in LRSPs governing
capital requirements are found in Japan, where credit ratings
issued by DRAs are used to calculate the solvency margin ratios
regarding estimating credit risks for insurance companies, and
Australia, where prudential standards for both general insurers
and life insurers use credit ratings to assign counterparty grades
used in regulatory capital requirements.
B.
Asset Identification
1. Banking and securities sector
The field of LRSPs cited by the second highest number of
respondents was, broadly speaking, asset
identification/categorisation.
This includes, for example, the designation
of permissible investments and/or required investments for mutual
funds as well as the establishment of, and exceptions to,
investment concentration limits for particular types of assets.
In most cases, member jurisdictions reported that credit ratings
were used in both the banking and securities sectors. In addition,
the United Kingdom Financial Services Authority (UK FSA) noted
that credit ratings are not used in any of its three financial
sectors for asset identification.
In the EU, the Undertakings for
Collective Investment in Transferable
Securities Directives (UCITS Directives) on collective
investment schemes does not contain provisions which make
reference to credit ratings.
However, Commission Directive 2007/16/EC,22 which clarifies
certain definitions used in the UCITS Directives, contains two
specific references to credit ratings relating to money market
instruments.
In Japan, a securities dealer is
generally not allowed to be a lead manager for a security issued
by its parent or subsidiary company.
However, it is exempt from this regulation if the security is
rated by a DRA that is subject to the Cabinet Office Ordinance of
Act on Financial Instruments Business Operators Art153(iv) under
the Financial Instruments and Exchange Act.
As in the case of US capital
requirement LRSPs, the extensive banking and securities LRSPs
using credit ratings in the US generally restrict such use to
credit ratings issued by credit rating agencies designated as
NRSROs through the US SEC’s registration process.
Finally, in Canada, both the OSFI and
the Ontario Securities Commission (OSC) use credit ratings in
their LRSPs for asset identification/categorisation purposes, for
example, in OSFI LRSPs determining eligible collateral for
securities lending loans and OSC LRSPs establishing money market
fund investment guidelines.
2.
Insurance sector
In the United States, many state
insurance laws describe permissible investments and/or
concentration limits in terms of ratings and/or NAIC designations
for insurance companies.
For example, New York State insurance law delineates permissible
investments for the portion of assets corresponding to insurance
liabilities.
In describing permissible investments in the obligations of
American institutions (other than an insurance company), the law
indicates that such investments are permitted as long as they meet
one of several criteria.
The list of criteria makes at least two references to rating
agency ratings.
First, investment in the obligations
of American institutions are permitted if they are rated “A” or
higher (or the equivalent thereto) by a securities rating agency
recognised by the Superintendent of Insurance.
Second, such investments are
permitted if such obligations are insured and, after considering
such insurance, are rated “Aaa” (or the equivalent thereto) by a
securities rating agency recognised by the Superintendent of
Insurance.
In addition, some state insurance laws provide limitations on the
types of obligations that financial guarantee insurance companies
can insure.
For example, New York State insurance law
provides that an insurer may insure municipal obligation
bonds that are not investment grade so long as at least 95 percent
of the insurer’s aggregate net liability is investment grade.
In Japan, insurance regulations
restrict the concentration of non-DRA rated assets to specific
ratios calculated under the Insurance Business Law and the
Ordinance for Enforcement of Insurance Business Law.
Ratings are also used in the German insurance sector for asset
identification as one possible criterion to determine the safety
of the asset.
C.
Securitisations and covered bond offerings
1. Banking and securities sectors
A significant number of respondents indicated that their LRSPs
addressing securitisations and/or covered bond offerings used
credit ratings, generally by requiring that securitisations
offered to investors be rated by one or more credit rating
agencies.
The breadth of the use of credit ratings in member authorities’
LRSPs addressing securitisations varied, with some covering all
securitisations and other covering only certain identified types
of securitisations (eg, in Italy, only where securities are sold
to non-professional investors).
The UK FSA noted that ECAI ratings are used to determine the
credit quality of a firm’s securitisations positions.
It also noted that with regard to the “covered bond” regime, it
may consider whether the counterparty has an appropriate credit
rating in considering whether an asset pool is of sufficient
quality.
In the United States and Canada, a number of banking and
securities LRSPs governing asset-backed instruments reference
external ratings.
2.
Insurance sector
No respondent stated that credit ratings are used in the insurance
sector regulation specifically with regard to securitisations.
In practice, supervision of insurance companies necessarily takes
into consideration credit ratings if insurance companies invest in
or guarantee securitisation products.
D.
Disclosure requirements
1. Banking and securities sectors
A significant number of respondents indicated that credit
ratings were used in their LRSPs regulating disclosure.
Such usage fell into two broad categories:
requirements and exemptions.
A number of respondents indicated that their LRSPs required rated
entities to disclose their ratings as well as to disclose when
such ratings were changed (or when they believed changes were
imminent).
Others noted that their disclosure LRSPs contained exceptions for
credit rating agencies, eg, explicitly exempting credit ratings
from requirements to disclose certain documents such as pre-sale
reports.
Several jurisdictions identified unique disclosure requirements.
For example, in Japan, the JFSA requires ECAIs to disclose certain
information regarding the securitisation exposures for credit
ratings to be eligible under the Basel II framework (eg, rating
criteria, rating transition matrix, and transaction-specific
information).
2.
Insurance sector
In Japan, DRA ratings are used to
determine which disclosures must be made with regard to certain
re-insurance contracts.
E.
Prospectus eligibility
Several respondents indicated that credit
ratings play a role in their LRSPs governing prospectuses for
securities offerings.
For example, certain types of prospectuses, such as “short form”
prospectuses, include an investment grade rating as one of the
criteria for eligibility to use the form.
Among EU jurisdications, the UK FSA
noted that in the United Kingdom, there are no references to
credit ratings with regard to prospectuses for equities.
For debt instruments, however, the prospectus must disclose the
credit ratings assigned to an issuer or its debt securities at the
request or with the cooperation of the issuer in the rating
process.
Italian legislation allows, in
certain instances, the sale of investment grade public bonds
issued by OECD States and originally placed with qualified
investors without the use of a prospectus.
In the US and Canada, the US SEC and
OSC each have a number of LRSPs referring to credit ratings in the
context of prospectus requirements, for example, their regulations
governing the use of short-form prospectuses in securities
offerings.
In Japan, issuers can use the
“reference system” of the securities registration statement and
the shelf registration system for the public offering of corporate
bonds if they meet certain requirements, including that they are
rated by DRAs.
Member assessments and initiatives
As noted in the introduction, the questionnaire submitted to
member authorities requested a description of their assessments,
if any, of unintended implications of the use of credit ratings in
LRSPs.
The questionnaire included specific questions as to whether the
use of credit ratings has had the effect of implying an
endorsement of such ratings and/or rating agencies or discouraging
investors from performing their own due diligence.
In addition to answering these questions, members provided the
working group with information concerning a number of initiatives
relevant to both such an assessment and the future use of credit
ratings in LRSPs.
A. Assessments on the impact of the use of credit ratings in LRSPs
No respondent reported that it had conducted a comprehensive,
formal assessment of the impact of the use of credit ratings in
LRSPs on investor behavior.
Nonetheless, many offered their views on the question.
In general, respondents were split as to whether their use of
credit ratings and/or reference to credit rating agencies has had
the effect of implying an endorsement of such ratings and/or
agencies, although a slight majority answered in the affirmative.
Respondents answering in the affirmative were generally cautious
in their analysis with only a small minority providing an
unconditional affirmative response.
Several respondents whose LRSPs use the term ECAI noted that
while Basel II’s introduction of the term
was merely meant to be in line with market practice concerning the
use of credit ratings issued by major credit rating agencies, the
designation of those agencies as ECAIs may have reinforced the
tendency of the marketplace to rely on the ratings excessively.
In addition, a small number of respondents noted that the
eagerness of some smaller credit rating agencies to obtain the
ECAI designation implied a perception that the designation carried
an endorsement effect.
Several respondents indicated some additional possible unintended
consequences of the use of credit ratings in LRSPs.
Some respondents noted that the use of credit ratings in LRSPs
could lead to increased demand for highly rated instruments issued
by off-balance sheet entities, as the use of credit ratings in
LRSPs may have “officialised” credit ratings for those instruments
and therefore made such highly rated investments more desirable.
One respondent suggested that the use of credit ratings in LRSPs
may have led to increased barriers to entry for the credit rating
industry, as the possible endorsement effect of designating
certain credit rating agencies in LRSPs could have negative
business effects on agencies not so designated.
Another respondent noted that the use of credit ratings in LRSPs
may have resulted in an amplified perception of credit risk as
predominant, resulting in reduced attention to other kinds of
risk, in particular liquidity and market
risks.
Finally, one respondent suggested a possible “relaxing effect” on
financial institutions’ internal assessment procedures, as firms
may have placed too much reliance on external ratings in lieu of
performing their own thorough due diligence of investment
opportunitites.
Respondents expressing a belief that their
use of credit ratings and/or reference to credit rating agencies
in LRSPs has not had any untended “endorsement” effects, generally
stressed the purely technical nature of their LRSPs’ use of credit
ratings.
Several respondents indicated that their ECAI
recognition/designation process was based purely on the
verification of a credit rating agency’s compliance with published
criteria and thus did not imply any endorsement.
In addition, a majority of respondents
expressed their belief that their use of credit ratings and/or
reference to credit rating agencies did not discourage investors
from performing their own due diligence.
Several respondents indicated that while there may have been
investor over-reliance on credit ratings, it was not clear whether
the use of credit ratings in LRSPs played a material part in such
over-reliance.
B. New Initiatives relating to credit ratings
1. Banking and securities sector
The US SEC noted that it has issued proposed rule amendments that
would eliminate references to NRSROs and their ratings from most
of its LRSPs, stating that by doing so, it would “remove any
appearance that the Commission has placed its imprimatur on
certain ratings.”
The OSC indicated that it was in the process of considering
replacing the word “approved” in its LRSPs employing credit
ratings with the word “designated” in order to “avoid
misconceptions regarding regulatory endorsement of credit ratings
or credit rating agencies.”
The OSC also noted that the Canadian Securities Administrators
have published a paper for consultation (until February 2009) that
seeks to reduce reliance on credit ratings in Canadian securities
legislation by considering possible alternatives to the use of
credit ratings or removing the references to credit ratings.
On July 31, 2008, the European Commission (EC) published two
working documents for consultative purposes.
The first document sought public views on a draft proposal for a
regulation with respect to the authorisation, operation and
supervision of credit rating agencies.
Following the public consultation, the EC adopted the proposal on
November 12, 2008, in the hope that the Council of the European
Union and the European Parliament would adopt the final proposal
before the next European Parliament elections in June 2009.
The main objective of the EC proposal is to
ensure that ratings are reliable and accurate pieces of
information for investors.
Credit rating agencies will be required to
deal with conflicts of interest, have sound rating methodologies
and increase the transparency of their rating activities.
The proposal also introduces a registration and surveillance
procedure for credit rating agencies whose ratings are used by
credit institutions, investment firms, insurance, assurance and
reinsurance undertakings, collective investment schemes and
pension funds within the EU.
The second document, of particular relevance to the Joint Forum’s
project, identifies in broad terms the references made to ratings
in the existing EU legislation and looks at possible approaches to
the potential problem of excessive reliance on ratings.
The EC proposed three possible (but not
mutually exclusive) approaches:
(1) require regulated and sophisticated investors to rely more on
their own risk analysis, especially for (relatively) large
investments;
(2) require that all published ratings include ‘health-warnings’
informing of the specific risks associated with investments in
these assets; and/or
(3) examine the regulatory references to credit ratings and
revisit them as necessary.
In August 2008, the JFSA added new supervisory “checkpoints” for
financial institutions in order to avoid uncritical reliance on
credit ratings when contemplating investment in structured
products.
The checkpoints seek to encourage an understanding of rating
methodologies and relevance (eg, what does the rating really mean
for purposes of the investment?) as well as establishing better
risk management functions within the organisations.
Since April 2008, in order to meet the checkpoint for the sales of
securitisation products, the JFSA ensures that distributing
institutions are effectively carrying out the collection, risk
valuation and disclosure of the underlying securitised assets, as
well as assessing the risk factors associated with securitised
products without relying solely on credit ratings.
The JFSA’s Financial System Council
has pointed out the necessity to review the use of DRA credit
ratings for the purpose of the reference system and the shelf
registration system for public offerings of corporate bonds.
In December 2008, the JFSA’s Financial System Council has also
reported that credit rating agencies should be regulated under the
framework of the registration system.
2. Insurance sector
Under current LRSPs, US insurers ceding to
reinsurers must obtain collateral from non-US licensed reinsurers
in order to reflect the statutory accounting credit for
reinsurance, but no collateral is required when ceding to US
licensed reinsurers.
Florida recently promulgated rules allowing ceding insurers to
take full credit for reinsurance with reduced collateral for
reinsurance placed with financially strong foreign reinsurers from
qualifying jurisdictions.
In this rule, a preliminary filter, not an
absolute criterion, is based on acceptable ratings from recognized
rating agencies.
New York is finalizing a similar
rule.
Within the frameworks, the reinsurer’s credit ratings serve as a
maximum cap on the amount of collateral reduction that is
available; further analysis and due diligence can, for a given
rating for a specific reinsurer, increase the amount of required
collateral.
On a broader scale in the United States, a
new Reinsurance Regulatory Modernisation Framework has been
adopted by the NAIC’s Reinsurance Task Force.
This framework, which is subject to ratification by the
NAIC, would change the manner and
extent to which US ceding companies can reflect offsets in their
statutory financial statements for reinsurance ceded.
Under the proposed framework, reinsurers (both US and non-US) will
be assigned to one of five rating categories determined by US
insurance regulators based on a number of factors, similar to the
New York and Florida frameworks.
Importantly, one of those factors is the reinsurer’s financial
strength rating provided from a recognized credit rating agency.
In particular, the lowest rating received by the rating agencies
will be used by the regulators to establish the maximum rating of
a reinsurer (eg, the maximum amount of collateral reduction).
The assigned rating category determines the extent to which the
reinsurer is required to collateralise its obligations in order
for US cedants to take credit for that reinsurance.
In July 2007, the EC proposed a revision of EU insurance law that
would replace 14 existing directives with a single directive
designed to improve consumer protection, modernise supervision,
deepen market integration and increase the international
competitiveness of European insurers.
Under the new system, known as Solvency II,
insurers would be required to take account of all types of risk to
which they are exposed and to manage those risks more effectively.
In addition, insurance groups would have a
dedicated ‘group supervisor’ that would enable better monitoring
of the group as a whole.
In February 2008, the EC published an
amended proposal.
The EC’s goal is to have the new system in
operation by 2012.
Currently, there are no references to
external credit ratings or ECAIs in the latest Directive proposal.
The most recent (fourth) draft Quantitative Impact Study (QIS4),
however, would use credit ratings as a proxy for financial
strength.
As this remains a work in progress, however,
it is unclear what the final capital requirements will be.
The precise design of capital requirements in Solvency II,
including the possible counterparty default risk capital charge,
will be set out in the future level 2 implementing measures to be
developed by end 2010.
Conclusion
The stocktaking of the use of credit ratings in the legislation,
regulations, and/or supervisory policies (ie, LRSPs)
of the 26 agencies, representing 12
different jurisdictions, that delivered responses to JFRAC’s
questionnaire reveals a wide spectrum of use.
Member authorities’ responses displayed significant variations
both in the breadth and number of the LRSPs referring to credit
ratings as well as in the categories of LRSPs in which they were
used.
In general, in the jurisdictions covered by the survey, credit
ratings are used predominantly in LRSPs in the banking and
securities sectors, with more limited use in insurance sector
LRSPs.
Geographically, the North Amercian LRSPs
used references to credit ratings –specifically, to credit ratings
issued by NRSROs – significantly more than in the LRSPs of the EU,
Australia, and Japan.
In addition, US and Canadian LRSPs had more
in common with one another, while the LRSPs of the EU, Australia,
and Japan shared similarities to one another.
Notwithstanding the general differences in the way credit ratings
are used in the LRSPs of the member authorities that responded to
the questionnaire, the survey revealed notable similarities among
the respondents as well.
The category of determining regulatory capital clearly displayed
the broadest extent of the use of credit ratings in LRSPs, both in
numbers of LRSPs and in the number of jurisdictions in which they
are used.
The second most significant category of use was
identifying or classifying assets, usually
in the context of eligible investments or permissible asset
concentrations.
The remaining major categories of use were providing a credible
evaluation of the risks associated with assets purchased as part
of a securitisation offering; determining disclosure requirements;
and determining prospectus eligibility.
While no member authority had conducted a formal assessment of the
impact of the use of credit ratings in LRSPs on investor behavior,
almost all appear to have considered the issue.
Respondents were split as to whether their use of credit ratings
and/or reference to credit rating agencies has had the effect of
implying an endorsement of such ratings and/or agencies; however,
a slight majority answered in the affirmative.
Finally, as noted above, the US, Canada, the
EU, and Japan are considering proposals that may lead to various
changes in the use of credit ratings in the LRSPs of those
jurisdictions.
Appendix 1
Definitions of key terms
The terms “credit rating” and “credit rating
agency” are defined only by a minority of respondents, primarily
in regulations (with the US SEC defining both terms in
legislation).
Several respondents noted that the definitions were “implicit” in
their regulations or that familiarity with the terms is
understood.
The two most significant related terms for subsets of “credit
rating agencies” are the US SEC’s “nationally recognised
statistical rating organisation” (NRSRO) and Basel II’s “external
credit assessment institution” (ECAI).
“NRSRO” is defined in US legislation, and
that definition is cross-referenced extensively in US regulations
as well as the Ontario Securities Commission’s definition of
“rating organisation.”
While Basel II sets forth criteria to be used by national
supervisors for the “recognition” of ECAIs, it does not contain a
definition of the term.
Almost half of the respondents referenced
the term “ECAI” in their responses to this question, with several
referencing the Basel II framework and/or the Committee of
European Banking Supervisors (CEBS) “Guidelines on the recognition
of External Credit Assessment Institutions” (CEBS Guidelines) as
well.
A small minority indicated that their LRSPs include an explicit
definition of the term “ECAI.” For instance, under the Australian
prudential standards, an ECAI is defined as “an entity that
assigns credit ratings designed to measure the creditworthiness of
a counterparty or certain types of debt obligations of a
counterparty.”
The Markets in Financial Instruments
Directive (MiFID) includes the term "competent rating
agency" as one that "issues credit ratings in respect of money
market funds regularly and on a professional basis and is an
eligible ECAI within the meaning of Article 81(1) of Directive
2006/48/EC."
Article 81(1) is contained with the EU Capital Requirements
Directive (CRD) that implements the Basel II framework and,
consistent with that framework, does not define an ECAI, but
instead sets forth criteria for the recognition of eligible ECAIs.
Specifically, Article 81 states that “Competent authorities shall
recognise an ECAI as eligible … only if they are satisfied that
its assessment methodology complies with the requirements of
objectivity, independence, ongoing review and transparency, and
that the resulting credit assessments meet the requirements of
credibility and transparency.”
The term “investment grade” and its
variants (eg, “non-investment grade”) are also defined by almost
half of the respondents, with those definitions almost evenly
divided between those that define the term by reference to
specific ratings from specified entities (eg, at or above a Baa
rating from Moody’s) and those that define it by reference to
categories of ratings and/or entities (eg, rated in one of the
four highest categories by an NRSRO).
Other related terms included subsets of credit ratings such as
“approved ratings,” “applicable external
ratings,” and “credit rating grades” as well as subsets of credit
rating agencies such as “approved rating organisations” and
“designated rating organisations.”
One respondent defined the terms “solicited rating” and
“unsolicited rating.”
The US SEC’s definition of the term “NRSRO” is cross-referenced in
a number of US banking regulations as well as several Canadian
securities regulations.
As noted above, almost half of the
respondents referenced the term “ECAI” in their responses to
question I.A.2, with several referencing the Basel II framework
and/or the Committee of European Banking Supervisors (CEBS)
“Guidelines on the recognition of External Credit Assessment
Institutions” (CEBS Guidelines) as well.
While the majority of respondents clarified their implementation
of Basel II,in several cases the responses were unclear on this
point.
The majority of respondents indicated that their LRSPs reference
specific credit rating agencies.
All but one of those respondents mentioned Moody’s Investors
Service, Standard & Poor’s Ratings Services, and Fitch Ratings,
with the exception being a US OTS regulatory bulletin, which
referenced the former two entities only.
DBRS Limited and Japan Credit Rating Agencies were each cited by
several respondents, while Rating and Investment Information,
Inc., Mikuni & Co., Fedafin AG1, and AM Best were each cited by
one respondent.
In several cases, it was unclear as to whether a respondent was
indicating that individual credit rating agencies were mentioned
directly in an LRSP, (eg, ““approved rating organisation” means
each of DBRS Limited, Fitch Ratings Ltd., Moody’s Investors
Service, Standard & Poor’s and any of their successors.”) or that
the LRSP used a term generally, with a list of credit rating
agencies meeting the criteria for that term contained elsewhere (eg,
“Investment grade corporate debt security shall mean any security
that…is rated in one of the four highest ratings categories by at
least one Nationally Recognised Statistical Ratings
Organisation.”)
Several respondents indicated that the
individual credit agencies listed are formally reviewed on a
regular basis, in some cases on a fixed schedule (ie, annually or
every five years).
Several others noted that the Basel II
and/or CEBS designation procedures for ECAIs also applied to the
removal of the ECAI designation.
Finally, a number of respondents indicated that their LRSPs naming
individual credit rating agencies could be amended through their
jurisdiction’s standard legislative or regulatory process.
The majority of respondents cited the ECAI designation procedures
set forth in Basel II as the basis for their
selection of the specific entities, with several referencing the
CEBS Guidelines as well.
The US SEC cited its 2007 regulations establishing a voluntary
registration program for NRSROs.
Several other respondents referred to industry consultation or
widespread market use as the basis for their use of specific
agencies in LRSPs.
Appendix 2
Structural overview of Basel II
The different uses of external credit ratings
This section does not aim at being exhaustive but rather at
explaining the main usages of
ratings.
Pillar
I (Minimum Capital Requirements)
Credit risk
Credit ratings are widely used for the
calculation of capital charges for credit risk in order to
differentiate the exposures in a risk-sensitive manner and set the
capital charges accordingly.
External and/or internal ratings might be used under the revised
framework, but as a general principle, Basel II promotes the use
of internal ratings, in the context of the internal ratings based
approach.
Under the Internal-Rated based Approach,
the risk sensitivity of the regulatory capital requirements is
attained through the use of internally produced credit ratings
models for all the different exposures class (sovereign, bank,
corporate, retail and equity).
External ratings are not supposed to be used for the calculation
of capital charges (with the exception of securitisation exposures
–see below).
However, the implementation of the IRB approach might result in
some marginal indirect uses of external ratings; the main use is
within the area of models validation in, for instance,
benchmarking exercises.
Consequently, external ratings are primarily used in the context
of the standardised approach.
In the standardised Approach, the
risk sensitivity of the regulatory capital requirements is
attained through the recourse to external credit ratings for
exposures within the corporate, sovereign and bank exposure class.
Institutions may only use the external ratings provided by rating
agencies recognised by supervisors (see. Section 4 below), with
the exception of exposures to sovereign where banks might directly
use the ratings provided by export credit agencies.
In practice, the risk weights applied to sovereign, banks and
corporate exposures are differentiated according to the individual
external credit assessment of each exposures.
The Basel II framework provides tables that
pre-map regulatory determined risk-weights to sets of credit
ratings scales from authorised rating agencies, enabling the
simple determination of an exposure’s risk weight (tables mapping
external ratings and risk-weights are specific to each exposure
class).
For example, for corporate exposures, the risk weights applicable
might vary from 20 percent to 150 percent depending on the credit
assessment of the exposure (see table below), whereas under the
Basel 1 framework a 100% risk-weight was applied to all corporate
exposures.
Credit risk mitigation rules define how funded credit protections
(collateral) and unfunded credit protections (guarantees and
credit derivatives) can be recognised.
They are applicable to the standardised approach and to some
extent to the IRB foundation approach.
Credit risk mitigation rules refer to
authorised external ratings in order to:
• Identify the eligible credit protection (for example, only the
guarantees provided by an entity with a rating higher than a
predetermined threshold might be recognised)
• Adjust the extent of the recognition of the credit protection
(for example, haircuts proportionate to the credit quality of the
issuer are applied to collateral under the comprehensive
approach).
The securitisation framework differs from
the general credit risk rules in the way that both the
standardised and the IRB approach use authorised external credit
ratings.
• For banks using the standardised Approach,
the risk sensitivity of the regulatory capital requirements is
attained through the recourse to authorised external credit
ratings for the subset of authorised securitisation transactions.
• For banks using the Internal Ratings based
Approach, the risk sensitivity of regulatory capital
requirements is attained through the recourse to authorised
external credit ratings within the Ratings-based approach and to a
lesser extent within the Internal Assessment Approach, and through
a regulatory setting within the SF (Supervisory formula) when
credit ratings cannot be inferred.
The prescribed long term and short term tables that pre-map
regulatory determined riskweights to sets of credit ratings scales
from authorised ECAIs for the standardised and the IRB approaches
differ; the IRB table is more granular and its risk weights are
different from that of the standardised approach.
Market
risk
When considering market risk measurement, external ratings are
only used for the calculation of the specific risk capital charges
arising from debt position under the standardised approach for
market risk.
In a way similar to what is done within the frame of the credit
risk rule, different risk weights are applied to the trading book
debt positions according to the external ratings of the issuer.
The rules on specific risk also refer to a
notion of qualifying category, which is notably (but not only)
based on its turn on the fulfilment of attaining an
“investment-grade” credit rating from credit rating agencies.
Under the Internal Model Approach,
the risk sensitivity of regulatory capital requirements is
attained through the use of internally designed risk management
models that are subject to supervisory approval.
Given that these models usually focus on general market risk, the
treatment of the capital charge for the area of specific risk
measurement will be made separately if the internally designed
models do not encompass on top a modelling of specific risk.
A fallback on authorised external credit ratings is possible, or
else a broader treatment within the Incremental Risk Capital
charge.
Operational risk
Under all the different approaches used to measure operational
risk, there is no use of external ratings, with the exception of
the treatment of risk mitigation techniques in the Advanced
Measurement Approach (in line with the overall treatment of risk
mitigation techniques under the credit risk rules, the protection
provider must have a rating above a defined threshold).
Pillar II (Supervisory Review Process)
There is no specified use of external ratings in the context of
the Supervisory review process.
Pillar III (Market Discipline)
Pillar III requirements contain specific qualitative disclosure
requirements (among others) with respect to the use of external
credit assessment institutions (ECAIs) and Export Country Agency (ECAs).
• Credit Risk: Disclosures for
Portfolios subject to the standardised and supervisory risk
weights in the IRB approaches (see table 5 of the Revised
Framework).
Qualitative disclosure (a) Names of ECAIs and ECA used, types of
exposures for which each ECAI, ECA is used, alignment of
alphanumerical scale with each bucket or evidence of compliance
with the mapping published by relevant supervisors.
• Securitisation: Disclosure for
standardised and IRB Approaches (see table 9 of the Revised
Framework). Qualitative disclosure ( c ) Names of the ECAIs used
for securitisation and types of securitisation exposures for which
each agency is used.
Authorised external ratings and the notion of “ECAI” (External
Credit Assessment Institution)
Definition of ECAI and the principle of the “recognition”
External ratings that can be used for the capital purposes,
according to the Basel II framework, are limited to the ratings
provided by recognised External Credit Assessment Institutions (ECAI).
Supervisors are in charge of the recognition of ECAI.
The ECAI recognition process has two main
dimensions:
• Identification of the rating
agencies that provide external ratings suitable for capital
calculation purposes.
The BCBS has defined criteria in this respect (see. 4.1 below) and
supervisors are in charge of assessing whether those criteria are
satisfied by the rating agencies willing to be recognised as ECAI.
• Mapping of the external ratings to
the risk-weights (or credit quality steps in the EU CRD
implementation) defined by the Basel II framework (see. 4.2 below)
The ECAI recognition process does not constitute a form of
regulation of ECAIs by supervisors or a form of licensing of
rating agencies.
It simply aims at the determining the ratings that can be used by
banks, by ensuring that the ratings are appropriate for
supervisory and capital purposes.
Eligibility criteria
The key purpose of the recognition criteria is to identify rating
agencies that produce external credit assessments of sufficiently
high quality, consistency and robustness to be used by
institutions for regulatory capital purposes.
In order to achieve this goal, the Basel
Committee on banking supervision has defined criteria that should
be satisfied by rating agencies.
Paragraph 91 of the Basel II framework details those criteria:
•
Objectivity:
The methodology for assigning credit assessments must be rigorous,
systematic, and subject to some form of validation based on
historical experience.
Moreover, assessments must be subject to ongoing review and
responsive to changes in financial condition. Before being
recognised by supervisors, an assessment methodology for each
market segment, including rigorous backtesting, must have been
established for at least one year and preferably three years.
•
Independence:
An ECAI should be independent and should not be subject to
political or economic pressures that may influence the rating.
The assessment process should be as free as possible from any
constraints that could arise in situations where the composition
of the board of directors or the shareholder structure of the
assessment institution may be seen as creating a conflict of
interest.
•
International access/Transparency:
The individual assessments should be available to both domestic
and foreign institutions with legitimate interests and at
equivalent terms.
In addition, the general methodology used by the ECAI should be
publicly available.
•
Disclosure: An
ECAI should disclose the following information: its assessment
methodologies, including the definition of default, the time
horizon, and the meaning of each rating; the actual default rates
experienced in each assessment category; and the transitions of
the assessments, eg the likelihood of AA ratings becoming A over
time.
•
Resources: An
ECAI should have sufficient resources to carry out high quality
credit assessments.
These resources should allow for substantial ongoing contact with
senior and operational levels within the entities assessed in
order to add value to the credit assessments. Such assessments
should be based on methodologies combining qualitative and
quantitative approaches.
•
Credibility: To
some extent, credibility is derived from the criteria above.
In addition, the reliance on an ECAI’s external credit assessments
by independent parties (investors, insurers, trading partners) is
evidence of the credibility of the assessments of an ECAI.
The credibility of an ECAI is also underpinned by the existence of
internal procedures to prevent the misuse of confidential
information.
In order to be eligible for recognition, an ECAI does not have to
assess firms in more than one country.
The
mapping process
Once it has been assessed that a rating agency meets the ECAI
recognition requirements, its credit assessments are ‘mapped’ by
supervisors to the risk weights (credit quality steps)
defined by the Basel II framework, which in
turn determines the risk weight (amount of capital) to be applied
to each exposure.
The ‘mapping’ is notably based on reference defaults rates (in
particular the 3-year cumulative default rates evaluated over the
long-term), which should ensure the stability of the mapping but
also an equivalent treatment of the ratings provided by the
various rating agencies.
European specific aspects
The uses of external ratings in the CRD (Capital Requirements
Directive - the European implementation of the Basel II framework)
is fully consistent with the international rules.
Nevertheless, two significant differences can be observed :
• in the context of the standardised
approach, external ratings can also be used to risk-weight
exposures to CIUs (Collective Investment Units).
Specific risk-weights are provided for this exposure class.
• The risk-weight tables, that link credit
assessment to risk-weight, are generally more granular.
The CEBS (Committee of European Banking Supervisors) issued in
January 2006 “Guidelines on the recognition of External Credit
Assessment Institutions” which:
(i) Clarify the recognition process at the
European level, by :
• Defining a standard application form, that should be submitted
to supervisors by rating agencies willing to be recognised.
The content of the package should allow supervisors to assess the
application.
• Creating a joint assessment process, applicable to international
ratings agencies (or ratings agencies operating in more than one
country).
(ii) Present CEBS Common understanding of
the ECAI recognition criteria laid down in the CRD
A rating agency can become a recognised ECAI if a member state
supervisor determines that it meets the following criteria in one
or all of the three market segments (financial institutions,
corporate (includes public sector) and securitisations:
• Objectivity – methodology for assigning credit assessments is
systematic, rigorous, continuous, and subject to validation.
• Independence – factors taken into account include ownership and
organisational structure, financial resources, staffing and
expertise, and corporate governance.
• On-going review – responsive to changes in financial conditions
and reviewed at least annually.
• Transparency & disclosure – methodologies need to be public so
users can decided whether they are derived in a reasonable way.
In addition their credit assessments had to be:
• Credible and accepted by the market – market share, revenues,
whether pricing is on the basis of credit assessments.
• Transparent & disclosed - credit assessments need to be
available on an equivalent basis.
(iii) Precise the qualitative and
quantitative factors that should be used by supervisors when
mapping external ratings and regulatory credit quality steps.
Forecasting Exercises
from the IMF
INTERNATIONAL MONETARY FUND, Fiscal Affairs
Department
The State of Public Finances Cross-Country Fiscal Monitor
New evidence on underlying fiscal weakening in
advanced countries during the last few years.
Many advanced economies entered the crisis
with relatively weak structural fiscal positions, and these have
been eroded further, not only by anticrisis measures but also by
underlying spending pressures.
This will raise the bar on fiscal adjustment.
The outlook for emerging economies is
stronger, if fiscal tightening plans materialize in 2010.
But these countries remain exposed to considerable risks, which are
quantified through new statistical analysis.
New estimates of needed medium-term fiscal adjustment in advanced
economies
Government debt in advanced G-20 economies
is projected to reach 118 percent of GDP in 2014,
even assuming some discretionary tightening next year.
Getting debt below 60 percent
by 2030
will require raising the average structural primary balance by 8
percentage points of GDP relative to 2010 (10½ percentage points for
the headline primary balance).
Action will be needed on entitlement spending, on other spending,
and on revenues.
Japan, the United Kingdom, Ireland and Spain
are projected to require the largest fiscal adjustment.
Only Denmark, Korea, Norway, Australia and Sweden
among advanced economies will require little or no medium-term
adjustment to keep debt stocks at safe levels.
What
is the “Volcker Rule” for Financial Institutions?
President Obama has called for new restrictions on the size and scope of
financial institutions to rein in excessive risk-taking and protect
taxpayers.
The proposed legislation is called the “Volcker Rule” in recognition
of the efforts of former Federal Reserve Chairman and current
President’s Economic Recovery Advisory Board Chairman Paul Volcker.
Paul Adolph Volcker, an American economist, was the Chairman of the
Federal Reserve under United States Presidents Jimmy Carter and
Ronald Reagan (from August 1979 to August 1987).
The
Volcker Rule
seeks to reenact to some extent the Glass-Steagall Act
that separated commercial and investment banking.
Obama Called for New Restrictions on Size and Scope of Financial
Institutions to Rein in Excesses and Protect Taxpayers
President Obama joined
Paul Volcker, former chairman of the
Federal Reserve; Bill Donaldson, former chairman of the Securities
and Exchange Commission; Congressman Barney Frank, House Financial
Services Chairman; Senator Chris Dodd, Chairman of the Banking
Committee and the President's economic team to call for new
restrictions on the size and scope of banks and other financial
institutions to rein in excessive risk taking and to protect
taxpayers.
The President’s proposal would strengthen the comprehensive
financial reform package that is already moving through Congress.
“While the financial system is far stronger today than it was a year
one year ago, it is still operating under the exact same rules that
led to its near collapse,” said President Barack Obama.
“My resolve
to reform the system is only strengthened when I see a return to old
practices at some of the very firms fighting reform; and when I see
record profits at some of the very firms claiming that they cannot
lend more to small business, cannot keep credit card rates low, and
cannot refund taxpayers for the bailout. It is exactly this kind of
irresponsibility that makes clear reform is necessary.”
The proposal would:
1.
Limit the Scope
- The President and his economic team will work with Congress to
ensure that no bank or financial institution that contains a bank
will own, invest in or sponsor a hedge fund or a private equity
fund, or proprietary trading operations unrelated to serving
customers for its own profit.
2.
Limit the Size
- The President also announced a new proposal to limit the
consolidation of our financial sector. The President’s proposal will
place broader limits on the excessive growth of the market share of
liabilities at the largest financial firms, to supplement existing
caps on the market share of deposits.
In the coming weeks, the President will continue to work closely
with Chairman Dodd and others to craft a strong, comprehensive
financial reform bill that puts in place common sense rules of the
road and robust safeguards for the benefit of consumers, closes
loopholes, and ends the mentality of “Too Big to Fail.”
Chairman
Barney Frank’s financial reform legislation, which passed the House
in December, laid the groundwork for this policy by authorizing
regulators to restrict or prohibit large firms from engaging in
excessively risky activities.
As part of the previously announced reform program, the proposals
announced today will help put an end to the risky practices that
contributed significantly to the financial crisis.
Obama Announced Economic Advisory Board
President Barack Obama signed an
executive order establishing the new Economic Recovery Advisory
Board.
Modeled on the Foreign
Intelligence Advisory Board created by President Dwight D.
Eisenhower, the Board will provide an
independent voice on economic issues and will be charged with
offering independent advice to the
President as he formulates and implements his plans for economic
recovery.
The Economic Recovery Advisory Board will provide regular briefings
to the President, Vice President and their economic team.
The Board will be
established initially for a two-year term, after which the President
will make a determination on whether to extend the work of the
Board.
Members of the Board are distinguished
citizens outside the government who are qualified on the
basis of achievement, experience, independence, and integrity.
The Board will bring a
diverse set of perspectives and voices
from different parts of the country and different sectors of the
economy to bear in the formulation and evaluation of economic
policy.
The Board will meet regularly and provide advice directly to the
President on the programs to jump-start economic growth and
facilitate economic stability. The Board will also focus on how the
response to the short-run economic crisis is laying the groundwork
for the reforms necessary for longer-run prosperity.
Members of the Board include:
William H. Donaldson, Chairman, SEC (2003-2005)
Roger W. Ferguson, Jr., President & CEO, TIAA-CREF
Robert Wolf, Chairman & CEO, UBS Group Americas
David F. Swensen, CIO, Yale University
Mark T. Gallogly, Founder & Managing Partner, Centerbridge Partners
L.P.
Penny Pritzker, Chairman & Founder, Pritzker Realty Group
Jeffrey R. Immelt, CEO, GE
John Doerr, Partner, Kleiner, Perkins, Caufield & Byers
Jim Owens, Chairman and CEO, Caterpillar Inc.
Monica C. Lozano, Publisher & Chief Executive Officer, La Opinion
Charles E. Phillips, Jr., President, Oracle Corporation
Anna Burger, Chair, Change to Win
Richard L. Trumka, Secretary-Treasurer, AFL-CIO
Laura D'Andrea Tyson, Dean, Haas School of Business at the
University of California at Berkeley
Martin Feldstein, George F. Baker Professor of Economics, Harvard
UniversityDear members,
Write in your CV, resume,
websites etc. that you are members of the Basel ii
Compliance Professionals Association (BCPA).
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