The Pakistan Credit Rating Agency Limited

Transcription

1 RULES OF THE GAME CREDIT RATING PRACTICES CONTENTS Section Title Page # 1 Regulatory Regime An Overview 1 2 Legislative Framework supporting credit ratings- Securities and 1 Exchange Board (SECB) regulations for credit rating agencies Eligibility as external credit assessment institution (ECAI) Bangladesh Bank (BB) criteria 7 MAY 2010

2 1. REGULATORY REGIME AN OVERVIEW A comprehensive set of Credit Rating Rules 1.1 The Securities and Exchange Commission (SEC) of Bangladesh holds a central position in the regulatory regime in Bangladesh. SEC was established in 1993 under the Securities and Exchange Commission Act, The Chairman and Members of the commission are appointed by the government and have overall responsibility to administer the securities legislation. The commission is a statutory body and attached to the Ministry of Finance. 1.2 In 1996, a comprehensive set of credit rating rules, titled CREDIT RATING COMPANIES RULES, 1996 were issued by SEC. Later on, in November 2009, amendments, termed NOTIFICATION by SEC, were made in the rules in the form of adding further rules and regulations in addition to the existing ones, which remained intact. 1.3 On September 23, 2008, BB issued a comprehensive set of guidelines i outlining the eligibility criteria for ECAIs. The BB provides a parallel layer of regulation to the credit rating industry. 2. LEGISLATIVE FRAMEWORK SUPPORTING CREDIT RATINGS 2.1 Bangladesh has adequate support from both the BB and SEC legislature for various dimensions relating to the credit rating business: WHEN Credit Ratings become MANDATORY in Bangladesh? SEC credit rating rules A comprehensive set of guidelines and legislature Bangladesh Bank (BB) - Instrumental in promoting the use of credit ratings Legislature SEC Credit Rating Agencies Rules 1996 ii SEC Rights Issue Rules, 2006 iii SEC Asset Backed Security Issue Rules, 2004 iv Bangladesh Bank (circulars) Chief Controller of Insurance vii (circulars viii ) Mandatory Ratings Public offering of all debt instruments (bonds, debentures, commercial papers, structured finance asset/mortgage backed securities) and preference shares Public issue of shares at a premium All rights issue (of a public listed company) at premium Credit rating of asset pools to be securitized Optional requirements of credit rating of the originator. All scheduled Banks on an annual basis v All financial institutions vi in case of IPO All general insurance companies on an annual basis All life insurance companies on biannual basis 2.2 The RULES OF THE GAME in the credit rating business emanate from the regulator s (SEC) policies. These are outlined in the following areas with an explanation for each sub-area. It should be noted that Only key areas are highlighted with explanation provided for rules and regulations found different from the norms existing in Pakistan s credit rating industry. A credit rating agency (CRA) is termed credit rating company (CRC) in SEC s rules and, hence the rest of the document uses the term CRC to denote a CRA. I What are Regulations governing the business of CRCs? RATING REGULATORY FRAMEWORK Page 1 of 10

3 i Are Ratings Mandatory in Bangladesh? ii What conditions are to be fulfilled for a New Entrant CRC? iii What makes a CRC fall from SEC favor? iv What is the scope of SEC s directives to a CRC? v What are the periodic submissions from a CRC to SEC? 2.3 Are Ratings MANDATORY in Bangladesh? For a list of which ratings constitute mandatory ratings (See Section 2.1 above). In all such cases, the common denominator is solicitation of general public s money and, hence, the credit rating serves as an independent opinion on the credit risk present therein. 2.4 What conditions are to be fulfilled for a new entrant CRC? Incorporation as a public limited company A minimum paid-up capital of BDT 5,000,000 (USD 0.1mln ix ) A joint venture / technical collaboration with a reputed CRC A pristine professional and ethical record with no criminal history on the part of any director, officer or employee Human Resource requirements include: (i) At least two staff members (with finance-related educational qualification) with minimum two years experience in credit ratings / investment advisory, (ii) appointment of a compliance officer within six months of establishment The functions of a compliance (as mentioned in these rules) officer include: (i) submitting a report on compliance of the securities related laws, rules, regulations, etc. by the Credit Rating Company to SEC and the CRC in the format and in the time prescribed by the SEC from time to time. 2.5 What makes a CRC fall from SEC favor? Any non-compliance with SEC rules OR any conduct deemed detrimental in the public interest would result in suspension or outright cancellation of a CRC s license The CRC is given the right of defense (hearing) before such a decision. 2.6 What is the scope of SEC s directives to a CRC? SEC s scope of directives to the CRCs is mainly regulatory. However, within this purview, it may, if deemed necessary in public interest, make directives in the rating methodologies of the CRC as well. 2.7 What are the periodic submissions from a CRC to SEC? Within fifteen (15) days of the close of each quarter, every CRC is to submit to SEC a report giving such details of credit rating (in the substance and form specified by SEC) Any other document, information or explanation relating to the CRC s affairs as SEC might require from time to time. II What are the key CODES of conduct to be followed by a CRA? vi What are some key measures of the quality of the rating process? vii How is surveillance (monitoring of outstanding ratings) and rating updating exercises carried out? RATING REGULATORY FRAMEWORK Page 2 of 10

4 viii How to maintain the integrity of the Rating Process? ix How does a CRC maintain its independence and avoids conflict of interest? x What are some key CRC procedures and policies (to discourage rating shopping practices)? xi How to ensure Analyst and Employee Independence? xii What are the key CRC Responsibilities to the Investing Public and Issuers? xiii How to go about the disclosure of these rules? 2.8 What are some key measures of the quality of the rating process? Each credit rating report has reference to the particular methodology or methodologies that have been followed in formulating that rating opinion The Rating Committee (RC) reviews the rating criteria, methodology and models at least once every year and makes necessary amendments The CRC s RC comprised of a minimum of five members including two senior analysts having requisite knowledge and experience The CRC maintains internal records including: (i) workings of the analysts, and (ii) proceedings of the RC meetings concerning its rating decisions for a period of at least five years after expiry of validity of the concerned rating The CRC structures its rating teams for an assignment composed of at least two analysts in order to make objective assessment with different viewpoints. A rating analyst is assigned to a certain area or industry for a minimum period of time as determined by the CRC, in order to promote consistency in the rating evaluation. However, an analyst may be assigned to more than one area or industry simultaneously The CRC forms an Internal Review Committee (IRC) comprising of appropriate professionals (the reporting lines and place in the organizational structure of this committee is not clear from the rules), whose function is to doublecheck the documents and information on which the analysts make ratings. The idea is to avoid issuing ratings on the basis of analysis or reports that contain misrepresentations or are otherwise misleading It may be inferred from the description of this function that it is within the IRC s purview to comment upon the quality of the rating process and analysis underlying a rating opinion. As such, it is distinct and separate from the compliance function, which oversees only whether the rating process was executed or not in its entirety. 2.9 How is surveillance (monitoring of outstanding ratings) and rating updating exercises carried out? Inside the rating mandate, the terms and conditions of surveillance are clearly spelled out. Based on these, subsequent to an agreement for entity rating, surveillance rating (a rating update exercise) is carried out at least for the next three years after the initial rating. Thus, one initial rating and three surveillance rating periods constitute ONE CONTRACT PERIOD A rating agreement, once executed, cannot be terminated before performing the initial rating and three continuous surveillance ratings. In case, a termination by any party is intended prior to the conclusion of the contract period, an application has to be made to SEC Once a rating is assigned and announced, the minimum monitoring frequency RATING REGULATORY FRAMEWORK Page 3 of 10

5 for the CRC is bi-annually for entities and quarterly for instruments. When a CRC makes a rating available to the public, the CRC announces, on its public website, the initial rating, monitoring reports (summary reports) and periodical surveillance ratings How to maintain the integrity of the Rating Process? The CRC conducts seminars and training programs to enhance the capabilities of its rating analysts CRCs prohibit themselves and their analysts from designing the structure of structured finance products that they rate The CRC employs a formal whistle-blowing policy. Upon becoming aware that another employee / entity under common control with the CRC is or has engaged in any conduct that is illegal, unethical or contrary to the laws, guidelines and internal and external standards and code of conducts etc., a CRC employee shall report such information immediately to the Compliance Officer. CRC management shall prohibit retaliation by other CRC staff or by the CRC itself or by any of its directors against any employee who, in good faith, makes such reports How does a CRC maintain its independence and avoids conflicts of interest? For avoidance of conflict of interest and to ensure independence at the time of credit rating activity, a number of formal undertakings / declarations are required at the level of various tiers across the CRA. These are: i Undertaking/Declaration in Form-III to be made by the member of Board of Directors on election and assumption of the position as the member of the Board of Directors. ii Affidavit in Form-IV to be sworn in by the employee/official at the time of joining the service. iii Undertaking/Declaration in Form-V to be made by the employee/official to be made at the time of engagement in the Credit Rating Assessment for a particular entity iv Letter of Withdrawal in Form-VI to be made by an employee/official if he/she faces any conflict of interest or pressure during performing his/her duties v Undertaking/Declaration in Form-VII to be made by the employees/officials after the Credit Rating Assessment is completed On the basis of the above undertaking/ declaration, the Chief Executive Officer (CEO) of the CRC certifies (apparently in the form of a written letter to be placed in the rating assignment file) that the rating is done independently, free from any conflict of interest, and economic, social, political or any other pressures Also, on the basis of above undertaking/ declaration, the CEO ensures that no employee, with a conflict of interest, is engaged with that particular rating activity. Furthermore, if a board member is found to be a member of the BOD of another entity, the CRC refrains itself from any type of rating activity to that particular entity What are some key CRC procedures and policies (to discourage rating shopping practices)? A CRC has to disclose publicly all such cases where an organization has provided it with final data and information to obtain a preliminary rating, however: i Does not contract with the CRC for a final rating, at the same time, contracting with another CRA for a final rating of the same rating assignment; or ii Contracts with the CRC for a final rating and does not publish the CRC s final RATING REGULATORY FRAMEWORK Page 4 of 10

6 rating, at the same time, publishes the ratings of another CRC for the same rating assignment How to ensure analyst and employee independence? A CRC / any of its analyst / employee is not to buy or sell or engage in any transaction in any listed security or derivative other than holdings in diversified collective investment schemes (mutual funds) In case, a portfolio of such securities already exists, then a written notice has to be sent simultaneously to SEC and the stock exchanges. (Though, the rules do not require compulsory divestment) At the time of voluntary intended divestment of such portfolio, again, a comprehensive notification has to be sent to the regulator and the stock exchange at least seven working days prior to actual transaction. The aforementioned is also applicable to the directors of the CRA Moreover, in case the CRA has entered into a rating agreement with a company, securities of which are held by the CRA in its portfolio of investment at the time of signing of such agreement, the CRA is to make a disclosure to the SEC and the stock exchanges within three working days of signing of this agreement The directors of CRC are to disclose the respective holding position of securities (pertaining to the security for which the CRC has signed the rating mandate) as well as trading in listed securities by each of them on a half-yearly basis on the public website of the CRC, simultaneously with a copy to the SEC What are the key CRC Responsibilities to the Investing Public and Issuers? The CRC publishes the rating in its public website when it issues or updates a final rating or discontinues with a rating, except for private rating where there is contractual agreement with the entity not to do so For each rating, the CRC discloses whether the entity participated in the rating process. For each rating not initiated at the request of the issuer, the CRC discloses whether the issuer participated in the rating process. The CRC also discloses its policies and criteria regarding unsolicited ratings How to go about the disclosure of these rules? The CRC establishes an internal function charged with communicating with market participants and the public about any questions, concerns or complaints that the CRC may receive. These are non-client calls. The objective of this function is to help ensure that the CRC s officers and management are informed of those issues that the CRC s officers and management would want to be made aware of when setting the CRC s policies The CRC observes comprehensive disclaimer requirements for reports furnished to the SEC and stock exchanges What are the public disclosure requirements for a CRC? The following information is mandatorily required to be in the public domain, through the CRC s / ECAI s official website: For Both CRCs and ECAIs: i Rating methodologies, standards and assumptions. Any material modification to its methodologies and significant practices, procedures, and processes. Where feasible and appropriate, disclosure of such material modifications is made prior to their going into effect. RATING REGULATORY FRAMEWORK Page 5 of 10

7 ii Written procedures for obtaining ratings according to the rating methodology iii In case of a public rating, the initial rating, monitoring reports and periodical surveillance ratings iv Code of conduct for employees v Receipt of 10 percent or more of the annual revenue from a single entity or a group vi All such cases where an organization has provided the CRC with final data and information to obtain a preliminary rating of an entity or issue, but: (1) does not contract with the CRC for a final rating and does contract with another CRC for a final rating of the same product/entity; or (2) contracts with the CRC for a final rating and does not publish the CRC s final rating, but does publish the ratings of another CRC for the same product/entity vii The directors holding position of such securities (companies) that have signed a rating mandate with the CRC as well as trading in listed securities by each of them on a half-yearly basis viii All public ratings when they are issued or updated, a final rating or discontinuation of a rating ix In order to promote transparency and to enable the market to best judge the performance of the ratings, the CRC, where possible (the use of the term wherever possible apparently refers to the CRC having few years of rating history in order to make the study meaningful) publishes sufficient information about the historical default rates of CRC rating categories and whether the default rates of these categories have changed over time along with the methodology used for calculating default rates. This information includes verifiable, quantifiable historical information about the performance of its rating opinions, organized and structured, and where possible, standardized in such a way as to assist investors in drawing performance comparisons between different CRCs For ECAIs x ONLY: x Definition of Default xi The ECAIs schedule of credit rating fees annually III What are the key Inspection and investigation procedures of a CRC? xiv Does SEC have any right to inspect or investigate a CRC? xv Is a Notice served to the CRC before inspection or investigation? xvi What are the obligations of a CRC on inspection or investigation? xvii What are SOME OTHER KEY dimensions related to the investigation of a CRC? 2.17 Does SEC have any right to inspect or investigate a CRC? The SEC has ALL the right to inspect and investigate a CRC. For this purpose, the SEC may appoint one or more persons as inspecting or investigating officers. An investigation by SEC could be prompted in the following instances: To ascertain whether the books of account, records and documents are being maintained properly To ascertain whether the provisions of these Rules are being complied with To investigate into complaints received from investors, clients or any other RATING REGULATORY FRAMEWORK Page 6 of 10

8 person on any matter having a bearing on activities of the CRC In the interest of the securities market or in the interest of investors The inspection or investigation ordered under ordinarily does not go into an examination of the appropriateness of the assigned ratings, until and unless, prompted by an investor complaint. In the latter case, the investigation is carried out by a designated officer of the SEC or independent expert with relevant experience or combination of both Is a Notice served to the CRC before inspection or investigation? Before ordering an inspection or investigation, SEC gives not less than three days written notice to the CRC. However, where SEC is satisfied that in the interest of the investors, no such notice should be given, it may, by an order in writing, direct that the inspection or investigation be taken up without such notice During the course of an inspection or investigation, the CRC is bound to discharge all its obligations as contained in the SEC rules What are the obligations of a CRC on inspection or investigation? It is the duty of the CRC, its employees and directors to extend full cooperation to SEC. Specifically, the CRC is required to: Allow the investigating officer to have reasonable access to its premises Extend reasonable facility for examining any books, records, documents and computer data Provide copies of documents or other materials which, in the opinion of the investigating officer, are relevant for the purposes of the investigation 2.20 What actions are taken by the SEC upon the completion of the investigation? Subsequent to completion of investigation, the inspecting officer submits a comprehensive report to the SEC. The SEC, after consideration of inspection or investigation report, may take appropriate action under the SEC Ordinance Under this ordinance, penalties may include monetary fines as well as revocation of license. 3. ELIGIBILITY AS EXTERNAL CREDIT ASSESSMENT INSTITUTION (ECAI) BB CRITERIA Criteria laid out by Bangladesh Bank 3.1 BB, in December 2008, issued guidelines on the New Capital Adequacy Framework xi to banks operating in Bangladesh based on the Basel II framework. Under the standardized approach for measuring credit risks, the risk grades are determined on the basis of ratings assigned by the ECAIs. 3.2 At present, two rating agencies in Bangladesh have been designated as eligible ECAIs. These are: i Credit Rating Information and Services Limited (CRISL), and ii Credit Rating Agency of Bangladesh Limited (CRAB) 3.3 The following six parameters are considered in determining the eligibility of an ECAI: i Objectivity ii Independence iii International access / transparency iv Disclosure v Resources RATING REGULATORY FRAMEWORK Page 7 of 10

9 vi Credibility 3.4 Mapping Process: BB s ECAI eligibility criteria are more detailed in terms of the mapping of the risk weights to the rating categories of an ECAI. In this regard, BB considers both qualitative and quantitative measures. It is not mentioned as such in the eligibility criteria but it may be inferred that the frequency of reviewing the mapped risk weights to the rating categories of an ECAI by BB is ANNUAL, unless otherwise warranted through special circumstances For quantitative factors, BB evaluates the consistency of an ECAI's rating category (Notch/Notation) through analysis of Cumulative Default Rate (CDR). CDR is the measure of movement of a rating category into 'Default Rating Category during a time period. The transition of individual notch/notation towards default rating category observed in a particular ECAI rating category is compared to the standards available domestically/regionally/ internationally BB uses two benchmark CDRs namely monitoring level CDR and a trigger level CDR in interpreting whether a CDR falls within an acceptable range for a rating category to qualify for a particular risk-weight. BB has adopted the two benchmarks of CDR standard in line with domestic/regional/international standard. In this connection, Basel Committee standards are specified in the following table for information: Exceeding the trigger level benchmark implies that transition of an ECAI's notch/notation towards default rating is considerably above the domestic/regional/international standards. If the observed three-year CDR exceeds the trigger level in two consecutive years, the ECAIs rating category would be degraded Newly established ECAIs who have only a short history of transition and default data are required to provide a projection of the ten-year average of the threeyear CDR on the basis of two most recent CDRs Furthermore, Definition of 'Default Rating' has an impact on the assessment of CDR. ECAI is required to declare definition of 'default rating' at their website and submit a copy to BB. Subsequently, if any amendment on the same is made must be reported to BB with due justification as to the change In terms of qualitative factors, criteria under qualitative factors is be set by BB's working group to assess different rating methodology and their scoring standard forms the necessary basis of the mapping process. Quantitative data may be inconclusive for mapping risk weights, in that situation qualitative criteria may be the only basis of mapping risk weight. 3.5 Guidelines applicable to banks regarding nomination of ECAIs: A key guidelines in this regard is that if any bank or a client has reasonable ground sufficient to raise question about ECAIs assessment of the credit rating, they may inform BB in writing with valid explanation. BB shall look into the matter and take necessary step(s) as it deems fit. 3.6 BB, in its eligibility criteria, also issues some general instructions for ECAIs, that are as follows: i The ECAI(s) would disclose credit ratings of related parties quarterly to BB RATING REGULATORY FRAMEWORK Page 8 of 10

10 after the assessment is finalized. All the ratings would be supported by declaration (duly signed by CEO) that the ratings are independent and free from conflict of interest. Such statement would be based upon the declaration made by each member/official related to rating activities ii The ECAIs should have a unique pricing system for credit rating. They should disclose their schedule of credit rating fees annually iii The ECAIs would follow the IOSCO/SEC Code of Conduct 3.7 Mapping of CRISL and CRAB ratings with BB Rating Grade is be as follows: BB Rating Grade Equivalent Rating OF CRISL CRAB Risk weights for claims on corporates xii 1 AAA AAA 20% 2 AA+, AA AA1, AA2 50% 3 AA-, A+, A, A- AA3, A1, A2, A3 100% 4 BBB+, BBB, BBB- 5 6 BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC- CC+, CC, CC-, C+, C, C-, D BBB1, BBB2, BBB3 BB1, BB2, BB3, B1, B2, B3, CCC1, CCC2, 100% 150% CCC3, CC, C, D 150% Unrated % Source: Bangladesh Bank xiii 3.8 In Bangladesh, the following conditions are to be fulfilled for an external rating by an ECAI to be used for BASEL II capital savings purpose: The rating agreement must be made between the issuer and the CRA The rating must be solicited The rating must be accepted by the client 3.9 In terms of CRA s practices, the following are in vogue: Banks typically request and refer their clients for ratings for BASEL II purposes to the CRAs The rating fee is paid by the CRA client (borrower). This is despite the fact that the BB guidelines do not differentiate between fee paid either by the bank or the ratee. However, as per general practice prevalent amongst Bangladesh s ECAIs, the fee for the external rating to be used by the bank is paid by the borrower RATING REGULATORY FRAMEWORK Page 9 of 10

11 i BRPD Circular No Guidelines for recognition of eligible External Credit Assessment Institutions (ECAIs), dated September 23, 2008 ii Credit Rating Companies Rules, 1996 (Notification No. SEC/Section-7/117, Dated 24th June 1996) Chapter II; Clause 3 iii SEC (Rights Issue) Rules, 2006, Section 3 (g) iv SEC (Asset Backed Security Issue) Rules, 2004, Section B (VII and VIII) v Prudential Regulations for Banks: Selected Issues Updated till June, 2009, Section (Credit Ratings); p BRPD Circular No. 06 dated July 5, 2006 vi financial institution means such non-banking financial institutions, which: i) make loans and advances for industries, commerce, agriculture or building construction; or ii) carry out the business of underwriting, receiving, investing and reinvesting shares, stocks, bonds, debentures issued by the Government or any statutory organization or stocks or securities or other marketable securities; or iii) carry out installment transactions including the lease of machinery and equipments; or iv) finance venture capital; and shall include merchant banks, investment companies, mutual associations, mutual companies, leasing companies or building societies (Source: BB s Financial Institutions Act, 1993) vii Insurance companies in Bangladesh come under the Ministry of Commerce and have been governed by the Chief Controller of Insurance of the Department of Insurance. At present, there is no regulatory body for insurance in Bangladesh. As per a news report (Cabinet approves new insurance laws Weekly Economic Times) dated May 23, 2010, the government (cabinet body) has approved new insurance draft laws on May 22, 2010 to replace the 71-yearold ones. Two acts -- Insurance Regulatory Authority (IRA) Act 2009 and Insurance Act have been approved at the Cabinet meeting. The laws, drafted on the basis of the ordinances promulgated during the caretaker rule, will now be sent to the law ministry for vetting before sending those to parliament. With the enforcement of the IRA Act 2009, the Department of Insurance will no longer exist and the sector will get rid of the Insurance Act, 1938 once the IO 2008 comes into effect. If the laws are finalized, insurance companies in Bangladesh would come under the purview of the Ministry of Finance, as is the practice worldwide viii The Chief Controller of Insurance took steps in 2007 to make credit ratings compulsory for insurance companies ix USD/PKR = x These ECAI-specific requirement for public dissemination stems from BB s eligibility criteria for BB titled Guidelines for recognition of ECAIs Section 2 (a-viii), p. 5 and Section 6 (6.2), p. 7 xi BRPD Circular 09, dated xii Any claim on a corporate, as per BB, includes all exposures including loans and advances to and investments in a corporate. The term Corporate refers to any proprietorship, partnership or limited company that is neither a public sector enterprise (PSE), Bank, Non bank financial Institutions (NBFIs) nor borrower within the definition of retail portfolio and Small Enterprises. Retail is defined as any individual exposure whose maximum value does not exceed 0.2% of the overall retail or BDT 7.5mln, whichever is lower. Small enterprise has been categorized in: (i) Trading concern, (ii) Services concern, and (iii) manufacturing concern. All three categories share similar criteria. In general terms, it means an enterprise which is ideally not any public limited company and has total fixed assets, excluding land and building, amounting to a maximum of BDT 15mln and/or working manpower not exceeding 25 persons xiii BRPD Circular No. 05, dated April 29, 2009 Analysts Humaira Jamil humaira@pacra.com Shahzad Saleem shahzad@pacra.com Disclaimer: PACRA has used due care in preparation of this document. Our information has been obtained from sources we consider to be reliable but its accuracy or completeness is not guaranteed. PACRA shall owe no liability whatsoever to any loss or damage caused by or resulting from any error in such information. None of the information in this document may be copied or otherwise reproduced, stored or disseminated in whole or in part in any form or by any means whatsoever by any person without PACRA s written consent. Our reports and ratings constitute opinions, not recommendations to buy or to sell RATING REGULATORY FRAMEWORK Page 10 of 10