Call for Evidence on Competition, Choice and Conflicts of interest in the credit rating industry: aba response

Transcription

1 aba Arbeitsgemeinschaft für Call for Evidence on Competition, Choice and Conflicts of interest in the credit rating industry: aba response Responses to the questions 6 Questions for investors and other users of credit ratings 6.1 About your organisation 58. The questions in this part aim to obtain information about the nature of the organisation you represent and the different markets in which you are active. This information will help ESMA to put your responses in context and to compare responses from similar respondents. Q1: Please provide the name of your organisation. Arbeitsgemeinschaft für (aba) Q2: Please explain whether you invest in instruments with credit ratings at local, national, EU and/or global level. If your organisation invests in instruments at EU or global level, please provide a list of the jurisdictions covered. The aba itself is not an institutional investor, but the German association representing all matters concerning occupational pensions in the private and public sector. The aba has 1,200 members including corporate sponsors of pension schemes, IORPs, actuaries and consulting firms, employer associations and unions, as well as insurance companies, banks and investment managers. According to our statutes, our mission is to represent existing schemes as well as to expand coverage of occupational pensions independent of vehicle. Q3: Please explain whether you invest in CRAs or related companies, and if so, provide a list of these and your percentage shareholding in each. As stated above, the aba is not an institutional investor.

2 aba Arbeitsgemeinschaft für Seite Due diligence and use of credit ratings 59. The CRA Regulation aims to increase investor protection and reduce reliance on credit ratings through a number of transparency and disclosure requirements. 60. The questions in this part aim to understand what impact the CRA Regulation has had on how you use credit ratings in the course of your business and whether there is other information which you could use to assess credit risk instead of credit ratings. Q4: Please explain the due diligence process you follow and the types of information you consider in order to decide which instruments to invest in. The direct investments of most German IORPs cover predominantly bonds that have special collaterals such as covered bonds (German Pfandbriefe ) or bonded loans (German Schuldscheindarlehen ) or whose issuing bank is member of a protection scheme. Other asset classes are mostly organized via indirect investments (see answer to Q7). Of course, external ratings are a very important instrument within the investment process and the assessment of credit risk of IORPs, not only for regulatory reasons but also because of the in general high quality of ratings by credit rating agencies due to specialization and informational advantages (see also our response to Q9). But for the kinds of assets described above a variety of information and criteria in addition to external ratings are assessed by default to check for credit risks, amongst others: issuer, kind of issue, amount, duration, coupon/return financial indicators such as total assets, minimum standards regarding annual surplus, own capital ratio and core capital ratio (and trends), business model, legal form / structure of owners, protection schemes / loss-sharing agreements, details of the coverage funds / collaterals (excess coverage relative to legal requirements, minimum standards regarding the rating or default rates of assets), an external rating (if available) and plausibility check (by comparison with other external ratings if available or by using rating publications). Most German IORPs also consider current publicly available information or analyses that might not have been available at the time of the rating being published (media, research, etc.) for their investment process and internal risk analyses (for example trade press; website of the issuer, bank research, special websites for institutional investors with assessments covering individual issuers, the Covered Bond Newsletters, development of cover funds of German Pfandbriefe, Staatencompass, Credit-Newsletter (see answer to Q6 for more detail). German IORPs rarely use raw data to do the calculations themselves. IORPs have stipulated by prudential regulation - a clearly structured and well documented investment process. Regarding the process a first internal asset manager (member front office) collects and checks the information and criteria described above and gives an assessment if to buy the respective bond or loan. A second asset manager checks the data (four-eyes principle). If all criteria are fulfilled the asset manager is allowed to buy; if not all criteria are fulfilled the risk management and the head of asset management department have to approve the buying decision.

3 aba Arbeitsgemeinschaft für Seite 3 Q5: Please explain whether your overall use of credit ratings in the course of your business or in making investment decisions has increased or decreased since 2010, giving reasons for your answer. From our perspective the use of ratings has remained on a similar level, but in practice formal processes (mostly documentation) have been extended. As described above (see Q4) external ratings have been and still are a very important instrument within the investment process and the assessment of credit risk for IORPs that regulation should continue to allow in the future. But by default German IORPs have assessed for the directly invested asset classes (covered bonds, etc.) a variety of information and criteria in addition to external ratings to check for credit risks and still do so. Within these asset classes no essential problems with the accuracy of ratings could be seen and thus the use of ratings of IORPs in their investment process has not essentially changed since Taking a broader view we believe that credit rating agencies caused problems in the area of structured products such as collateralised debt obligations (CDO) and collateralised loan obligations (CLO). Credit rating agencies were involved in both the design and credit assessment of these products. Since they had a financial stake in these products, they were exposed to moral hazard. Doubts regarding the quality of these products together with the growing scarcity of liquidity led to a collapse of the respective markets. From our perspective in addition to the retention requirement for originators CRA III introduced several measures with regard to originators of securitized products and to rating agencies to separate product creation and product rating even more and to avoid conflict of interest. It is now important that the credit rating agencies comply with these rules and do not get involved in product creation. In addition to separating product creation and credit rating, several other regulatory measures have been taken to mitigate the risk of future failure of credit ratings. Most important from our perspective was the introduction of an issuance calendar for sovereign debt (at the end of the calendar year stating the planned ratings for the following year) and the supervision of rating agencies (i.e. additional reporting requirements and the introduction of a legal liability of rating agencies or the new rules regarding investments in rating agencies) in the context of CRA III. Q6: Please explain whether and if so what information you use to assess the quality of credit ratings. Overall, IORPs tend to use publicly available data or analyses for their internal risk analyses, they rarely use raw data to do the calculations themselves. To give an overview: 1) Analysis of publicly available press clippings and research publications - Trade press (e.g. Börsenzeitung in Germany); website of the issuer (e.g. for annual financial statement, risk management reports) - Research departments in banks provide extensive analyses, which could be used for internal credit assessments; e.g. on special websites for institutional investors (for example assessments covering individual issuers, the Covered Bond Newsletters, development of cover funds of German Pfandbriefe, Staatencompass, Credit-Newsletter). 2) Analysis of the key contractual data 3) Use of additional market data such as CDS or credit spreads where available.

4 aba Arbeitsgemeinschaft für Seite 4 4) Assessment of creditworthiness by asset managers and investment management companies - Asset managers and investment management companies often have their own credit processes. In this case it could be possible that the already existing information is used as an additional creditworthiness assessment within the internal process. 5) Plausibility check of one external rating by comparison with another external rating where available. Thus we strongly support the introduction of the European Rating Platform in summer 2015 including the information of the current European databases CEREP and SOCRAT (issuance of new ratings; upgrades; downgrades; assignation or removal of an outlook; rating affirmations; defaults; withdrawals; change in the solicitation status, ) and further comprehensive information on ratings especially credit ratings on all the rated financial instruments, not just issuer ratings as in CEREP. Q7: Please explain whether and if so to what extent you use internal rating models in addition to or instead of credit ratings in your business or investment decisions. IORPs generally use external ratings for their credit risk assessment of issuers; ratings are therefore important for the asset allocation of IORPs. However, for this question it is important to distinguish between direct and indirect investments. Direct investments cover securities bought by the IORP directly based on its own inhouse investment process. Indirect investments cover securities bought through an external fund manager, whereby the investment process is outsourced to the manager. For indirect investments, which are managed by specialised asset managers, we see the investment management company (in Germany: KVG) or the asset managers as solely responsible for the observation and the use of credit ratings in line with the respective investment guidelines. This position is also held by BaFin as German competent supervisory authority in its advice (see Bundesanstalt für Finanzdienstleistungsaufsicht, Requirements for Insurance Companies and IORPs) 1. It should be ensured through the respective investment committee or the rules laid down in the specific fund conditions that the investment management company complies with the supervisory and individually set requirements regarding credit ratings and assessment of creditworthiness. It is standard practice for IORPs to require written confirmation of compliance with legal requirements. In discussing individual investments the IORP might instruct the investment manager to deviate from the proposed allocations, to refrain from buying securities from certain issuers (even though their credit rating might be acceptable) or to tolerate passive guideline-breaches by continuing to hold recently downgraded investments. Summing up, overruling is possible and IORPs are currently doing it. Moreover, it is understood that in actively managed investment mandates, the manager has a credit research process in place which ensures that investment decisions are not purely based on external ratings. Regarding direct investments, from our perspective the respective requirements of BaFin (see again the BaFin requirements) 2 are adequate and could be considered good practice across the EU, in particular the required plausibility checks (Plausibilisierung). IORPs would welcome if rating agencies were required to provide their rating reports free of additional charge to them, so that they could be used as a basis for the plausibility checks. 1 BaFin Notes on the use of external ratings and on making own credit risk assessments 2 BaFin Notes on the use of external ratings and on making own credit risk assessments

5 aba Arbeitsgemeinschaft für Seite 5 While there are important differences between direct and indirect investments, we would like to stress that investment decisions of IORPs in both instances are never based exclusively on credit ratings. Nevertheless the use of an external rating should be possible at least in cases where other external ratings are available for plausibility checks. Q8: Do issuers or CRAs currently give you more information about how their credit ratings are developed, issued and revised and how their credit ratings compare to the market performance of the rated instruments than they did before 2010? If so, does this additional information make it easier for you to understand and compare: (1) the ratings products and other services being offered by different CRAs; and (2) the quality of the credit risk analysis carried out on rated instruments? Since 2010, the quality of the rating reports has significantly improved. They contain more information about the company and the rating methodology; in addition, the time lag between exceptional events and a change in the rating has been shortened. The disclosure requirements towards ESMA as stated in Art. 14 (3) CRA III EU Regulation 3 should also include a requirement to disclose this information towards IORPs. A plausibility check of the rating reports and with that the submission of a risk assessment by IORPs requires comprehensive disclosure of the information on which the rating is based. IORPs would welcome if rating agencies were required to provide their rating reports free of additional charge to them, so that they could be used as a basis for the plausibility checks. Q9: Are there other sources of information which you would use to make investment decisions instead of credit ratings? No, from our perspective, credit rating agencies have a number of advantages: Simplicity: Easy to use for institutions whose core business does not focus on credit rating. High degree of objectivity: Objective criterion about which credit qualities are generally acceptable and which are easy to describe / implement in guidelines and contracts. Relative low cost: Because of the specialisation of credit rating agencies, economies of scale lead to lower costs for the provision of credit ratings (compared to the costs if IORPs produced ratings internally). Information advantage: Credit rating agencies have confidential insights into company documents and discussions with management, which IORPs do not have access to. This is particularly important for forward looking analyses. 3 According to Art. 14 (3) of the CRA 3 3, the rating agencies shall notify ESMA of the intended material changes to the rating methodologies, models or key rating assumptions or the proposed new rating methodologies, models or key rating assumptions when the credit rating agency publishes the proposed changes or proposed new rating methodologies on its website in accordance with Article 8(5a).

6 aba Arbeitsgemeinschaft für Seite 6 Expertise and experience: Credit rating agencies have had many years of working in the area, building up expertise learning from experience. Standardised processes: Credit rating agencies follow well-established and clear cut processes based on sound methodologies when assessing credit worthiness. The last three points should, ceteris paribus, lead to a superior credit assessment by ratings agencies. While IORPs could in theory run the same standardised processes as credit rating agencies, they are likely to produce results in lower quality and at higher costs because of their lack of experience, information, expertise and limited capacities. Q10: Please explain whether and if so how your business uses unsolicited credit ratings, giving reasons for your answer. This can happen with respect to country ratings. Country ratings are regularly used when making investment decisions, i.a. when checking the quality of the investments for the security assets (Sicherungsvermögen). Q11: Please explain whether, and if so how, your approaches to the issues raised in questions 4-10 above have changed since See answers above. 6.3 Independence and quality of credit ratings 61. One of the aims of the CRA Regulation is to increase the quality of credit ratings by seeking to reduce the conflicts of interest inherent where issuers pay for the rating of their financial instruments. 62. The questions in this part aim to understand the different ways that CRAs can seek payment for the credit ratings issued and to assess the impact of the CRA Regulation on increasing the quality and independence of credit ratings. Q12: Please explain in which circumstances you currently pay for credit ratings. If you do not currently pay for credit ratings, please explain whether, and if so under which circumstances, you would be willing to pay for credit ratings. In general, the costs for credit ratings should be borne by the issuers and not by the users. Q13: Irrespective of whether you pay for credit ratings, please explain the circumstances in which links or existing relationships between an issuer of a particular instrument and a CRA would have an impact on how you would use a credit rating of that instrument. In general, we believe that credit rating agencies caused problems in the area of structured products such as collateralised debt obligations (CDO) and collateralised loan obligations (CLO). Credit rating agencies were involved in both the design and credit assessment of these products. Since they had a financial stake in these products, they were exposed to moral hazard. Doubts regarding the quality of these products together with the growing scarcity of liquidity led to a collapse of the respective markets. From our perspective in addition to the retention requirement for originators CRA III introduced several measures with regard to originators of

7 aba Arbeitsgemeinschaft für Seite 7 securitized products and to rating agencies to separate product creation and product rating even more and to avoid conflict of interest. It is now important that the credit rating agencies comply with these rules and do not get involved in product creation. Q14: Please explain whether the quality of credit ratings has increased or decreased since 2010, giving reasons for your answer. See our answer to Question 12. There is still a reliance on a small number of providers, but the number of providers has increased in the aftermath of the financial crisis. Q15: Please explain what, if any, further measures could be taken to increase the quality of ratings, giving reasons for your answer. We generally support the current system. The quality of ratings would definitely not increase if institutional investors were required to produce their own ratings (see Q 9). VM/SD 31 March 2015