The Financial Stability Board (FSB) has published its the final peer review report on national authorities’ implementation of the FSB ‘Principles for Reducing Reliance on Credit Rating Agency (CRA) Ratings’. The principles, first developed in 2010 but only now coming into force, are intended to reduce the mechanistic reliance on CRA ratings evident during the last crash and promote stronger internal corporate and financial institution (FI) credit risk assessments and disclosure patterns.
The latest FSB implementation report includes an action plan http://www.financialstabilityboard.org/publications/c_140429.htm for each national jurisdiction in the G20 detailing how it can improve after its efforts to eliminate the automatic and sometimes unconscious use of CRA ratings. The earlier stage one thematic review published last summer comprised of a stocktake of references to CRA ratings in national laws and regulations and advised on their removal.
Part of the FSB roadmap agreed in 2012, this latest nation-by-nation initiative is designed to ensure a less mechanistic reliance on CRA ratings and promote better internal risk procedures by examining national policies. It makes a number of recommendations; principally that national authorities should:
• Implement their action plans quickly if they haven’t already done so, and refine them as lessons of experience are gained. For instance, some national authorities may need to establish stronger internal credit risk assessment practices for certain market participants and/or allow CRA ratings to be just one of many indicators of credit risk.
• National bodies should engage market participants to develop, adopt and share alternative risk approaches that work, such as strengthening internal credit assessment processes. A review of firms’ typical reliance on CRA ratings in private contracts, such as automated ratings triggers, is also recommended.
• A mechanistic reliance on a very limited number of alternative risk and ratings measures is cautioned against by the FSB, which fears one set of mechanistic practices might be replaced by another; amplifying herd behaviour. A diversity of approach and cross-referencing is encouraged.
The FSB review found that progress toward the removal of references to CRA ratings from standards, laws and regulation has so far been uneven across jurisdictions and finance sectors. Even so, removing references is only the first step; market practices and contracts also need to change more fundamentally and alternative standards of creditworthiness and procedures need to be developed so that CRA ratings are not the sole input to future credit risk assessments, as they often were before the 2008 crash. More action is required by national bodies from the US, UK, EU, Brazil, China, Japan and other G20 members to make the roadmap a reality.
Ravi Menon, managing director of the Monetary Authority of Singapore (MAS) and chairman of the FSB’s Standing Committee on Standards Implementation (SCSI) which oversaw this latest peer review, said of the update: “The objective is not to eradicate CRA ratings but to promote sound judgement in assessing creditworthiness. This means taking account of a more comprehensive set of factors besides CRA ratings. We have made some progress in reducing the reliance on CRA ratings but there is still some way to go in identifying an array of practical and suitable complements to CRA ratings.”
The report itself was prepared by a team of experts drawn from FSB member institutions and led by Thomas Butler, director of the office of credit ratings in the US Securities and Exchange Commission (SEC). The FSB is chaired by Mark Carney, governor of the Bank of England (BoE) and its activities are coordinated by a secretariat based at the Bank for International Settlements (BIS) offices located in Basel, Switzerland.
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