Clients of credit rating agencies (CRAs) have a low awareness of the corporate structures that the organisations use for selling alternative product lines, warns a new report from the market’s top watchdog.
Following a lengthy investigation of so-called Other CRA Products (OCPs), the International Organization of Securities Commissions (IOSCO) has concluded that when clients purchase such offerings, they are typically under the impression that they are buying directly from the headline, CRA brand.
However, it is often the case that clients are dealing with a subsidiary that has been set up with the specific purpose of being legally separate from the primary CRA.
As The Treasurer reported in November 2016, in the earlier stages of its investigation, IOSCO defined OCPs as tools that “may be used by market participants in making investment and other credit-related decisions”.
Issuers and obligors may also use them to make decisions about whether or not to obtain a credit rating from a particular CRA.
In its final report, the watchdog points out that some OCPs operate entirely outside the credit-ratings process, and are retailed through spinoffs that are not subject to established, CRA regulations.
IOSCO defines those ‘Outside the Ratings Process’ OCPs as products or services whereby CRAs provide information or assessments on:
“Such information or assessments,” the report says, “may focus on specific aspects of creditworthiness – for example, an opinion on the ability of an entity to generate value for shareholders and an overview of the enterprise risk management practices of a company.”
Equally, it may provide a “quantitative assessment of specific aspects of the cash flow” of a transaction or ongoing concern. Examples of such assessments may include estimates of:
They may also encompass credit scores.
In the report’s assessment, “Some of these clients stated that they do not necessarily focus on whether a legal and corporate separation exists between the Regulated CRAs and their – or their parent companies’ – affiliates, divisions or business combinations [that are] not subject to CRA regulations.”
As such, they may not understand that the product in question “is issued by an entity that is legally or otherwise separate from the Regulated CRA”.
The issue has come to particular attention within IOSCO’s Committee 6, which specialises in overseeing the CRA market.
As the report notes: “While CRAs have organised themselves according to legal and/or corporate structures that they consider to be optimal for their business, Committee 6 believes that all of the activities of CRAs that result in [either] a Traditional Credit Rating or OCP should be responsive to the spirit of the four, high-level objectives set forth in the IOSCO CRA Principles.”
It adds: “Committee 6 also observed that the legal and/or corporate organisational structures chosen by CRAs to engage in an activity, or offer a service or product, are not indicative of whether such activity, service or product is subject to the Code of Conduct.”