PrefBlog

The Bank for International Settlements has announced the release of a report, Ratings in structured finance: what went wrong and what can be done to address shortcomings?, from a study group chaired by Nigel Jenkinson Executive Director, Financial Stability of the Bank of England.

In sharp contrast to the IOSCO Report on CRAs, this report actually contains and addresses industry criticism of the report’s recommendations.

The recommendations are:

• Investment fund trustees and managers should review their internal procedures and guidelines concerning how ratings information on SF products is used in their investment mandates and decisions.
• Rating reports should be presented in a way that facilitates comparisons of risk within and across classes of different SF products.
• Rating agencies should provide clearer information on the frequency of rating updates.
• More user-friendly access to CRA SF models and their documentation should be provided. Rating models made available by CRAs should facilitate the conducting of “what if?” analysis or stress tests by users on key model parameters.
• CRAs should document the sensitivity of SF tranche ratings to changes in their central assumptions regarding default rates, recovery rates and correlations.
• CRAs should clearly and regularly disclose to investors their economic assumptions underlying the rating of SF products.
• Limited historical data on underlying asset pools should be clearly disclosed as adding to model risk, as should any adjustment made to mitigate this risk.
• CRAs should monitor more intensively the performance of the various agents involved in the securitisation process,
• CRAs should periodically consider the wider systemic implications of a rapid growth of similar instruments or vehicles, or of new business undertaken by existing vehicles, for the continued robustness of their original ratings criteria
• CRAs should consider how to incorporate additional information on the risk properties of SF products into the rating framework.

Everybody liked the first recommendation. It’s motherhood, after all … and the organizations that have ignored it in the past will ignore it in the future.

It is felt that providing information on what events would spark a review would be useful; but providing a schedule of future reviews would just lead to information overload.

The CRAs objected to disclosure of limited historical data, apparently fearing that this would lead to a box-ticking exercise amongst investors – such investors would ignore the possibility of structural breaks compromising the utility of historical data when it did exist.

The more intensive monitoring of agents in the securitization process was thought to be rather ambitious. That’s the regulators’ job!

Systemic implications are rather problematic – CRAs fear that it will become their responsibility to prick asset bubbles.

A separate rating scale was felt to be costly and cosmetic. A separate volatility indicator was thought to be genuinely useful.

This entry was posted on Thursday, July 3rd, 2008 at 4:18 pm and is filed under Interesting External Papers, Regulation. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.