ESMA Highlights Supervisory Concerns and Risks for CLO Credit Ratings
ESMA published a thematic review on the credit ratings of collateralized loan obligations (CLOs) in EU. The assessment provides an overview of CLO rating practices and identifies the main supervisory concerns and medium-term risks in this asset class. The identified issues include credit rating agencies’ (CRAs) internal organization, their interactions with CLO issuers, operational risks, commercial influence on the rating process, and the need for proper analysis of CLOs. The report is based on information collected until March 2020 but it also highlights the impact that COVID-19 may have on CLO methodologies.
It is too early to assess the aggregated consequences of the COVID-19 outbreak as it will depend on the length of the health crisis and on the effects of the associated government interventions. In light of this, ESMA expects CRAs to continue to perform regular stress-testing simulations and to provide market participants with granular information on the sensitivity of CLO credit ratings to key economic variables affected by the pandemic. ESMA identified the following key risks in its thematic review:
- Internal organization of CRAs. The CLO rating process is segmented between a CLO analytical team and a corporate analytical team in all CRAs. A smooth and ongoing exchange of information between internal teams is key to ensure a holistic assessment of CLO creditworthiness. CRAs should ensure the capacity for the timely identification of all inherent risks to CLOs.
- Interactions with CLO issuers. As CLO arrangers and managers can identify which CRA may assign the best ratings for each CLO tranche, it is key that CRAs ensure the independence of their rating process from any influence from their commercial teams and/or arrangers.
- Model or third-party dependencies leading to potential operational risks. The dependency on rating models and data provided by third parties, along with the high automation of processes, present operational risks which need to be monitored by CRAs to avoid potential errors in credit ratings.
- Rating methodologies, modeling risks, and commercial influence. CLO methodologies are underpinned by assumptions and modelling approaches that can impact credit ratings. ESMA highlights the importance of transparency to market participants on the limitations of methodological approaches. In addition, CRAs should ensure that evolutions in CLO methodologies are not influenced by commercial interests.
- Thorough analysis of CLOs. CRAs should continue to monitor market trends and to perform a thorough analysis of all relevant developments in CLO contractual arrangements.
Related Links
Keywords: Europe, EU, Banking, Securities, Credit Rating Agencies, Collateralized Loan Obligations, Credit Ratings, Modeling Risk, Governance, ESMA
Previous Article
EC Issues Rule on Technical Information for Solvency II CalculationsRelated Articles
EBA Publishes Final Regulatory Standards on STS Securitizations
The European Banking Authority (EBA) published the final draft regulatory technical standards specifying and, where relevant, calibrating the minimum performance-related triggers for simple.
ECB Further Reviews Costs and Benefits Associated with IReF
The European Central Bank (ECB) is undertaking the integrated reporting framework (IReF) project to integrate statistical requirements for banks into a standardized reporting framework that would be applicable across the euro area and adopted by authorities in other EU member states.
EBA Publishes Funding Plans Report, Receives EMAS Certification
The European Banking Authority (EBA) has been awarded the top European Standard for its environmental performance under the European Eco-Management and Audit Scheme (EMAS).
MAS Launches SaaS Solution to Simplify Listed Entity ESG Disclosures
The Monetary Authority of Singapore (MAS) set out the Financial Services Industry Transformation Map 2025 and, in collaboration with the SGX Group, launched ESGenome.
BCBS to Finalize Crypto Rules by End-2022; US to Propose Basel 3 Rules
The Basel Committee on Banking Supervision met, shortly after a gathering of the Group of Central Bank Governors and Heads of Supervision (GHOS), the oversight body of BCBS.
IOSCO Welcomes Work on Sustainability-Related Corporate Reporting
The International Organization of Securities Commissions (IOSCO) welcomed the work of the international audit and assurance standard setters—the International Auditing and Assurance Standards Board (IAASB)
BoE Allows One-Day Delay in Statistical Data Submissions by Banks
The Bank of England (BoE) published a Statistical Notice (2022/18), which informs that due to the Bank Holiday granted for Her Majesty Queen Elizabeth II’s State Funeral on Monday September 19, 2022.
ACPR Amends Reporting Module Timelines Under EBA Framework 3.2
The French Prudential Control and Resolution Authority (ACPR) announced that the European Banking Authority (EBA) has updated its filing rules and the implementation dates for certain modules of the EBA reporting framework 3.2.
ECB Paper Discusses Disclosure of Climate Risks by Credit Agencies
The European Central Bank (ECB) published a paper that examines how credit rating agencies accepted by the Eurosystem, as part of the Eurosystem Credit Assessment Framework (ECAF)
APRA to Modernize Prudential Architecture, Reduces Liquidity Facility
The Australian Prudential Regulation Authority (APRA) announced reduction in the aggregate Committed Liquidity Facility (CLF) for authorized deposit-taking entities to ~USD 33 billion on September 01, 2022.
