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
NGFS Updates Address Short-Term Climate Scenarios and Transition Plans
The Network for Greening the Financial System (NGFS) is exploring the development of short-term climate scenarios to complement its existing scenario framework of long-term climate scenarios.
ISSB Updates Address ESG Issues while IASB Consults on Impairments
The International Sustainability Standards Board (ISSB) is seeking feedback, until August 09, 2023, on the exposure draft that sets out the methodology proposed by ISSB to amend the Sustainability Accounting Standards Board (SASB) Standards' metrics
OSFI to Review Liquidity Adequacy Guidelines and Policy Architecture
The Office of the Superintendent of Financial Institutions (OSFI) is consulting, until June 21, 2023, on a review of the liquidity treatment provided in the Liquidity Adequacy Requirements (LAR) Guideline for wholesale funding sources with retail-like characteristics.
ESRB Publishes Report on Cryptos and DeFi; ECB Updates on Digital Euro
The European Systemic Risk Board (ESRB) published a report that outlines the systemic implications of crypto markets and proposes policy options to address the risks stemming from crypto-assets and decentralized finance or DeFi.
EU Agencies Issue Updates on DORA, ESAP, and Crowdfunding Regulation
The European Supervisory Authorities (ESAs) published a discussion paper on their joint advice to the European Commission (EC) on proposals to specify criteria for critical information and communication technology (ICT) third-party service providers
ESAs Propose ESG Disclosure on STS Securitization, Issue Other Updates
The Joint Committee of the three European Supervisory Authorities (ESAs) proposed to amend the Implementing Regulation 2016/1799 on the mapping of External Credit Assessment Institutions' (ECAIs) credit assessments.
UK Authorities Issue Updates, Finalize Policy on Model Risk Management
The Prudential Regulation Authority (PRA) finalized the model risk management principles for banks, the policy statement PS5/23 on risks from contingent leverage, and PS4/23 on moving senior managers regime forms from the PRA Rulebook.
APRA Revises Implementation Timeline for Operational Risk Standard
The Australian Prudential Regulation Authority (APRA) updated the implementation date of the new cross-industry prudential standard CPS 230 on operational risk management
BCBS Consults on Basel FAQs and Amendments, Issues Other Updates
The Basel Committee on Banking Supervision (BCBS) published a report assessing implementation of the global Basel standards on net stable funding ratio (NSFR) and large exposures (LEX) in South Africa
EBA Announces Multiple Regulatory and Reporting Updates in April 2023
The European Banking Authority (EBA) published consultations on the amendments to the guidelines on risk-based anti-money laundering and countering the financing of terrorism (AML/CFT) supervision