By Yakubu LAAH InvestAdvocate
Lagos (INVESTADVOCATE)- Global securities regulator, the International Organisation of Securities Commissions (IOSCO) Wednesday said its seeking ways of reducing over reliance on credit rating agencies (CRAs) by asset managers.
IOSCO said its report ‘’ Good Practices on Reducing Reliance on CRAs in Asset Management’’ is aimed at gathering the views and practices of investment managers, institutional investors and other interested parties, with a view to developing a set of good practices on reducing over reliance on external credit rating in the asset management space.
The global securities regulator said CRAs play a prominent role in today’s global financial markets.
IOSCO said however, approaches may differ across jurisdictions, ‘’investment managers often use the services of CRAs to form an opinion on the creditworthiness of a particular issuer before purchasing securities, selecting counterparties, or choosing the best collateral to secure transactions. On their part, investors often refer to CRA ratings before buying shares of a fund, or when guiding investment managers on the basis of a tailored investment mandate,’’ IOSCO said.
It affirmed that the role of CRAs has come under regulatory scrutiny, mainly as a result of the over-reliance of market participants, including investment managers and institutional investors, on CRA ratings in their assessments of both financial instruments and issuers in the run-up to the 2007-2008 financial crisis.
‘’To address this concern, the Financial Stability Board (FSB) published in October 2010 its report on ‘’Principles for Reducing Reliance on CRA Ratings’’ (“FSB 2010 Principles”). The goal of these Principles is to end mechanistic reliance on ratings by banks, institutional investors, and other market participants. They concluded with a call for regulators and standard setters such as IOSCO to consider steps for translating the Principles into more specific policy action,’’ the securities commission said.
IOSCO further affirmed that the report stresses the importance for asset managers to have the appropriate expertise and processes in place to assess and manage the credit risk associated with their investment decisions.
It said recognising the utility of external ratings, the report mentions that they can be used as an input among others to complement a manager’s internal credit analysis and provide an independent opinion as to the quality of the portfolio constituents.
In order to avoid the over-reliance on external ratings, the report lists some possible good practices that managers may consider when resorting to it and these include: investment managers making their own determinations as to the credit quality of a financial instrument before investing
Second, throughout the holding period, an internal assessment process that is commensurate with the type and proportion of debt instruments the investment manager may invest in, and a brief summary description of which is made available to investors, as appropriate.
Third on the list is that regulators should encourage investment managers to review their disclosures describing alternative sources of credit information in addition to external credit ratings.
Also, regulators should encourage investment managers– as represented collectively through trade associations and/or SROs – to include in their credit assessments alternative (internal) sources of credit information in addition to external credit ratings.
Further to these, regulators should encourage investment managers to disclose the use of external credit ratings and describe in an understandable way how these complement or are used with the manager’s own internal credit assessment methods.
Another good practice in asset management is that regulators should advise investment managers that when assessing the credit quality of their counterparties or collateral not to rely solely on external credit ratings and to consider alternative quality parameters (e.g., liquidity, maturity, etc.).
IOSCO in its report suggested that where an investment manager clearly relies on external credit ratings among others to assess the credit worthiness of specific assets, ‘’a downgrade does not automatically trigger their immediate sale and whereby the manager/board conducts its own credit assessment, a downgrade may trigger a review of the appropriateness of its internal assessment.
In both cases, should the manager/board decide to divest, the transaction is conducted within a timeframe that is in the best interests of the investors,’’ the IOSCO report said.
