Consultation Paper on the recognition of External Credit Assessment Institutions (CP07)

Start Date: 29/06/2005 | Deadline: 30/09/2005

Executive Summary

1. The Capital Requirements Directive (CRD) allows institutions to use external credit assessments to determine the risk weight of their exposures, provided the External Credit Assessment Institutions (ECAIs) that produce those assessments have been recognised as eligible for that purpose by the competent supervisory authorities. This recognition is granted only if the competent authorities judge an ECAI to meet the recognition criteria laid down in the CRD.

2. ECAI recognition for capital purposes does not in any way constitute a form of regulation of ECAIs or a form of licensing of rating agencies to do business in Europe. Its sole purpose is to provide a basis for capital requirement calculations in the Standardised Approach and the Securitisation Ratings Based Approaches. These approaches are intended to increase the risk-sensitivity of capital requirements relative to the current framework, and to ensure that institutions using these approaches have appropriate levels of regulatory capital to support their aggregate credit risk.

3. This paper sets out for consultation CEBS' proposed common approach to the recognition of eligible ECAIs. This covers:

  • the recognition process
  • the implementation of the CRD recognition criteria
  • the criteria for the 'mapping' of external credit assessments to the CRD risk weights.

4. The paper details the significant convergence that has been achieved amongst supervisors over recent months on both the procedural and substantive aspects of ECAI recognition. This includes a significantly enhanced common understanding of the recognition criteria set out in the CRD and of their implementation across the EU.

5. The intention is to provide the basis for consistent decision-making across jurisdictions, enhance the single market level playing field and reduce administrative burdens for all participants, including potentially eligible ECAIs, institutions and supervisory authorities.

6. The paper sets out agreed procedures for the application and assessment process. Two modes of supervisory recognition are set out in the CRD - direct and indirect recognition. Direct recognition is where supervisors make their own evaluation of an ECAI's compliance with the recognition criteria. Indirect recognition is where supervisors recognise an ECAI based on recognition in another Member State without carrying out their own evaluation process.

7. CEBS considers both of these approaches to be important and notes that indirect recognition can be a highly valuable instrument for enhanced efficiency and for reduced administrative burdens. It believes that the common understanding set out in this Consultation Paper will provide a good underpinning for the confident use by supervisors of the indirect recognition approach in relevant circumstances.

8. Where recognition is sought in more than one Member State, it is proposed to adopt a joint assessment process while respecting the requirements of the CRD for individual decisions by supervisors. The aim of this process will be to reach a shared view as to compliance with the recognition criteria.

9. Supervisors propose to carry out an overall assessment of ECAIs' eligibility according to the CRD recognition criteria, based on the common understanding set out in this paper and using information identified in a "common basis application pack".

10. Concerning the "mapping" of external credit assessments to the CRD credit quality steps, CEBS considers the Basel Committee's guidance for supervisors set out in Annex 2 of the Basel II framework published in June 2004, to be valuable and appropriate, and it is recommended that supervisors follow it. A common approach to mapping is important for ensuring consistency across the EU and reducing the risk of regulatory arbitrage.

11. Further consideration and input during the consultation period will help CEBS to continue its work on remaining issues, such as the mapping of credit assessments of Collective Investment Undertakings (CIUs) and of securitisation positions to the CRD risk weights.

12. In view of the shortening timeframe towards implementation, it is desirable that the recognition of ECAIs should advance as quickly as possible. While formal processes cannot begin in advance of the finalisation and transposition of the CRD, nonetheless many supervisors intend to be in a position to receive informal applications, as far as legally possible, in the near future. For those supervisors, it is expected that this will take place on the basis of the proposals contained in this Consultation Paper shortly after the end of the consultation period indicated below and in light of the comments made.

13. In developing its guidelines, CEBS has benefited from preliminary informal contacts with a number of ratings market participants.

14. Moreover, CEBS participated as an observer to the Committee of European Securities regulators (CESR) task force on Credit Rating Agencies which drafted the technical advice to the European Commission on possible measures concerning credit rating agencies in March 2005. The fluid dialogue between the two Committees has since continued in order to ensure complementary approaches.

15. CEBS guidelines are now presented for formal public consultation. The consultation period will run until 30 September 2005. Comments should be made in English. Comments received will be published on the CEBS website unless respondents request otherwise. CEBS expects to publish feedback on the responses received, along with the amended guidelines by early 2006.

16. Comments are specifically requested on the following questions:

1) If you are an institution or an ECAI, how do you envisage using the proposed recognition process, in particular in cases where applications for the same ECAI are submitted in more than one Member State at the same time?
2) Do you support the proposed joint assessment process? Does it address the need for efficiency, consistency and reduced administrative burdens in light of the CRD requirement that each competent authority make its own decision (direct or indirect) on eligibility?
3) What are your views on the proposed common understanding of the CRD recognition criteria to be implemented by supervisors in determining the eligibility of ECAIs?
4) What are your views on the proposed approach for implementing the mapping process?
5) Do you support the proposal that the "mapping" of credit assessments to risk weights should also be addressed under the joint process set out in Part 1 for applications made in more than one Member State?
6) Do you think that the concept of loss, rather than default probability alone, is the appropriate key parameter for mapping securitisation credit assessments? If not, what should be the appropriate parameter? How should it be measured statistically? To what extent do the same considerations apply for CIU credit assessments?

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