FR33/2015 Sound Practices at Large Intermediaries Relating to the Assessment of Creditworthiness and the Use of External Credit Ratings

Sound Practices at Large Intermediaries Relating to the Assessment of Creditworthiness and the Use of External Credit Ratings Final Report THE BOARD OF THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS FR33/2015 December 2015 ii Copies of publications are available from: The International Organization of Securities Commissions website www.iosco.org © International Organization of Securities Commissions 2015. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. iii Foreword The Board of the International Organization of Securities Commissions (IOSCO) has published this final report on Sound Practices at Large Intermediaries Relating to the Assessment of Creditworthiness and the Use of External Credit Ratings (Final Report) following publication of a Consultation Report, Sound Practices at Large Intermediaries: Alternatives to the Use of Credit Ratings to Assess Creditworthiness.1 The Final Report provideSound Practices at large intermediaries: Alternatives to the use of credit ratings to assess creditworthinesss background on the project and the work undertaken by IOSCO’s Committee on the Regulation of Market Intermediaries (Committee or C3) on assessment of creditworthiness by large market intermediaries. It also sets forth a number of sound practices2 that regulators could consider as part of their oversight of market intermediaries, and which large market intermediaries may find useful in the development and implementation of effective alternative methods for the assessment of creditworthiness. Further, it reflects edits made to address a number of public comments received on the Consultation Report. IOSCO recognizes that not every sound practice will be appropriate or equally effective for all large market intermediaries. However, IOSCO would still encourage individual market intermediaries to consider these sound practices where relevant to their activities. In addition, even though the focus of this report is on large intermediaries, we encourage smaller intermediaries to consider the points and analysis discussed in this report. 1 See CR05/2015 Sound Practices at large intermediaries:Alternatives to the use of credit ratings to assess creditworthiness, Consultation Report, Report of the IOSCO Board, May 2015, available at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD486.pdf. 2 Sound practices consist of practices that regulators could consider. Such practices would not be reflected in the methodology for the implementation of the IOSCO Objectives And Principles of Securities Regulation as they do not represent a standard that IOSCO members are necessarily expected to implement or be assessed against. iv Table of Contents I. E xecutive Summary 1 II. Background 2 A. Introduction 2 B. Previous Work 1. G-20 and FSB Projects 2 2. IOSCO’s Implementation 4 3. National Jurisdiction Implementation 4 C. Reduction of Mechanistic Reliance on Credit Ratings 5 1. Regulations on the Securities Industry 5 2. Relevant Prudential Regulations 6 D. Purpose and Scope of the Project 6 E. Methodology 7 III. How Large Intermediaries Use and Assess Creditworthiness 8 A. Overview 8 B. Sources of Credit Risk and Uses of Credit Assessments 9 C. Credit Risk Management 9 1. Resources for Credit Risk Management 9 2. Internal Organization 10 3. Corporate Governance 11 4. Review of Assessments of Creditworthiness 13 D. Assessing Creditworthiness 13 1. Financial Instruments 14 2. Counterparties 15 E. Monitoring and Review of Existing Credit Risks and Models 17 F. Use of Credit Ratings from External Credit Rating Agencies 18 1. Reliance on CRA Ratings 18 2. Deviations from CRA Ratings 19 IV. Challenges to the Adoption of Alternative Methods of Credit Assessment 19 V. Sound Practices for Market Intermediaries 20 A. Introduction 20 B. Sound Practices 20 Appendix 1: Summary of Roundtables 23 Appendix 2: Tables of Participating Regulators and Tally of Intermediary Responses by Jurisdiction 30 - 1 - I. Executive Summary The IOSCO Board requested that its Committee for the Regulation of Market Intermediaries (Committee or C3) examine the reliance on credit ratings by large market intermediaries in member jurisdictions and, most importantly, to identify “sound practices” currently in place at these firms with regard to the use of alternatives to credit ratings to asses