FR12/12 Credit Rating Agencies: Internal Controls Designed to Ensure the Integrity of the Credit Rating Process and Procedures to Manage Conflicts of Interest

Credit Rating Agencies: Internal Controls Designed to Ensure the Integrity of the Credit Rating Process and Procedures to Manage Conflicts of Interest Final Report THE BOARD OF THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS FR12/12 December 2012 i Copies of publications are available from: The International Organization of Securities Commissions website www.iosco.org © International Organization of Securities Commissions [Year]. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ii Contents Chapter 1 Executive Summary ............................................................................................. 1 Chapter 2 Background .......................................................................................................... 4 2.1 Previous work of IOSCO on CRAs ............................................................................. 4 2.2 The current project on internal controls and conflict procedures ................................ 5 2.3 Scope and purpose of the Final Report ....................................................................... 6 Chapter 3 Quality and Integrity of the Rating Process ......................................................... 8 3.1 Quality of the rating process ....................................................................................... 8 3.1.1 Overarching control functions within the CRA ................................................... 8 3.1.2 Preparatory phase – gathering and using information ......................................... 9 3.1.3 Assessment phase – use and consistency of methodologies .............................. 12 3.1.4 Decision phase – rating committee structure and voting process ...................... 13 3.1.5 Dissemination phase – release of rating actions ................................................ 15 3.2 Resources adequacy to ensure the quality of the rating process ............................... 16 3.2.1 Resources adequacy ........................................................................................... 17 3.2.1.a Resources adequacy – review function for new products ............................... 18 3.2.1.b Resources adequacy – periodic reviews of methodologies ............................. 18 3.2.1.c Resources adequacy – structured finance initial ratings and surveillance ...... 19 3.2.2 Continuity in the rating process and avoidance of bias ..................................... 20 3.3 Monitoring and updating ........................................................................................... 20 3.3.1 Regular ratings reviews...................................................................................... 21 3.3.2 Ad hoc ratings reviews....................................................................................... 21 3.3.3 Timely updates of ratings ................................................................................... 22 3.3.4 Comprehensive monitoring ................................................................................ 22 3.3.5 Disclosure of discontinued ratings ..................................................................... 22 3.4 Integrity of the rating process .................................................................................... 23 3.4.1 Firms’ compliance culture ................................................................................. 23 3.4.2 Role of compliance ............................................................................................ 24 3.4.3 Reporting of questionable behaviour ................................................................. 25 3.4.4 Staff ethics and integrity .................................................................................... 26 3.4.5 No “guarantee” of ratings .................................................................................. 26 3.4.6 Recordkeeping ................................................................................................... 27 Chapter 4 Management of Conflicts of Interest Discussion ............................................... 28 4.1 Managing firm-level conflicts ................................................................................... 28 4.1.1 Rating committees and reporting lines .............................................................. 29 4.1.2 Corporate and business structures ...................................................................... 30 4.1.3 Recordkeeping ................................................................................................... 30 4.1.4 Disclosure .......................................................................................................... 31 4.2 Managing employee-level conflicts .......................................................................... 32 4.2.1 Compensation setting structures .............