IOSCO outlines ways to reduce reliance on credit ratings

The impetus to reduce the prominence of credit ratings is yet another avenue of regulatory reform adopted in the wake of the financial crisis, when some investors relied heavily on ratings, which may have disguised certain risks. Back in 2010, the Financial Stability Board (FSB) published a report on a set of principles designed to end mechanistic reliance on ratings by banks, institutional investors, and other market participants. That report also called for regulators and standard setters, such as IOSCO, to consider steps for translating the principles into more specific policy action — which IOSCO’s new paper aims to do.

IOSCO notes that the practices identified will be targeted at national regulators, investment managers, and investors. It has also launched a separate project to identify good practices for the use of alternatives to credit ratings to assess creditworthiness.

The report stresses that it’s important for asset managers to have the appropriate expertise and processes in place to assess and manage credit risk; and that credit ratings can be used as an input as part of a manager’s internal credit analysis. However, it also enumerates some possible good practices that managers may consider when resorting to external ratings.

It also suggests that regulators could push investment managers to review their disclosure describing alternative sources of credit information; that they could push managers to include alternative sources in their credit assessments; and, that regulators could encourage firms to disclose the use of external credit ratings and to explain how these are used along with their own internal credit assessment methods.

Additionally, it says that regulators could encourage investment managers not to rely solely in external ratings when assessing the credit quality of their counterparties or collateral.

Comments on the paper are due by September 5.