* Difficult to ignore the risk of sovereign stress
* Regulators should revisit assumptions
By Anna Brunetti
LONDON, May 23 (IFR) - Credit rating agencies have sought to
shield their ABS rating logic from criticism that their link to
sovereign rankings is hampering the resurgence of the sector and
neglecting market performance.
Regulators should revisit their assumptions, such as
affording ABS more equitable treatment with other products,
rather than putting the blame on agencies as inhibiting ABS, the
"We believe our current rating methodologies are justified,
and we don't think that they are significantly constraining
securitization issuance prospects," S&P said in a paper this
week. The agency highlighted other factors that limit ABS
markets, such as the broader economic and credit downturn and
the regulatory risks that lie ahead.
Members of the European Central Bank have repeatedly pointed
to the reliance of ABS ratings on sovereign ratings as a hurdle
on the road to redemption of the ABS market.
And further criticism could follow the joint statement
issued in April by the Bank of England and the ECB in which they
said that "the reliance on ratings by credit rating agencies may
lead to unwarranted pro-cyclicality effects". They said at the
time that a more substantive paper would be issued in May, and
they called for regulatory relief on securitisation.
But regulators should "be careful in attributing to the
credit rating agencies" the role of drivers of investor
behaviour, said Gordon Kerr, head of European structured finance
research at DBRS. He argued that "it is rather the nature of
capital markets to be procylical" and to react to macro risks.
DBRS is the only agency that doesn't apply a hard sovereign
rating cap, believing "each transaction should be looked at in
its own merit," Kerr said. The other three agencies said the cap
was justified by the severity of risk that ABS would face in
case of country defaults and other major macro country events.
"We believe it is impossible to completely de-link
structured finance ratings from the creditworthiness of the
relevant sovereign," Fitch said in a report last month,
confirming caps of ABS ratings to a maximum of six notches above
the sovereign local currency issuer default rating.
And this view is shared by other raters.
"Apart from credit enhancement, portfolio diversification"
and other ABS back-ups, "you can't possibly immunize structured
finance if the sovereign is under stress," said Neal Shah,
managing director of structured finance at Moody's.
The cap applied on ABS ratings varies between countries, and
is determined by macro factors, counterparty and operational
risk analysis in addition to the sovereign ceiling.
According to the Moody's model, Irish, Spanish and
Portuguese ABS are capped at four notches above the respective
sovereign ratings - which means at Aa3, A1 and Baa1
SUPPORT FOR REMOVING RATING REFERENCE
However, the agencies say nothing should prevent regulators
moving away from a rating-based assessment for liquidity and
"We have been clear that we support removing references in
regulation that might encourage mechanistic reliance on external
credit ratings," said Andrew South, head of European Structured
Finance at S&P.
South also said ratings alone cannot address all the
elements of the risk that regulators should consider when
In the paper published on Tuesday, S&P questioned whether
lower ratings caused by the financial crisis could be seen as
the real culprit of poor ABS issuance. The agency noted that by
the end of 2013, it had downgraded 55% of outstanding ABS, a
lower proportion than the 65% for financial institutions, and
only slightly higher than the 50% of non-financial corporates.
The figure for sovereigns was 45%.
The sovereign rating cap also hardly justifies a
retrenchment of ABS markets, S&P added.
"While AAA ratings may have been the benchmark in the
securitisation market historically, investor sentiment could
evolve, recognising that ratings in the AA and A categories, for
example, still represent very strong or strong capacity to meet
financial commitments," the agency argued.
In contrast to agencies, which are tasked with credit
ratings and pursue a different remit, "there is a debate about
whether regulators may want to consider if they really see a big
difference between Triple and Double A" when they set out
requirements, said Michele Cuneo, senior director in credit
policy at Fitch.
Considering how punitive the ABS capital treatment outlined
so far would be, "they could investigate whether this is
consistent with their objectives", he said.
(Reporting By Anna Brunetti, editing by Anil Mayre)