Fitch Publishes Criteria Exposure Draft for Counterparty Risk in Structured Finance and CVBs
OREANDA-NEWS. Fitch Ratings has published an exposure draft detailing proposed revised criteria for counterparty risk in structured finance (SF) transactions and covered bond (CVB) programmes. Fitch invites feedback on the proposals during a one-month consultation period that will end on 16 May 2016.
The overall analytical framework remains unchanged and the proposals are predominantly related to the introduction of Derivative Counterparty Ratings (DCRs) by Fitch's Financial Institution Group and to considerations related to counterparty eligibility, collateral posting by derivative providers and likelihood of operational disruption upon banks' distress.
The main proposals upon which feedback is sought are:
Introduction of Derivative Counterparty Ratings
Fitch expects to introduce DCRs, see Derivative Counterparty Ratings, published 14 April 2016). As a result, for the definition of eligible derivative counterparty, minimum Long-Term (LT) Issuer Default Ratings (IDRs) will be replaced by minimum DCRs, if these are assigned to a specific counterparty.
Eligibility of Long- or Short-term Ratings
Fitch is proposing to introduce the optionality between minimum Long- and Short-term ratings. For example, a counterparty rated 'A' or 'F1' will be considered eligible for 'AAAsf' notes. Fitch deems counterparty risk for the majority of SF transactions as inherently short-term. Remedial actions upon downgrade are meant to prevent sudden deteriorations in credit quality, as envisaged by the short timeframe in which these actions are expected to be implemented. The proposed increase in emphasis on short-term obligations is also commensurate with the definition of short-term in Fitch's rating scales (typically, up to 13 months for structured obligations).
Special Considerations for Highly Rated Banks
Fitch proposes to extend the expected remedial period to 60 days from 30 days for banks rated at least 'AA-' or 'F1+', provided mitigating remedial actions are specified in the transaction documentation in the event that the counterparty no longer maintains the 'AA-' and 'F1+' ratings. Fitch believes this proposal to be risk-neutral for SF transactions, since it will likely be applicable to the strongest institutions only.
Derivatives: Reduction of Collateral Amount and Simplification of Formulae
Fitch proposes to modify the collateral amounts available for SF notes in two ways: 1) eliminate Formula 3 and 2) reduce the adjustment factor to 60% from 70% under Formula 1, to cater for a reduced "jump-to-default risk" from a fairly high rating. Fitch believes that the Liquidity Coverage Ratio (LCR) requirements (contingent liquidity to be set aside for banks' derivative exposures, assuming a three-notch downgrade during a liquidity stress of 30 calendar days) and progress in resolution directives (in some jurisdictions collateralised derivatives are generally exempt from bail-in) better protect derivative exposures. Furthermore, Fitch also proposes to slightly alter the derivation of volatility cushions for cross-currency derivatives, as detailed in Exposure Draft: Counterparty Criteria for Structured Finance and Covered Bonds - Derivative Addendum.
Derivatives: Clarification on Collateral Posting
Fitch is also clarifying the importance of collateral posting for derivative counterparties. Collateralisation is seen as a key remedial action for derivative exposures and one that can be credibly executed in a short timeframe. Fitch would therefore expect collateral posting to be one of the remedial actions available upon downgrade of a derivative provider. If collateral posting is not envisaged in the transaction documentation Fitch would assess the impact on the transaction structure as per the section Examples of Materiality Assessment.
Other proposed changes relate to the eligibility of financial institutions rated 'BBB' or 'F2' to support 'Asf'-category ratings (currently the minimum IDR is set at 'BBB+' and 'F2') and to the assessment of payment interruption risk (for SF ratings in the 'Asf'-category and below, no protection would generally be required if the collection bank's Long-term IDR is within a five-notch rating differential from the SF note).
Fitch is also seeking feedback on some proposals for CVB-specific aspects.
Counterparty Minimum Ratings
Fitch clarifies that where documented counterparty provisions are weak or absent, unmitigated or partially mitigated counterparty risk is taken into account in its discontinuity assessment and counterparty exposures are sized for in the breakeven over-collateralisation for any given rating. Where the programme documentation is not (completely) in line with Fitch's counterparty criteria, the CVB could still be assigned a rating uplift, both for timely and ultimate payments. The CVB rating could ultimately be limited by the discontinuity risk assessment and/or by the relied-upon OC that Fitch tests, among others, against counterparty-related losses (i.e. commingling exposure or resulting mismatches in interest rates and/or currency rate mismatches).
Long- or Short-term Ratings Eligible
Similarly to SF transactions, Fitch is proposing to introduce the optionality between minimum Long- and Short-term ratings for highly rated issuers, i.e. issuers rated at least 'AA-' or 'F1+' for CVB rated in the 'AA' rating category or above and issuers rated at least 'A' or 'F1' for CVB rated in the 'A' rating category (as defined in the Exposure Draft: Counterparty Criteria for Structured Finance and Covered Bonds- Derivative Addendum).
Fitch is seeking feedback on the lengthening of the timeframe to mitigate interest rate or cross currency mismatches should an issuer cease to be highly rated relative to the rating of the CVB, provided the remedial action is defined in the programme documentation.
Collateral Posting
Fitch proposes to integrate the existing formulas for external derivative counterparties into the SF's framework and make uniform the relevant collateral posting expectations across rating categories for CVB. For certain rating scenarios this results in reduced collateral posting and it also reflects the elimination of Formula 3, which is also being applied to SF transactions.
Fitch's collateral expectations for an external derivative counterparty in CVB programmes where the issuer is rated at least 'BBB-' or 'F3' are generally lower than those applied to SF transactions to reflect the benefit of dual recourse to the issuer as a mitigating factor to counterparty default.
Expected Rating Impact
Overall, Fitch expects the revised criteria assumptions to have a limited positive effect on the existing ratings of SF transactions. SF ratings currently capped for counterparty eligibility or payment interruption risk could be subject to some upgrades. The absence of collateral-posting provisions in transaction documents may have negative impact when the resulting derivative exposure is deemed to be a material risk; however, such transactions are limited in numbers.
SF ratings could be upgraded to 'AAAsf' in the presence of direct support or derivative counterparties rated 'A' or 'F1'. Similarly, the most senior notes of SF deals could be upgraded to 'A+' from 'BBB+' if supported by a counterparty rated 'BBB' or 'F2'. Under the proposed changes to payment interruption analysis, SF ratings could be capped at five notches above the collection account bank's Long-term Rating, up from the current three notches.
The proposed changes could have a positive rating impact on up to 10 tranches across nine SF transactions globally and a negative impact on one tranche of an Australian ABS transaction.
The ratings of three CVB programmes out of 131 that we publicly rate globally could be impacted by the proposed changes on Counterparty Minimum Ratings for CVB. Limited rating impact is expected from the introduction of the optionality between Long- and Short-term ratings for highly rated issuers, depending on the level of OC available in the programmes.
Fitch will review the SF and CVB ratings using the revised criteria, always considering transaction- specific features where relevant.
Fitch is inviting market feedback for its proposed revisions until 16 May 2016. Comments can be emailed to 'sffeedback@fitchratings.com'.
Fitch will continue to apply the current criteria to its existing SF and CVB ratings. If the current criteria are updated after considering market feedback, Fitch will review all existing ratings within six months of the new criteria publication.
All new ratings will be based on the proposed criteria as they reflect the agency's current credit view. At the time of assigning those ratings Fitch will also disclose as rating sensitivity the ratings achievable under the existing criteria - this will give an indication of the rating impact if the proposed criteria are not adopted and existing criteria are maintained.
Комментарии