Select Committee on Treasury Written Evidence

Supplementary memorandum by Fitch Ratings

  This memorandum responds to the Committee's requests at the evidence session on 13 November 2007.


1.  Requested Information with respect to Fees: (a)  Please disclose all fees received by Fitch Ratings, and any sister company within the same group, from Northern Rock plc ("NR") during the period 2003 to 2007. (b)  Were these fees proportionate to fees paid by institutions comparable to NR for similar services? [Q977]

  1.1  Fitch Ratings received £3,857,011 (excluding VAT) with respect to ratings and £46,627 for one of our subscription products. The ratings fees relate to the rating of NR and its debt issuances, as well as discrete RMBS and covered bond transactions. With respect to the subscription fees, there is no significant difference between the price paid by NR in each of the relevant years, and the average price paid by other UK banks and non bank financial institutions which subscribed for the same service in those years. With respect to the ratings work, the fees paid by NR in each of the relevant years were in line with the average fees paid by similar financial institutions,[12] and often lower than the average. Please note that the amount of fees with respect to ratings work equates to 0.24% of the total revenues of Fitch, Inc. during this time period.

  1.2  No sister company of Fitch Ratings received any fees from NR.

2.  Requested Information with respect to Current Ratings: "It would be very helpful if we could have an analysis, Chairman, by rating category, by type of issuer, the volumes and the number of issuers". [Q1053]

  2.1  Please see attached spreadsheet.

3.  Requested Information with respect to Bank of England Suggestions: Provide your views on the following statements and proposals made by the Bank of England to improve the information content of ratings:

    (a)  "Agencies could publish the expected loss distributions of structured products, to illustrate the tail risks around them. Agencies have made significant efforts over the past few years to increase the transparency of their rating methodology for structured finance products, through publication of research reports describing their modeling methodology and their assumptions on correlations and recovery rates. But published distributions could provide a visual reminder of the fatter tails embedded in the loss distribution in structured products".

    (b)  "Agencies could provide a summary of the information provided by originators of structured products. Information on the extent of originators' and arrangers' retained economic interest in a product's performance could also be included. Such a summary may satisfy investors that incentives are well aligned or encourage investors to perform more thorough risk assessments".

    (c)  "Agencies could produce explicit probability ranges for their scores on probability of default. Probability ranges would provide a measure of the uncertainty surrounding their ratings. Although such figures are already available retrospectively as transition matrices, an explicit probability range would allow investors to monitor agencies' performance when rating different asset classes".

    (d)  "Agencies could adopt the same scoring definitions. Currently, some use probability of default, some loss given default and others a combination. Converging on a single measure would reduce the risk of misinterpretation by investors".

    (e)  "Finally, rating agencies could score instruments on dimensions other than credit risk. Possible additional categories include market liquidity, rating stability over time or certainty with which a rating is made. Clear scores on these dimensions could encourage more sophisticated investment mandates and easier monitoring of non-credit risks in a portfolio. It would clearly take some time and money for agencies to develop the necessary expertise on these other risks, but some agencies have already proposed these additions".

  3.1  Fitch Ratings initiated a dialogue with the supervisory community, including central banks around Europe, in the Spring and Summer of 2007. At individual meetings with central bankers during this period, many of the topics covered in the suggestions set forth above were raised and discussed. Specifically:

  3.2  With respect to (a) above, we are currently considering whether we could publish expected loss distributions. As discussed with the Bank of England in July of this year, this approach may lend itself more easily to some asset classes than to others (for example, it would be manifestly easier for those asset classes where the analytical process already creates a stochastic distribution of losses). Additionally, there would be challenges in ensuring that such distributions could be readily communicated to users in a concise and unambiguous format.

  3.3  With respect to (b) above, we support any initiative to enhance transparency and require more public disclosure from originators for the benefit of investors. We believe that the structured finance market is too opaque and that transparency can best be achieved by originators, servicers, issuers and arrangers making publicly available all information, both at issuance and throughout the life of a structured finance transaction, that they make available to rating agencies (in the context of their rating analysis). We further believe that the internet provides an excellent venue to host this information so that it is freely and publicly available to all interested parties. The public availability of this information would enable investors to make fully informed investment decisions without having to rely solely on credit ratings to determine credit risk and would allow investors to assess independently issues such as market and liquidity risk that credit ratings do not address. We do not think, however, that it should be the responsibility of the rating agencies to disclose the originator's data. Our Code of Conduct prohibits us from disclosing confidential information, consistent with the IOSCO Code of Conduct Fundamentals for Credit Rating Agencies. Moreover, with respect to disclosing any interest retained by the originator or arranger, rating agencies will not necessarily know who holds what proportion of the issued bonds.

  3.4  With respect to (c) above, we have been recognised, or are currently applying for recognition, as an External Credit Assessment Institution ("ECAI") in all major markets where we operate. One part of this recognition process involves an explicit comparison between the historical default experience of an ECAI against a target band of cardinal default rates. This comparison is repeated on a regular basis going forward in assessing the performance of ECAIs over time. As we intend to maintain our ECAI status in future, we will be subject to a de facto review of our cardinal default process by every bank supervisory authority in whose jurisdiction we are recognised as an ECAI. Additionally, we are considering how we may better communicate publicly the analysis we carry out internally of the movements in historical default and transition rates, relative to long-term trends.

  3.5  With respect to (d) above, we note that the topic of diverging definitions has been extensively reviewed as part of the wider debate surrounding comparability of rating scales over the past several years. In general, the distinctions in rating definitions among rating agencies are modest. The most independent review of this topic has been done in the context of the above-noted ECAI recognition process, which includes a "mapping" or correspondence table, established by each bank supervisory authority to plot rating agencies' scales against default rates prescribed by the Basel II process. This process also results in a mapping table plotting the ratings of one agency against the ratings of other agencies. It is important to note that this process did not result in pressure from the user base to standardise rating definitions. The topic has also been raised more recently at hearings in October, convened by the Committee on the Global Financial System, at the Bank of England's offices, involving investors, arrangers and central bank representatives. The consensus was that the current modest variation in rating definitions reflected a healthy variety in methodological approaches and at the same time did not provide material obstacles to comprehension or application of the ratings by users. Movement towards a stricter homogeneity of output would likely not serve the market well and would reduce investor choice. In addition, there would be a variety of practical problems—for example, how (and by whom) would such a set of common definitions and related criteria be developed and maintained. We believe, however, that the market would benefit from a common definition of default for purposes of the production of transition and default studies by the rating agencies and any other interested parties. A common definition of default would provide investors and all interested parties the ability to more readily compare these studies against each other and thereby more accurately assess the relative performance of rating agencies.

  3.6  With respect to (e) above, as discussed with the Bank of England at our July meeting, we are currently investigating whether we could provide opinions with respect to risk elements other than credit risk. For example, we have been working on ways to measure rating volatility, including stability scores. In fact, Fitch was the first agency to introduce such scores, after a lengthy development period, in early 2006. At the time we initiated Stability Scores, these were designed precisely to highlight the differing performance characteristics of instruments which carried the same rating on the "AAA" scale. At the time, it is fair to say the market was less interested in rating stability, or indeed rating differentiation, given the generally much higher appetite for risk at that time. As a result, penetration of the Stability Score concept in the market was limited. In the meantime, we have worked on revising the Stability Scores to broaden the scope of products covered. Equally, it is fair to assume the market is now more sensitised to risk differentiation than it was in March 2006. As a result, we will be looking at proposing an enhanced version of the Stability Score process in due course.

  More generally, Fitch has done much work researching the best way in which to reflect additional risks affecting issuers and transactions. Our discussions with institutional investors, central banks and other interested parties have indicated a marked preference for discrete scales for discrete dimensions of risk (ie, one scale covering default risk, one scale covering loss severity, etc) rather than combinations of risks on the same scale. Examples of successful multiple-scale sectors include our bank and insurance sectors, with a range of Support, Individual and Financial Strength ratings complementing the mainstream Issuer Default Ratings. In contrast, other areas where multiple scales have been introduced have seen more muted investor uptake. It is important to note that we cannot "force" usage of any of our scales, and equally—and reluctantly sometimes—we will withdraw scales for which we perceive low investor demand.

December 2007

12   The financial institutions used for purposes of this comparison were Bradford and Bingley, Abbey, HBOS, Alliance and Leicester and Nationwide. Back

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