Select Committee on Treasury Written Evidence


Supplementary memorandum from Standard & Poor's

  This memorandum reponds to the Committee's requests at the evidence session on 13 November 2007. These responses contain information which is available to Ratings Services in the time given.

FEES RECEIVED FROM NORTHERN ROCK [Q977]

  The Committee has asked for details of fees received from Northern Rock plc. We have always been transparent that we are paid by the issuers that we rate and have always been transparent as to the means by which we ensure that potential conflicts of interest are managed. That transparency deos not extend, however, to our disclosing confidential and commercially sensitive details of the fees received from particular issuers. For that reason we are not in a position to disclose that information. By way of response to your subsequent question, however, we can confirm that the fees received from Northern Rock plc were set in accordance with our normal commercial arrangements.

INFORMATION ON THE RATINGS ACCORDED TO PARTICULAR INSTRUMENTS AND INSTITUTIONS BY CATEGORY [Q1053]

  The Committee has asked for information on our ratings by rating category, by type of issuers, by number of issuers and by volume. Please find annexed to this letter, tables showing:

    (1)  the total volume of global issuance rated by Ratins Services by rating category in US $ millions;

    (2)  the total number of global issuers by department and rating category; and

    (3)  the percentage of global issuers by department and rating category.

  Please be aware that the table showing the total volume of rated issuance by rating category is based on initial maturities. For example, if a transaction has three classes and all three are active and currently rated AAA, the count shows three AAAs and not on transaction. For the table showing the total number of global issuers by rating category, regardless of issuance volume or number, each individual institution was counted once only.

  Please note that the term "financial institution" is quite broad. It ranges from commercial banks to development agencies to issuers of covered bonds. Some financial institutions benefit from national, state or regional guarantees which elevate their ratings. Due to varying regulations, some issuers set up funding entities in multiple locations.

  The data has been calculated as at 28 November 2007 by reference to long term issuer ratings, but excluding national scale ratings and US public finance ratings in order to be responsive to your request. This is a point in time data set and no trends can be deducted from it. Please also not that bond insured transactions, mostly rated AAA, are included in the universe.

  By way of response to Mr Dunne's specific question, using the above definitions approximately 43% of the debt at issue rated by Ratings Services globally is rated AAA.

VIEWS OR RATINGS SERVICES ON THE SPECIFIC STATEMENTS AND PROPOSALS MADE BY THE BANK OF ENGLAND

  You referred to the suggestion, in the Bank of England's October 2007 Financial Stability Report, that some investors may not have "fully appreciated that rating agency assessments are currently intended to cover only credit risk". While we cannot speculate as to the extent to which investors utilised structured finance credit ratings to address issues other than credit risk, we have always been very clear that our credit ratings speak only to the default risk associated with an issuer or an issue and that they do not speak to other factors such as their likely market performance or the amount that may be recovered in a post-default scenario. We seek continually to enhance our communications on this point.

  In relation to the Bank's specific "suggestions for improvement", at page 57 of its Financial Stability Report, we would make the following comments in relation to each of the suggestions, which are included below for ease of reference. Please note that in light of the fact that these suggestions were only published last month, we have not yet had an opportunity to discuss them in detail with the Bank of England.

    "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 modelling methodoloty 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".

  A Standard & Poor's rating assigned to a structured finance security reflects our opinion of the likelihood that the security will pay timely interest over its remaining lifetime and/or full principal no later than its final maturity date. In other words, it is an opinion on the security's default risk. Our ratings currently do not seek to quantify default risk explicitly, for example, by associating a given rating level with a certain "probability of default" estimate. Rather, the performance of our ratings over time is demonstrated by the ex post probability of default of the assigned ratings as shown in our published default and transition studies. Similarly, our current rating methodologies for most structured finance asset classes do not model the probability of default for a given security or involve deriving a probability distribution for possible losses incurred by holders of the security. However, as noted above, we are still reviewing this proposal and may have additional views at a later time.

  Our existing CDO rating analysis does generate modelled loss distributions for the asset portfolio backing the transaction, though not for the rated securities themselves. This information is already available as an output from our freely-distributed credit model, CDO Evaluator.

    "Agencies could provide a summary of the information provided by originators of strcutured 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".

  Our rating analysts publish pre-sale and post-sale reports for the majority of transactions that we rate publicly. These reports include summary information relating to the transaction's characteristics, which may include information provided by originators, as well as details of our rating analysis. To the extent the originator is provided explicit support to the transaction, these aspects of the originator's risk will be disclosed. However, to the extent the originator is holding some of the securities, and these securities are saleable in the market, we are aware of no current way to monitor which market participants hold of sell any given security at any give time during the life of those securities.

  Much of the information we receive when rating a transaction is also disseminated to market participants by the issuer in various forms, eg in the transaction's offering circular. Most of the information we receive that is not disclosed in this way is confidential. Our analysts are bound by our Confidential Information Policy and the relevant provisions of the IOSCO Code (incorporated in our own Code of Conduct). For these reasons, we believe the extent to which data is made available to investors in structured finance securities is ultimately a decision for issuers or originators taking into account applicable regulations, which are a matter for government and regulators. However we will continue to consider whether we could provide the market with a summary of information provided by originators in a way that would not call into question our confidentiality undertaking and still provide meaningful information.

  Originators or arrangers often have an ongoing involvement in structured finance transactions: for example, the arranger may also act as a swap counterparty. In these cases—where the originator's or arranger's credit standing may have implications for the tranches' default risk—we analyse their involvement and consider their creditworthiness in the same way that we would analyse any other entity performing the same role. In general, the identity of investors in the tranches of a structured finance transaction does not have a bearing on those tranches' default risk. Similarly, the level of originators' or arrangers' retained economic interest in this sense (eg in cases where the originator retains some of the rated securities) does not generally have a bearing on our rating analysis.

    "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".

  As noted above, our ratings currently do not correlate to an explicit probability of default range. However, we are still reviewing this possibility.

  An effective way to monitor rating agencies' performance when rating different asset classes is via historic default statistics. These are published as part of our regular transition and default studies, which are available on our public website at www.standardandpoors.com. This historic data shows that structured finance ratings have been successful diffentiators of default risk. For example, between 1981 and 2006, the average three-year default rate for "AAA" strcutured finance securities was around 2 basis points (bps), compared to 168 bps for "BBB" rated securities. Regarding comparability of ratings across asset classes, our intention is that ratings should provide a reasonably consistent framework for assessing default risk across different sectors. This is also borne out by historic data. For example, the equivalent average three-year default rates for "AAA" and "BBB" corporate issuers have been 9 bps and 132 bps respectively, ie broadly comparable with the structured finance data mentioned above.

  While such long-term average default rates are useful proxies for rating performance, default rates over a shorter timeframe must be interpreted with caution. Significant variations in default rates can occur over time, even if ratings are assigned with great precision. This is because default rates are derived by observing the co-movement of multiple ratings, whose behaviour may be more or less correlated, depending on the sample used.

    "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".

  We believe the presence of multiple rating agencies in the structured finance market affords a valuable diversity of opinions and choice for the users of our ratings. For example, an investor may decide they most value the opinion of one agency when making investment decisions in CNBS, whereas they most value the opinion of a different agency when making similar decisions in CDOs. On balance we would see little merit in enforcing a homogeneous analytical framework on multiple institutions working in parallel. Indeed, such homogeneity would deprive the market of the variety of opinions that exist today. We believe investors are capable of understanding what the ratings of different agencies mean, what they can infer from them, and how they incorporate them into their investment decision-making process. It is also important for agencies to work with markets so participants understand their rating definitions and methodologies. Ratings Services continues to make efforts in this regard via multiple media, including publication of research articles, teleconferences, and investor seminars and meetings.

    "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 there 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".

  As discussed above, we believe it is positive for the structured finance market for investors to be offered a wide range of risk assessment tools and opinions. We believe it is important that credit ratings continue to meet market expectations by addressing credit risk. We continue to consider ways in which we would further serve the needs of structured finance market participants, including in the areas of liquidity and rating stability.

  We note that rating agencies (or any other organisations) already have an incentive to bring such new products to market if they are commercially viable. The fact that no publicly available third party assessments of different sectors' liquidity risks, for example, are currently in widespread use, may be a reflection of the practical challenges in forming such assessments with a sufficient level of confidence, even though there may be demand for such a product.

  Nevertheless, as part of our ongoing assessment of ways in which we could potentially further serve the needs of structured finance market participants, we continue to consider possible additions to our current product range.

December 2007


GLOBAL AMOUNTS AS ISSUE (US $ MILLIONS)

Dept
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
Grand Total

Corporate Ratings
336,892
546,054
1,642,888
2,344,489
1,160,597
973,161
277,001
6,058
1,534
23,719
7,312,394
Financial Institutions Ratings
3,869,608
2,849,339
2,170,690
377,942
137,014
40,861
8,057
200
1,514
9,455,227
Insurance Ratings
48,614
223.769
242.546
95,829
18,217
16,198
3,650
190
1,071
650,138
Sovereigns and International Public Finance
10,953,552
6,279,815
10,340,689
251,078
318,666
113,040
119,873
28,376,712
Structured Finance Ratings
9,307,585
742,632
551,369
463,067
134,262
57,056
31,586
3,508
1,360
28,949
11,321,374
Grand Total
24,516,250
10,641,609
14,948,183
3,532,406
1,768,810
1,200,316
320,294
9,956
2,894
175,126
57,115,845

  
  
NUMBER OF GLOBAL ISSUERS

Dept
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
Grand Total

Corporate Ratings
327
221
790
1,377
959
1,175
294
13
3
25
5,184
Financial Institutions Ratings
82
256
714
320
102
72
9
1
5
1,561
Insurance Ratings
38
171
168
164
54
31
11
1
5
642
Sovereigns and International Public Finance
123
142
110
32
35
25
1
468
Structured Finance Ratings
9,418
2,128
1,450
1,304
530
460
197
20
1
98
15,606

Grand Total
9,988
2,918
3,232
3,197
1,679
1,763
511
35
4
134
23,461
  
  
NUMBER OF GLOBAL ISSUERS AS A %

Dept
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
Grand Total

Corporate Ratings
6.31
4.26
15.24
26.56
18.50
22.67
5.67
0.25
0.06
0.48
100
Financial Institutions Ratings
5.25
16.40
45.74
20.50
6.53
4.61
0.58
0.06
0.00
0.32
100
Insurance Ratings
5.92
26.64
26.17
25.55
8.26
4.83
1.71
0.16
0.00
0.78
100
Sovereigns and International Public Finance
26.28
30.34
23.50
6.84
7.48
5.34
0.00
0.00
0.00
0.21
100
Structured Finance Ratings
60.35
13.64
9.29
8.36
3.40
2.95
1.26
0.13
0.01
0.63
100





 
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