Supplementary memorandum from Moody's
This memorandum responds to the Committee's
requests at the evidence session on 13 November 2007. I deal with
each area in turn.
1. FEES RECEIVED
As Moody's has indicated on previous occasions,
we have an "issuer-pays" business model. In general,
issuers pay for the ratings that we assign to their debt securities.
We recognise that this model creates potential conflicts of interest
that must be managed effectively. That is to say, if Moody's rates
a given company and is paid by that company, then we must protect
against the company's potential influence on the initial rating
process and potential interference in future rating actions. The
market broadly understands this potential conflict
and we believe that Moody's manages our business model to a global
best practice standard.
In specific response to the Committee's concern
about Moody's relationship with Northern Rock, we can confirm
that Moody's has not provided consulting or non-rating services
to Northern Rock. This assertion holds equally true for the subsidiaries
of our corporate parent, Moody's Corporation ("MCO").
The only fees earned by MCO were for the provision of Credit Rating
by Moody's of which 95% was for the provision of credit ratings
and 5% for the sale of related research.
Because of confidentiality reasons and competitive
concerns, we are unable to provide you with the exact fees charged
to Northern Rock. However, Moody's assigned over the last five
years first time ratings to Northern Rock, its subsidiaries or
its related special purpose vehicles as follows:
1. Eight covered bond issues.
2. Twenty one structured finance deals principally
relating to the Granite issuance programme.
In addition Moody's had five distinctive fundamental
ratings on Northern Rock PLC (Deposit, Bank Financial Strength,
Short Term, Subordinated Debt and Hybrid).
Moody's was paid rating fees for these ratings.
To provide further context for the Committee,
we note that the total fees earned by MCO from Northern Rock in
2006 accounted for less than 0.1% of MCO's total revenues.
Furthermore, in 2006, the fees earned from Northern Rock were
significantly below the average and median fees earned by Moody's
from other top 10 UK banks, as sized by total assets.
Moody's would not sacrifice our reputation with
the investor community for providing credible and reliable ratings,
which has been built over 100 years, for any rating relationship.
2. RATINGS BY
For the information requested on ratings accorded
to particular instruments and institutions, please see Annex 1.
3. OUR VIEWS
Moody's welcomes the Bank of England's important
contribution to the current international dialogue relating to
credit rating agencies. It is our understanding that these suggestions
are considered to be ideas that merit consideration rather than
reflecting the final position of the Bank of England.
We set out below our current thinking about
the Bank of England's suggestions. It would be premature, however,
to provide the Committee with our definitive position on these
suggestions because of the developing nature of the global dialogue
on the role and function of rating agencies. In this regard, the
Committee should be aware that Moody's is fully engaged with numerous
market participants, including issuers, investors and regulatory
authorities in exploring the appropriate set of responses to the
issues arising from the current market turmoil.
Suggestion 1: Rating agencies could publish
the expected loss distributions of structured products
"Agencies could publish the expected loss
distributions of structured products, to illustrate the tail risks
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."
It is our understanding that this recommendation,
if implemented, would ask for credit rating agencies to provide
a simple metric that alerts the investor to the nature of the
tail risk. Moody's already publishes much, if not, all of the
relevant information necessary for assessing tail risk. Having
said that, we appreciate that there is market interest in such
a simple metric. We are currently exploring a number of possible
approaches to this issue. At this point, however, we have not
been successful in reducing such complex information into a meaningful
metric and we are concerned that simple metrics might themselves
be misleading. Nevertheless, we are working on means to improve
investor understanding of the potential uncertainty that surrounds
the expected credit performance of different rated securities.
This work includes careful consideration of how we present our
already available public information.
Suggestion 2: Rating agencies could produce
a summary of the information provided by originators
"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."
Credit rating agencies are one of many participants
with historically well-defined roles in the structured finance
market. Our role is fundamentally the same as the role we have
played over the last hundred years in the corporate bond market:
we provide a public opinion (based on both quantitative and qualitative
information) that speaks to one aspect of the securitisation,
specifically the credit risk associated with the securities that
are issued by securitisation structures.
Our credit opinions are based on information
made available to us, which we analyse in accordance with our
methodologies. The Committee should note that, in cases where
we believe we do not have sufficient public and private information,
our practice is either not to issue a credit rating in the first
place or, following a rating committee deliberation, to withdraw
a previously issued rating and make the reason for such withdrawal
public in a press release.
Consequently, any enhancements in the quality and level of issuer
information disclosure would, in turn, enhance the quality of
our credit ratings. Because our role is that of a user of information
provided by others, Moody's has always supported transparency,
both in the corporate market and in the structured finance market.
If authorities would like to increase the level
and quality of transparency in the market by requiring that summary
level data on a structured product and the level of economic interest
in that product's performance is retained by the originator, we
would suggest that rating agencies are not the appropriate entity
on which to place such disclosure obligations. While we fully
support the Bank of England's enhanced transparency recommendation,
we believe that issuers are the logical entity to provide such
information to the market. Our suggestion is based on several
From a practical perspective, requiring rating
agencies to disclose issuer-level information may have a detrimental
affect on the quality of our credit ratings. Issuers provide certain
information to us with the understanding that the information
will be held in confidence. If they believed that credit rating
agencies would disclose it to the market, the issuers might provide
less information to us. This outcome could adversely affect the
quality of our opinions, since they would be based on potentially
incomplete data. More importantly, only the issuer has complete
access to its own data and, consequently, only the issuer has
the ability and appropriate expertise to assert that the summary
data disclosed is an accurate and complete representation of its
financial and economic status.
Suggestion 3: Rating agencies could produce
explicit ranges for their scores on probability of default
"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
This suggestion seems very close in spirit to
Suggestion 1. The suggestion invites the credit rating agencies
to illustrate potential elements of credit risk that go beyond
those envisaged by the rating itself. A Moody's credit rating
is a probabilistic opinion about future events. Our opinions are
by their nature the product of a range of probabilities based
on our assumptions of various factors and expectations about a
transaction's future creditworthiness. Furthermore, in many cases,
investors can access models developed by Moody's. These models
allow investors to change various assumptions and estimate the
impact on a published rating. Consequently, we believe that there
is a risk that, if we were to adopt this suggestion, it might
lead to results that are inconsistent with the nature of our ratings.
Having said this, there might be demand for us to provide some
guidance on how widely we might expect the performance of pools
of similarly rated securities within specific sectors to vary
over time in the future.
On the question of performance of our ratings,
the Committee should note that Moody's already publishes idealised
expected loss tables which, rather than indicating a range of
loss expectations, identify an idealised target expected loss
rate. This information already allows the market to measure our
historical performance and the overall quality of our ratings.
Suggestion 4: Rating agencies could adopt
the same scoring definitions
"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".
Moody's believes that rating agencies should
not be required to harmonise their processes, methodologies, rating
opinions or rating definitions. Because credit ratings are forward-looking
opinions about creditworthiness that address inherently uncertain
future events, Moody's believes that there is no single approach
that should be adopted for developing and publishing them. Two
rating agencies looking at the same set of facts may legitimately
reach different conclusions based on their individual points of
view, understanding of market behaviour, or analytical methodologies.
Moreover, capital markets constantly evolve, with changes in financial
products, issuers and the credit environment. Measures that specify
a particular approach may create a static, inflexible system.
Even if initially aligned with market practices, such a system
would require or promote harmonisation of rating opinions and
could ultimately make rating agencies less capable of responding
to innovations and meeting demands in a continuously evolving
market. Over time, diversity of opinion would suffer, and the
motivation and ability of rating agencies to compete on the basis
of improving credit analysis would be materially eroded.
We can confirm to the Committee that we are
endeavouring to explore means of more clearly and transparently
identifying the limitations and attributes of our credit ratings.
Suggestion 5: Rating agencies could score
instruments on dimensions other than credit risk
"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".
Moody's already provides several non-credit
scores. Examples include those which assess operational quality
of managed funds, alternative liquidity of corporate entities,
and, as discussed in our evidence before the Committee, financial
strength of banks. Recently we introduced a "fundamental
value" product based on discounted cashflow analysis for
structured finance securities. This product should also allow
scope for volatility analysis based on changes to assumptions.
We will continue to explore areas where we believe we can provide
tools that would be useful to the market.
6 December 2007
20 When referring to Northern Rock we include any of
it subsidiaries and all special purpose vehicles related to Northern
We would note that under an alternative business model in which
bond investors rather than issuers pay for ratings, it is also
likely that a large investor paying fees to Moody's would have
an incentive to apply pressure to influence the rating process-especially
an investor holding concentrated positions. Rating actions often
have implications for an entity's equity valuation, and so investors
who also hold equity positions may be doubly motivated to influence
rating actions. Back
For a detailed discussion of the various policies and mechanisms
we have in place that manage and mitigate the potential conflicts
in our business model please see "Moody's Investors Service
Report on the Code of Professional Conduct", April 2006 (hereafter
"Moody's Report"). The report is available on our website,
As defined in the Moody's Code of Professional Conduct: "Credit
Rating Services are those products and services that are derived
from the Credit Rating process and include, but are not limited
to, the production and sale of Credit Ratings and related research,
data products and related analytical tools". The Code is
available on our website, www.moodys.com at: http://www.moodys.com/cust/content/Content.ashx?source=StaticContent/Free%20Pages/Regulatory%20Affairs/Documents/professional_conduct.pdf Back
Moody's fees earned from Northern Rock peaked in 2005. This reflected
the number of structured finance transactions issued by Northern
Rock. The fees in 2005 were some 40% higher than in 2006. In 2002,
2003 and 2004 Moody's earned fees that were some 30%, 40% and
20% lower respectively than in 2006. Back
Northern Rock is a top 10 UK bank. Back
Bank of England footnote: "The risk that extreme losses are
more likely than what would be expected from a normal distribution". Back
A decision to withdraw a rating is made by a rating committee.
Language similar to the following typically would appear in such
a press release: "The rating has been withdrawn because Moody's
believes it lacks adequate information to maintain a rating. Please
refer to Moody's Withdrawal Policy on moodys.com". Back
Bank of England footnote: "Moody's announced in 2006 that
it would start disaggregating some of its long-term ratings into
their two key components-loss given default and probability of
22 June 2006)". Back
Bank of England footnote: "Moody's is considering issuing
measures of liquidity risk and market risk alongside traditional
ratings for complex financial instruments (Source: Financial
Times, 17 September 2007)". Back