Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 1060 - 1079)

TUESDAY 13 NOVEMBER 2007

MR PAUL TAYLOR, MR CHARLES PRESCOTT, MR MICHEL MADELAIN, MR FRÉDÉRIC DREVON, MR IAN BELL AND MR BARRY HANCOCK

  Q1060  Mr Dunne: That is a good line. How carefully do you look at what is going into the individual products as they are evaluated? Let us look at a complicated one. How about a first default basket? How closely do you get into what comprises the first default basket?

  Mr Drevon: The analysis would be on each individual instrument that goes into that transaction, and we would take a view on what is the likelihood of default of that specific instrument, what is the correlation between those different instruments, model that and come to a conclusion.

  Q1061  Mr Dunne: If we take something else, a CDO square, which is new expression to me, that essentially is a CDO vehicle investing in pools and tranches of other CDO instruments?

  Mr Drevon: That is correct.

  Q1062  Mr Dunne: Do you go down to the underlying individual asset across a pool?

  Mr Drevon: That is correct, yes. We do what we call a "look-through", so we go, in fact, not at the first level, but we go for the underlying assets, which is the corporate risk.

  Q1063  Mr Dunne: Is the issuer able to provide access to the underlying data in every case?

  Mr Drevon: In most cases the underlying corporate names are rated; so we use the rating information.

  Q1064  Mr Dunne: Let us suppose we are not dealing with corporate names, we are dealing with packages of securities which do not have to issue accounts and do not have to issue public statements.

  Mr Drevon: Typically those instruments would be rated by us and we would use the rating as an input.

  Q1065  Mr Dunne: So you rely on your own rating of an underlying instrument.

  Mr Drevon: That is correct, yes.

  Q1066  Mr Dunne: Without necessarily going in to look at whether that rating is correct or not?

  Mr Drevon: No, we believe that our ratings are correct as a policy for our rating system.

  Q1067  Mr Dunne: How frequently do you reassess ratings of individual instruments? Particularly I am interested in the financial products rather than the corporates, which have a natural publication cycle.

  Mr Drevon: It is on-going work at Moody's. The day we assign the first rating is also the first day we start monitoring the rating; so there is no specific day in the year we decide we are going to review the ratings, it is an on-going review.

  Q1068  Mr Dunne: Once a year, once every two years, once every three years?

  Mr Drevon: It really is instrument specific. In some instruments we will review them every week because there are very specific events surrounding that instrument. In some other instruments, take a high quality sovereign risk, we know that the likelihood of that changing is going to be lesser, and so the monitoring is going to be on an annual basis.

  Q1069  Mr Dunne: Who monitors the monitors? Is there any independent assessment of any of your methodologies? Perhaps I will ask somebody else. Mr Bell, you are nodding.

  Mr Bell: The independent assessment is basically conducted by the investors. Our criteria are public. Therefore, it can be conducted by anyone who wishes: the regulators, CESR, the investors.

  Q1070  Mr Dunne: Do any investors in your experience ever analyse your methodology, other than in relation to questioning your decision? Do they go back to first principles? Do they ask for all of your data to cross-check with their own models—

  Mr Bell: Yes.

  Q1071  Mr Dunne: —in relation to that instrument.

  Mr Bell: Certainly in Europe I have come across a number of investors. Also we do do exactly that. If the information that we have received suggests that we should change our criteria, we will often request a comment from the investors. We sometimes get quite vociferous comments for or against any proposed change, so is there an on-going debate with the investor community.

  Mr Hancock: I would just add, it is exactly the same on the corporate and government side. We have an enormous number of phone calls from investors and other interested parties questioning our opinions every day and, as a matter of policy, we put the names and phone numbers of the analysts on each piece to encourage that.

  Q1072  Mr Dunne: Do you publish your methodology in relation to individual instruments and your model? Can somebody actually come in and look at your model?

  Mr Bell: Yes. In CDOs, for example, our model is available for free on the website. I believe that is the case for the other agencies.

  Q1073  Mr Dunne: Do any regulators overlook your methodologies or models? Do you have discussions with them at all?

  Mr Bell: We have had discussions with regulators where they have asked questions about our methodologies.

  Q1074  Mr Dunne: Any question of whether it is valid, or was it more to do with the conclusions that you have come to for a particular instrument that they are interested in?

  Mr Drevon: I believe the regulators have been looking more at the conclusion than the methodology itself.

  Mr Taylor: The experience that I have had is just that they are trying to understand how we look at things, how the process works.

  Q1075  Mr Dunne: So they are looking ultimately at how you arrive at the outcome, but they are not seeking to question whether the methodology itself is correct or appropriate?

  Mr Taylor: Correct.

  Q1076  Mr Dunne: Can you explain why it is that different credits with the same rating have such widely different spreads in the market place? To give you an example which was given to me the other day, if you take an emerging market, Peru 2016, which is trading this spring at 96 basis points above the relevant US treasury and you compare that with a US corporate dollar bond, say General Motors, 2031, which had a 250 basis point spread over Treasury, whereas a foreign corporate dollar bond, KazCommerce Bank 2013 had a 263 basis point spread, that is a significant difference, all of which have got a double-B plus rating, I think it was from Moody's in that case, so perhaps Moody's can answer. Why is it that the spread is so significant if the rating is the same?

  Mr Madelain: I think the spread speaks to more than just credit risk but also to the liquidity of the instruments, and there may be also some diversions of view between our perspective on the credit risk as a suitable security and the general consensus of the market.

  Q1077  Mr Dunne: So the credit rating is not a guide to an investor as to the performance of the underlying instrument, it is merely a guide as to whether it is going to repay at the end of its maturity.

  Mr Madelain: If you define performance as return, that is correct.

  Q1078  Mr Dunne: What about the default rate of different types of instruments? What has the experience been of that?

  Mr Drevon: We published a very significant amount of statistics looking at the performance of our ratings, and if you look over long periods of time, particularly 15 years or more, the performance of structured finance ratings, in fact, are in line with the performance of other bonds, such as corporate bonds.

  Q1079  Mr Dunne: That is interesting, because there was an article in the FT in August that suggested that actually the performance of CDOs was ten times riskier than corporate bonds, and that was from a Moody's study?

  Mr Drevon: I think you always have the possibility to drill down and say, if we look for a period of six months at a specific asset category and specific rating level, there will be differences—that is absolutely normal—but the work we do is based on long-term statistical data and when we look over the long-term horizons, there is a high degree of convergence in terms of the performance of the ratings on the structured final side and the corporate side.


 
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