IOSCO recommends Sound Practices on the Assessment of Creditworthiness and the Use of External Credit Ratings

On 22 December 2015 IOSCO (International Organization of Securities Commissions) published the final report on Sound Practices at Large Intermediaries Relating to the Assessment of Creditworthiness and the Use of External Credit Ratings. The recommendation of IOSCO confirms unceasing international focus on the risk of usage of external ratings as ratings became a concern for financial regulators, especially as a result of financial crisis. The efforts are concentrated on the requirements on financial entities to undertake their own due diligence and internal risk management, and reconsideration of references to ratings in the regulatory framework, in light of their implicit potential to be regarded as public endorsement of CRA (Credit Rating Agency) ratings.

Twelve sound practices that regulators could consider as part of their oversight of market intermediaries are recommended by IOSCO. The recommendations may be also useful in the development and implementation of effective alternative methods for the assessment of creditworthiness. The objective is to reduce the overreliance on credit rating agencies.

IOSCO in developing the final report conducted a survey of market intermediaries in IOSCO jurisdictions, held two roundtables with large market intermediary firms and considered the public comments.

The recommended practices may be briefly summarized in the following points:

1. Establish an independent credit assessment function that is clearly separated from other business units.
2. Involve senior management in order to ensure the successful implementation of a robust credit assessment process, including promotion of a risk-sensitive culture throughout the organization.
3. Establish a coherent oversight structure to ensure that the credit assessment process is properly implemented and adhered to, including the establishment of reporting lines and responsibilities.
4. Take steps to ensure that a firm’s governing committee receives an appropriate level of information on the amount of credit risk to which the firm is exposed.
5. Invest in staff and other resources necessary to develop a robust internal credit assessment management system that appropriately reflects the nature, scale, and complexity of the business.
6. Avoid exposure to particular credit risks whenever the firm does not have the internal capability to independently and adequately assess the exposure.
7. Incorporate a wide variety of qualitative measures into robust credit assessment processes in addition to quantitative measures.
8. Prescribe internal risk levels and investment appetites for the assessment of creditworthiness that focus on the intrinsic value of the instrument to set limits and risk.
9. Subject non-investment grade or unrated financial products to enhanced scrutiny.
10. Avoid mechanistically relying on external CRA ratings.
11. Strive to update and improve continually the firm’s credit risk assessment practices.
12. Ensure internal audit or another independent party performs regular reviews of credit policies and procedures.