IOSCO pronounces on how asset managers can reduce reliance on rating agencies

Chris Hamblin

22 July 2015

The report stresses the importance of asset managers having the appropriate expertise and processes in place to assess and manage the credit risk associated with their investment decisions. It is to be found at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD488.pdf

IOSCO identifies 8 'sound' strategies by which asset management firms might offset the influence of the top ratings agencies, which have often wildly over-valued worthless stock and thereby helped to create bubbles such as the one that blighted the Earth in 2007-8.

Asset managers could make their own determinations about the credit quality of a financial instrument before investing and throughout the holding period.
Asset managers should have the appropriate expertise and processes in place to perform credit risk assessments appropriate to the nature, scale and complexity of any investment strategy they embark on and the type and proportion of debt instruments they invest in, and should refrain from investing in products / issuers when they do not have enough information to perform an appropriate credit risk assessment.
External credit ratings may form one element, among others, of the internal assessment process without constituting the sole factor supporting the credit analysis.
The manager’s internal assessment process is regularly updated and applied consistently.
Where external credit ratings could be used, asset managers should understand the methods and the basis on which the ratings agency formed its opinion and have adequate means and expertise to identify the limitations of its methods and assumptions.
Asset managers could review their disclosures, describing alternative sources of credit information in addition to external credit ratings. They could make available to investors, as appropriate, a brief summary of their internal credit assessment process.
When assessing the credit quality of their counterparties or collateral, asset managers need not rely solely on external credit ratings and couold consider alternative quality parameters (e.g. liquidity, valuation, correlation, etc.).
If they use external credit, they might decide that a downgrade does not automatically trigger the immediate sale of the asset. Should the manager/board decide to divest the fund of the asset, they might process the transaction in a timeframe that is in the best interests of the investors.