Credit rating agencies -guidance on certain AFS licence conditions

This is Information Sheet 143 (INFO 143). It is for credit rating agencies providing services in Australia. It gives guidance on the meaning of certain conditions that apply to these credit rating agencies under their Australian financial services (AFS) licence.

This information sheet covers:

• the scope and purpose of our guidance
• separating advisory services from credit rating services
• applying methodologies in a continuous manner
• timely disclosure of actual and potential conflicts of interest
• periodic review of methodologies and models, and
• review of and disclosure about affected ratings after material changes.

Scope and purpose of our guidance

The conditions covered by this information sheet reflect certain provisions of the IOSCO Code of Conduct Fundamentals for Credit Rating Agencies (IOSCO Code), which credit rating agencies must adopt with specified modifications under their AFS licence.

Our guidance is provided in the context of the assessment by the European Securities and Markets Authority (ESMA) as mandated by the European Commission of whether Australia’s regulation and supervision of credit rating agencies is equivalent to the European Union’s Regulation on Credit Rating Agencies (EU Regulation).

Under the EU Regulation, regulation and supervision of credit rating agencies in Australia that is at least as stringent as that in the EU is necessary for ratings prepared in Australia to be endorsed for use in the EU. Regulation and supervision of credit rating agencies in Australia needs to be considered equivalent in order for ratings prepared in Australia by a credit rating agency without any legal presence in the EU to use those ratings in the EU.

Separating advisory services from credit rating services

A credit rating agency must separate, operationally, its credit rating business and analysts from any other businesses of the credit rating agency, including consulting businesses, that may present a conflict of interest: provision 2.5, IOSCO Code.

We consider that all advisory services to a rated entity or related third party will present a conflict of interest. Therefore, credit rating agencies must operationally separate their credit rating businesses and analysts from advisory services provided to rated entities and related third parties.

Applying methodologies in a continuous manner

A credit rating agency must use rating methodologies that are rigorous, systematic, and, where possible, result in ratings that can be subjected to some form of objective validation based on historical experience: provision 1.2, IOSCO Code.

Analysts involved in a rating action must use methodologies established by the credit rating agency: provision 1.3, IOSCO Code. Analysts must apply a given methodology in a consistent manner, as determined by the credit rating agency.

We consider that compliance with the obligations that a credit rating agency’s methodologies must be rigorous, systematic and consistently applied requires, among other things, that methodologies must be applied in a continuous manner.

Timely disclosure of actual and potential conflicts of interest

Disclosures of actual and potential conflicts of interest by a credit rating agency must be complete, timely, clear, concise, specific and prominent: provision 2.7, IOSCO Code.

Where a conflict of interest potentially affects existing credit ratings, we consider that disclosure of this conflict will only be timely if it is made immediately after the conflict is identified. Such disclosures should be made in an announcement and placed in a prominent position on the credit rating agency’s website wherever the affected ratings are displayed.

Periodic review of methodologies and models

A credit rating agency must establish and implement a rigorous and formal review function responsible for periodically reviewing the methodologies and models and significant changes to the methodologies and models it uses: provision 1.7-2, IOSCO Code.

We consider that this obligation requires an ongoing review of methodologies and models which, at a minimum, would involve reviews being conducted annually.

Review and disclosure of affected ratings after material change

As a condition of its AFS licence, if a credit rating agency makes a material change to a methodology or material assumption, it must:

• as soon as possible, disclose any class of ratings likely to be affected, and
• as soon as possible, and in any case within six months, review any affected ratings.

We consider that the only changes to a methodology or assumption that are not material are those that would not result in a change to a rating.

We also consider that disclosure of any class of ratings likely to be affected by the change must be made immediately after the change is made.

Where can I get more information?

• Go to www.asic.gov.au/fs.
• Call ASIC on 1300 300 630.

Important notice

Please note that this information sheet is a summary giving you basic information about a particular topic. It does not cover the whole of the relevant law regarding that topic, and it is not a substitute for professional advice. We encourage you to seek your own professional advice to find out how the applicable laws apply to you, as it is your responsibility to determine your obligations.

You should also note that because this information sheet avoids legal language wherever possible, it might include some generalisations about the application of the law. Some provisions of the law referred to have exceptions or important qualifications. In most cases, your particular circumstances must be taken into account when determining how the law applies to you.