5.ECAI’s should have a methodology for assigning credit ratings that is rigorous and systematic, and is subject to validation based on historical experience. Ratings assessments should be based on methodologies combining qualitative and quantitative approaches. Moreover, assessments must be subject to ongoing review and responsive to changes in financial condition. To establish that an ECAI fulfils this primary component of eligibility criteria, it must demonstrate that it meets the following minimum standards:

1. (i)The ECAI has established rating definitions, criteria, and methodologies, and apply them consistently;
2. (ii)The ECAI should have a robust procedure of rating assignment based on published information, market data, interviews with management, and/or other sources of information that provide a sound basis for purposes of assigning the ratings;
3. (iii)When assigning risk ratings, the ECAI should take into account all major features of credit quality that are relevant under the ECAI’s applicable methodology, and should ensure that the ratings are assigned taking into account all risk factors of the rated entity or issue relevant under the ECAI’s applicable methodology;
4. (iv)The ECAI should demonstrate that rating methodologies are subject to quantitative back testing. For this purpose, the ECAI should calculate and publish default studies, recovery studies, rating transition matrices, or other analyses as relevant to the ECAI’s rating methodology. The analysis should reflect a definition of default that is consistent with international standards, subject to possible adjustments to take into account local practices or institutional or market conditions;
5. (v)The rating methodology for each market segment, including rigorous back testing, must have been established for at least one year and preferably three years;
6. (vi)All rating decisions should be made based on the ECAI’s established criteria and methodologies, subject to documented variations approved in accordance with the ECAI’s procedures;
7. (vii)The ECAI should have a mechanism to review its procedures and methodologies to adapt them to a potentially changing environment; and
8. (viii)The ECAI should maintain adequate systems and internal records to support its assigned ratings.

6.The ECAI should be free from any economic or external political pressures that may influence its credit ratings. In particular, an ECAI should not delay or refrain from taking a rating action based on its potential effect (economic, political or otherwise). The independence of an ECAI shall be assessed on the basis of the following five parameters:

1. (i)Ownership: The ownership structure should not be such that it could jeopardize the objectivity of the rating process. For example, the owners should not hold 10 percent or more of the equity of any entity rated by the ECAI.
2. (ii)Organizational Structure and Corporate Governance: The ECAI should demonstrate that its organizational structure minimizes the scope for external influences to influence the rating process inappropriately. The ECAI should have in place effective corporate governance that safeguards the independence of its credit ratings, promotes integrity, and ensures that internal disagreements over ratings are resolved in ways that do not compromise the overall effectiveness of the rating process.
3. (iii)Financial Resources: The ECAI must demonstrate that its business is financially viable and is able to sustain any commercial pressure that might be exerted by external entities, including the entities being rated. The ECAI’s financial position should not depend significantly on the provision of other services to the rated entities.
4. (iv)External Conflict of Interest: The credit rating process of the ECAI should have the ability to withstand external pressures. The ECAI should demonstrate that it is free from any type of external conflicts of interest, or that conflicts of interest are disclosed and managed.
5. (v)Separation: An ECAI should separate its rating business operationally, legally, and if practicable, physically from its other business operations that may present a conflict of interest, such as advisory services.

7.The individual ratings, the key elements underlying the ratings, and whether the issuer participated in the rating process should be information that is publicly available on a non-selective basis.

8.In order to promote transparency and enable stakeholders to make decisions about the appropriateness of its credit rating methods, an ECAI should disclose sufficient information (e.g., rating definition, methods of arriving at the rating, rating process, time horizon of the rating, and the surveillance and review procedure) to facilitate such decisions. The ECAI’s general procedures, methodologies, and assumptions for arriving at ratings should be publicly available.

9.A rating should be disclosed as soon as practicably possible after issuance. When disclosing a rating, the information should be clearly worded, and should indicate the nature of the rating and relevant limitations, while providing appropriate warning to users of the potential danger of unduly relying on the rating to make investment or other decisions.

10.To promote transparency and market discipline, an ECAI should demonstrate that it provides access to information that enables stakeholders to make decisions about the appropriateness of ratings for the intended use or uses. At a minimum, the ECAI is expected to make public the following information:

1. •Code of conduct;
2. •Definition of default;
3. •The time horizons reflected in ratings;
4. •Rating definitions;
5. •Rating methods;
6. •Actual default rates experienced in each rating category;
7. •Rating transition matrices;
8. •Whether particular ratings are solicited or unsolicited;
9. •The date of last review and update of ratings;
10. •The general nature of compensation arrangements with rated entities; and
11. •Any actual or potential conflicts of interest.

11.At a minimum, the following conflict-of-interest situations and their influence on the ECAI’s credit rating methodologies or credit rating actions must be disclosed:

1. (i)The ECAI is being paid to issue a credit rating by a rated entity or by the obligor, originator, underwriter, or arranger of a rated obligation;
2. (ii)The ECAI is being paid by subscribers with a financial interest that could be affected by a credit rating action of the ECAI;
3. (iii)The ECAI is being paid by rated entities, obligors, originators, underwriters, arrangers, or subscribers for services other than issuing credit ratings or providing access to the ECAI’s credit ratings;
4. (iv)The ECAI is providing a preliminary indication or similar indication of credit quality to an entity, obligor, originator, underwriter, or arranger prior to being hired to determine the final credit rating for the entity, obligor, originator, underwriter, or arranger; and
5. (v)The ECAI has a direct or indirect ownership interest in a rated entity or obligor, or a rated entity or obligor has a direct or indirect ownership interest in the ECAI.

12.An ECAI should disclose the general nature of its compensation arrangements with rated entities, obligors, lead underwriters, or arrangers. When the ECAI receives compensation unrelated to its credit rating services from a party such as a rated entity, obligor, originator, lead underwriter, or arranger, the ECAI should disclose such compensation as a percentage of the total annual compensation received from that party in the relevant credit rating report or elsewhere, as appropriate. An ECAI should disclose in the relevant credit rating report or elsewhere, as appropriate, if it receives 10% or more of its annual revenue from a single party (e.g., a rated entity, obligor, originator, lead underwriter, arranger, or subscriber, or any of their affiliates).

13.ECAI should possess sufficient human and technical resources to produce high quality credit ratings. Evidence of resource sufficiency includes:

1. (i)Technical expertise of the people should be sufficient to conduct the analysis to support the assignment of ratings, and to maintain contact with senior and operational levels within the entities that are rated. In particular, ECAIs should assign analysts with appropriate knowledge and experience to assess the creditworthiness of the type of entity or obligation being rated; and
2. (ii)With respect to technical resources, an ECAI is expected to apply quantitative techniques and models that can appropriately process and analyze the quantities of data required to support the rating process.

14.The ECAI must demonstrate that it enjoys credibility in the markets in which it operates. Such credibility is gauged on the basis of:

1. (i)The extent to which it meets the resources requirements stated above;
2. (ii)The extent to which independent parties (investors, insurers etc.) rely on the ECAI’s risk ratings; and
3. (iii)The existence of internal procedures to prevent misuse of confidential information.

15.The Central Bank may request the ECAI to demonstrate that it has not used unsolicited ratings to put pressure on entities to obtain solicited ratings. If the Central Bank becomes aware of an ECAI using unsolicited ratings to put pressure on entities to obtain solicited ratings, the Central Bank may consider whether it is appropriate to revoke the recognition of the ECAI as eligible for capital adequacy purposes.

16.Eligible ECAIs should notify the Central Bank of significant changes to methodologies, and should provide the Central Bank with sufficient access to external ratings and other relevant data to support initial and ongoing determination of eligibility.

17.The ECAI must adopt and adhere to a code of conduct that is consistent with the IOSCO CRA Code. The ECAI must be subject to effective supervision on an ongoing basis by a competent regulatory authority that has adopted a regulatory regime consistent with the IOSCO CRA Code, and that incorporates a registration system for ECAIs.

23.For the purpose of applying ECAI ratings to derive risk-weights for exposures, banks should apply the following process:

1. (i)Identify an ECAI (the “nominated ECAI”) whose assigned ratings the bank intends to use to derive risk weights for some type of exposure that is subject to an external ratings-based approach under Central Bank standards;
2. (ii)Confirm that the nominated ECAIs can provide reasonable coverage of the bank’s exposures in terms of the types of counterparties and the geographical regions covered;
3. (iii)Document the selection of the ECAI and the analysis demonstrating that the ratings of ECAI are appropriate for the specific use;
4. (iv)Notify the Central Bank of the nominated ECAI and of the intended application of the ratings of that ECAI to the bank’s external ratings-based calculations; and
5. (v)Use the ratings of the ECAI within external ratings-based calculations consistently.

24.Banks must use the chosen ECAIs and their ratings consistently for each type of claim for which the ECAI and its ratings are approved, and must seek the consent of the Central Bank on any subsequent changes to the application of those ratings. Banks may not “cherry-pick” the ratings provided by different ECAIs, and must maintain records of which ECAIs they use for various purposes within capital adequacy calculations. Banks may not use unsolicited ratings that may be provided by any ECAI.

25.When banks use external ratings to assign risk weight to securitisation exposures under the Central Bank’s Standards on Capital for Securitisation Exposures, additional operational requirements apply to the ratings and the ECAI that is the source of the ratings.

26.If there is only one rating by a nominated ECAI for a particular claim, that rating should be used to determine the risk weight of the exposure.

27.If there are two ratings by nominated ECAIs that map to different risk weights, the higher risk weight must be applied.

28.If there are three or more ratings with different risk weights, the ratings corresponding to the two lowest risk weights should be referred to. If these give rise to the same risk weight, that risk weight should be applied. If different, the higher risk weight should be applied.

29.External ratings for one entity within a corporate group cannot be used to risk weight other entities within the same group.

30.A bank must treat a relevant exposure or the person to whom the bank has a relevant exposure as “unrated” for risk weighting purposes if that exposure or that person does not have a rating assigned to it by the ECAI otherwise used by the bank.

31.Where a bank is applying external ratings to an exposure that corresponds to a particular issue with an issue-specific rating, the risk weight of the claim must be based on this issue-specific rating. In other cases, the following requirements apply:

1. (i)In circumstances where the borrower has a specific rating for an issued debt claim, but the bank’s exposure does not relate to this particular rated claim, a high-quality credit rating (that is, one that maps to a risk weight lower than the risk weight that would apply to an unrated claim) on that specific issue may only be applied to the bank’s un-assessed exposure if the exposure ranks pari passu with or senior to the rated issue in all respects. If not, the credit rating cannot be used, and the un-assessed claim exposure should receive the risk weight for unrated claims.
2. (ii)In circumstances where the borrower has an issuer rating, this rating typically applies to senior unsecured claims on that issuer. Consequently, only senior claims on that issuer will benefit from a high-quality issuer rating if one exists. Other un-assessed claims of a highly assessed issuer will be treated as unrated. If either the issuer, or a particular issue from that issuer, has a low-quality rating (that is, one that would map to a risk weight equal to or higher than would apply to an unrated exposure), then a bank with an unrated exposure to the same counterparty that ranks pari passu with or is subordinated to senior unsecured (in the case of an issuer rating) or to the specific issue (in the case of an issue-specific rating) should risk-weight that exposure using the low-quality rating.

32.Where a bank intends to rely on an issuer or an issue-specific rating, the rating must take into account and reflect the entire amount of credit risk exposure a bank has with regard to all amounts owed to it.

33.Where exposures are risk-weighted based on the rating of an equivalent exposure to that borrower, foreign currency ratings should be used for exposures in foreign currency. If there is a separate domestic currency rating, it should be used only to risk-weight exposures denominated in the domestic currency.

34.In order to avoid double counting of credit enhancement factors, no supervisory recognition of credit risk mitigation techniques will be taken into account if the credit enhancement is already reflected in the rating of a specific issue.