17 Jul 2008, Alexander Campbell, Risk magazine
Under the new scheme, the agency would award ratings based on its expectation of how far ratings would fall under a "moderate" stress such as a 1991-scale recession. For example, a AAA-rated security would be expected to fall no further than AA in one year of moderate stress and BBB in three years.
The change will not produce any upgrades, and is likely to have "very little, if any, effect on our ratings in the corporate and government segments", S&P said. It will mainly affect structured finance products, in particular collateralised debt obligations of asset-backed securities, constant-proportion debt obligations and leveraged super-senior structures.
S&P described the proposal as a response to misuse of its ratings. "Certain areas of the structured finance segment have favoured a narrow interpretation, essentially meaning 'likelihood of default' without regard to other factors. We are proposing to move beyond the narrow interpretation in favour of one that is more practical and useful for market participants. As a result, although our views on likelihood of default would remain a focus of our ratings, it would not be our only consideration," the agency wrote.
Yesterday's announcement was the latest in a series of suggested reforms from the agency. It has previously suggested using a ratings suffix to emphasise the difference, including in terms of ratings volatility, between structured products and other securities with the same rating - a high-grade structured product would be rated AAA.sf, for example, rather than simply AAA. It has also suggested publishing separate indicators of ratings volatility. No definite decision has yet been made.
In the wake of the credit crisis, all three major rating agencies have announced reforms aimed at repairing the damage done to their credibility by the multiple deep downgrades of structured finance products. These have focused on demarcating structured finance products from the less volatile corporate and government securities, giving more information on expected ratings volatility, and improving transparency and protections against conflicts of interest inside the agencies.
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