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May 14 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has updated its criteria for the analysis of counterparty risks in structured finance (SF) transactions and covered bond (CVB) programmes. The criteria are largely unchanged from the previous report and no rating changes are expected to result from the update. The agency has maintained its expectations for the timing of remedial actions. The criteria for the collateralisation of derivative counterparty obligations has been expanded to include certain sovereign bonds rated at least ‘A’ and ‘F1’.
In order to delink SF and CVB ratings from the risk of the counterparty, Fitch expects counterparties to be obligated to implement remedial actions on a timely basis upon becoming ineligible. Specifically where collateralisation is a feasible mitigant then action is expected within 14 calendar days, or for other remedial actions within 30 calendar days. The 30 calendar day remedial timing has been a feature of Fitch’s counterparty criteria since 2004.
In the past year, Fitch has observed an increased number of structural proposals seeking to accommodate longer remedial periods (e.g. 31 calendar days or 30 working days). Fitch believes that such structural proposals are motivated primarily by the advent of the Basel III liquidity coverage ratio (LCR) that will require counterparties to hold liquid assets to cover for certain potential outflows (including those in relation to remedial actions) that may occur within 30 calendar days of a three-notch downgrade.
One line of argument presented by counterparties in support of extended remedial timing is that actual remedial actions often take longer than 30 calendar days.
Fitch acknowledges that remedial actions may take longer to implement in practice, depending on factors including the amount of upfront preparation completed by the counterparty and the volume of counterparty replacement activity being undertaken at a particular point in time. However, Fitch does not consider it appropriate to amend its criteria expectations such that counterparty remedial obligations are placed beyond the 30 calendar day scope of the LCR.
Further, Fitch is of the opinion that the provisions of the LCR reinforce a key assumption of the counterparty criteria. Namely, that upon becoming ineligible, counterparties will have the financial ability to take remedial action. Where structural proposals are not consistent with Fitch’s expectations the agency will continue to analyse these in accordance with the “Non-Compliance with Criteria” section of the criteria report.
In this criteria update, Fitch has expanded the range of eligible collateral for derivative counterparty obligations to include eurozone and Japanese sovereign bonds with a minimum rating of ‘A’ and ‘F1’. Previously sovereign bonds were expected to have a minimum rating of ‘AA-’ and ‘F1+'. The ‘A’ and ‘F1’ rating threshold is consistent with that applied to other counterparty exposures while the market value risk of sovereign bonds is addressed via the application of advance rates specified in the derivative addendum. Advance rates for ‘AA-’ and ‘F1+’ sovereign bonds have been updated with minor changes to reflect updated market data.
Other than the above change, there are no other material changes and the criteria update is not expected to impact any structured finance or covered bond ratings.
The criteria report “Counterparty Criteria for Structured Finance and Covered Bonds” replaces the report of the same name dated 13 May 2013.
The criteria report “Counterparty Criteria for Structured Finance and Covered Bonds: Derivative Addendum” replaces the report of the same name dated 13 May 2013.
Link to Fitch Ratings’ Report: Counterparty Criteria for Structured Finance and Covered Bonds