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COFACE Summary of Comments on CEBS Consultation Paper on ECAI Recognition

Core Content

Coface, a leading provider of credit management services, has submitted detailed comments on the CEBS Consultation Paper regarding the recognition of External Credit Assessment Institutions (ECAIs). The paper outlines the proposed recognition process, emphasizing transparency, data quality, and the role of ECAIs in enhancing financial stability by providing reliable credit information to banks.

Coface supports the general approach of the CEBS Consultation Paper, particularly the joint recognition process, which is seen as cost-efficient and beneficial for harmonizing risk assessments across the EU. However, they highlight several areas where the proposals may be too restrictive and could hinder the development of a competitive ECAI industry.

Main Views and Key Points

1. Support for the Joint Recognition Process

• Coface agrees with the joint process as it reduces administrative burdens and promotes a harmonized playing field.
• However, the process should not ignore country-specificities, especially differences in default definitions.
• The joint process should focus on objective criteria rather than being a mere guideline for national authorities.
• For ECAIs with multiple subsidiaries, a group-level recognition process should be considered, allowing for a more comprehensive evaluation of expertise.

2. Concerns with the Mapping Process

• Coface believes the mapping process should not be based solely on existing rating agencies, as some ECAIs may have more experience in specific markets.
• The requirement of 10–13 years of default data is too rigid, especially for SME markets where sufficient data may be available.
• The mapping in Annex 2 of the CRD paper is not suitable for SMEs due to the heterogeneity in default definitions across countries.
• The proposed mapping should consider different default criteria (e.g., legal bankruptcy vs. bank loan default) and allow for country-specific or market-specific proposals.

3. Default Definition and Loss Given Default (LGD)

• Coface emphasizes that both PD (Probability of Default) and LGD are important in Basel II and should be considered together.
• They argue that the current approach of mapping only PD may lead to inconsistencies and regulatory arbitrage.
• The mapping should allow for flexibility in default definitions, taking into account country-specific legal and institutional frameworks.

4. Role of ECAIs in Financial Stability

• ECAIs contribute to financial stability by providing banks with reliable credit information, reducing information asymmetry, and helping in the assessment of credit risk.
• Their role extends beyond the Standard approach, supporting banks using Internal Ratings-Based (IRB) approaches as well.
• ECAIs help small firms access credit by offering alternative information sources where banks may lack sufficient data or expertise.

5. Criticism of Regulatory Barriers

• The requirement that an ECAI must have at least one bank using its ratings is seen as a barrier to entry.
• Coface suggests that ECAIs could be recognized based on their use in risk management by other firms, not necessarily in the Standard approach.
• They recommend that regulatory authorities should evaluate ECAIs based on their overall expertise rather than market acceptance.

Conclusion

Coface concludes that the proposed recognition process is a positive step towards enhancing the credit assessment system in the EU. However, they stress the need for flexibility in the mapping process, especially for SMEs, and the importance of considering both PD and LGD in the assessment. They also advocate for a more comprehensive and global evaluation of ECAIs rather than imposing rigid market-based requirements. Coface is ready to participate in any mapping experiments to ensure that the resulting risk weights better reflect the specific risks of SMEs across Europe.

Appendix 1 Summary

• The mapping process requires actual rating assignments and historical default data.
• Two main methods are used: the median-borrower method and the weighted-mean-default method.
• In the case of SMEs, default probabilities differ significantly depending on the default criterion (e.g., legal bankruptcy vs. bank loan default).
• Coface provides a detailed example using French SME data, showing that the same grade in different rating systems corresponds to different PDs.
• Due to the heterogeneity in default definitions and data availability, a one-size-fits-all mapping is unlikely to be effective.
• Coface suggests that supervisors should ask ECAIs to propose their own mapping experiments to create more accurate benchmarks.