Disclosure Requirements for Initial Reviews and Preliminary Credit Ratings Discussed

The European Securities and Markets Authority (ESMA) published its “Final Report” with “Guidelines on Disclosure Requirements for Initial Reviews and Preliminary Ratings“. The purpose of these Guidelines is to deliver guidance that will address inconsistencies in the application of these requirements by Credit Rating Agencies (CRAs), and by extension reduce the risks that are posed by rating shopping to the extent it is possible under the existing provisions of the CRA Regulation.

ESMA has conducted a public consultation on these Guidelines in order to gather the views of CRAs and other relevant stakeholders. A number of amendments and clarifications have been introduced into the final guidelines in order to take account of the views expressed during this consultation.

In one of the answers it was noticed that ESMA’s proposal assumes good behavior on the part of the issuer, although it is precisely about the cases in which an issuer hides a poorer rating. The rating can refer to a shelf registration or any other vehicle with a different LEI or an instrument with a different ISIN, which can be legally differentiated, but represent the same economic risk. These cases are particularly difficult to grasp when the greedy rating agency also collaborates on behalf of the issuer against competing agencies.

“However,” writes ESMA, “a number of respondents raised specific concerns over the provision of an LEI or ISIN for each disclosed instance. Specifically, one respondent outlined that not all entities currently have an LEI/ISIN and that this can depend on the maturity of the entity seeking a rating, its industry, or the stage of the considered transaction.” To address this issue, it was advocated to replace a missing LEI by the “reporting company’s unique key“ or unique rating identifier, as reported to ESMA under Commission Delegated Regulation (EU) 2015/23, while other respondents advocated for the exclusion of initial assessments for which an LEI and/or ISIN had not been provided from the proposed disclosures. This was on the basis that it would be difficult to monitor other CRAs’ public disclosures to assess whether that CRAs provided an initial review or preliminary rating for that same transaction.

Concerning the LEI or ISIN, ESMA now considers that it is not a point that needs to be populated in the disclosure if that information is not available to the CRA at the time of making the disclosure. “However, the CRA should back-fill this data point on subsequent publications when this data becomes available to the CRA”, writes ESMA.

In its public consultation, ESMA asked whether respondents agree that ESMA’s proposed timing of disclosures would better enable investors and the market to identify where rating shopping may have occurred. The wise choice of the timing of publications is a differentiating factor between the rating agencies. Investors and issuers prefer agencies that know how to choose their publication times sensibly. Rating agencies compete with each other to choose the wisest possible time for publication, for example before or after the market closes, before, after or at the same time as other notifications, etc. It takes many years of experience to understand the complex constraints and interests of issuers (and their boards and shareholders), banks, law firms, auditors, rating advisors, institutional and private investors, etc.

According to ESMA’s evaluation of responses, one respondent agreed that the proposed timing of these disclosures will better enable investors and the market to identify where rating shopping might have occurred, on the basis that “since all CRAs will publish an updated list on the same day of each month, it should enable investors to check the issuers and issuances”. Another respondent questioned whether the uniformity of dates would create a risk of a race to the bottom in terms of timing.