ESG Ratings: The Good, the Bad, the Ugly

Agencies, Methodologies

Headline ratings no longer enough

Prof. Dr. Nils Stieglitz gave a welcome address to the conference “ESG Ratings: The Good, the Bad, the Ugly” of the Corporate Governance Institute (Prof. Dr. Julia Redenius-Hövermann) at the Frankfurt School of Finance & Management, followed by Prof. Dr. Zacharias Sautner, showing data of Hartzmark and Sussman, 2019, proving that investors value sustainability. He introduces the subject “ESG Ratings in the Investment Process”.

“Corporate ESG ratings are the most unseful source of information”, says Zacharias Sautner. This is confirmed by various studies. ESG ratings provide data material to investment performance, supplement organization’s other research of corporate ESG performance/risk.

SustainAbility, an ERM Group company, is a think tank and advisory firm that works to inspire and enable business to lead the way to a sustainable economy. In 2010, SustainAbility undertook its first “Rate the Raters” project to better understand the environmental, social, and governance (ESG) ratings landscape and provide perspectives to help companies, investors and other stakeholders make sense of and derive more value from ESG ratings.

In general, investors recognize that ESG ratings and rankings are not going away any time soon. When
asked what changes and solutions they would like to see in the next five years the leading responses
from the survey were the following:

  • Improved quality and disclosure of methodology
  • Greater focus on relevant/material issues
  • Better linkage to company financial performance
  • Greater consistency and comparability across
  • rating methodologies
  • Greater engagement of rated companies in the
  • evaluation process
  • Consolidation of ratings

These expectations were reiterated in the interviews along with a desire for more timely coverage, more data, integration of ESG into financial reporting and the ability to evaluate corporate societal impact vs. just operational performance.

Dr. Florian Berg, Massachusetts Institute of Technology, spoke about the divergence of ESG ratings. Correlations of the varios raters’ ratings range from 38% to 71%. Based on data from six prominent rating agencies namely, KLD (MSCI Stats), Sustainalytics, Vigeo Eiris (Moody’s), RobecoSAM (S&P Global) the divergence into three sources. “We do not even know the truth, therefore we only can compare”, argues Florian Berg. “We describe ESG ratings in three elements.

  • Scope: which attributes are included?
  • Measuremaent: how ar e these attributes measured?
  • Weights: how are indicators aggreagted into one score?

Aggregation and mesurement are the biggest sources of differences. See Aggregate Confusion: The Divergence of ESG Ratings, 2019.

What are the implications for investors? According to Florian Berg, the following two tasks have to be accomplished: Clarify ESG preferences, scope and weights, and investors have to answer the question: What measurement methodology do you agree with most?

Ingo Speich, Head of Sustainability and Corporate Governance, Deka Investment, points to the fact that investors no longer look only at headline ratings, but dig deeply into the data. He outlines the problem that the regulator requires financial service providers to report on ESG criteria. However, the data required for this are not sufficiently reported by the companies concerned, so that the financial service providers are faced with the difficulty of collecting, processing and passing on this data.

luck technology travel time

First crypto fund ratings in Germany

Agencies, Assets, Methodologies

TELOS GmbH, known for their fund ratings in the institutional sector, and DLC Distributed Ledger Consulting GmbH announce a strategic cooperation in the field of crypto fund ratings.

The aim of the cooperation is to connect two worlds – that of classic asset management and that of digital asset management. On the one hand, the partners want to create more transparency in the crypto market, which is still new and relatively unknown for institutional investors. On the other hand, the qualitative rating should give investors security about the know-how of the fund providers in the management of this asset class.

“In the first step, crypto values ​​such as Bitcoin or Ether will probably find their way into multi-asset strategies, after the inclusion of illiquid assets, among other things, one can speak of ‘multi-asset 4.0’. Many investors are already indirectly already today invests in Bitcoin without knowing it – for example, if they hold shares of Tesla, MicroStrategy or the parent company of Twitter, Square, in their portfolio “, says Alexander Scholz, Managing Director of TELOS GmbH.

The expertise of TELOS as an established rating agency, even in complex fund products, and the in-depth expert knowledge in the field of crypto assets from DLC Distributed Ledger Consulting should complement each other: “We take on the role of technical specialists in the cooperation and also advise on innovative incentive models for digital assets. Specifically, for example, we carry out smart contract audits of the tokens in a fund and in this way significantly increase security for the respective asset manager and, of course, the investor,” says Dr. Sven Hildebrandt, who was employed by a capital management company before DLC was founded.

Both cooperation partners assume that the universe of crypto funds, which is attractive for institutional investors, will increase exponentially. As market participants understand the asset class and its attractiveness in the overall portfolio context (correlation effects, improvement of the Sharpe ratio), questions about practical portfolio implementation and risk management will come to the fore, especially when choosing the right investment product and asset manager.

monk surrounded by children

Is The Notion of Efficiency Alien to Charity?

Comments, Criteria, Definitions, Methodologies, Read

there are minimum requirements for recognized non-profit organizations. But can their efficiency and effectiveness also be rated?

At effektiv-spenden.org Sebastian Schwiecker, founder and managing director of UES – Gemeinnützige Unternehmergesellschaft (haftungsbeschränkt) für effektives Spenden, tries to give very specific answers to the question of how you can achieve the greatest possible effect with your donation, i.e. where you can help most for each euro.

He believes that the mission of his company is unique in Germany. Although there are two institutions, the German Central Institute for Social Issues (DZI) and PHINEO that assess charity organizations, Sebastian Schwiecker points to fundamental differences in the approach to effektiv-spenden.org.

The DZI, founded in 1893, has been awarding the DZI donation seal since 1992. To obtain this, an organization must undergo an annual audit. If the DZI standards are adhered to, the organization receives the DZI donation seal for the next 4 quarters. The following three are the main points:

  • The fundraising campaign is true, clear and factual.
  • The donations are used purposefully, economically and economically.
  • The organization has functioning planning and control.

Sebastian Schwiecker does not question, that these are criteria that must be met by an organization that wants to provide sustainable, highly effective aid. However, they are not sufficient, says Sebastian Schwiecker, since it would be necessary to examine the effect achieved by the respective aid organization and to put this in relation not only to the costs, but also to other organizations. The DZI does not do either. The information available online about the organizations with the DZI donation seal is limited. On the profile of the World Vision organization, whose total income in 2018 was more than 114 million euros, the full paragraph on the use of funds reads as follows (translated from German):

The share of advertising and administrative expenditure in total expenditure is appropriate according to the DZI standard (“appropriate” = 10% to less than 20%). The effectiveness of the use of funds is checked, and the results are documented and published.

The DZI itself does not examine the effect achieved, Sebastian Schwiecker criticizes and considers the publicly available information as very scarce with less than 500 words per audited organization. For comparison, Sebastian Schwiecker mentions the evaluations by GiveWell on which the recommendations of eeffektiv-spenden.org are based. Here even some of the often more than 100 footnotes are longer than the complete organizational profiles on the DZI website.

Due to this superficial view and the – in the eyes of Sebastian Schwiecker – large number of organizations with the DZI donation seal, most recently well over 200, interested donors are only given limited orientation. Sebastian Schwiecker cautions that the designation of the DZI as “donation TÜV”, which is often used in the media, may be appropriate, but one should be aware that the task of the TÜV is to exclude unfit vehicles from road traffic and not to judge what is best in relation to its costs.

The situation is different with the PHINEO consulting company founded in 2009. Since 2010, it has been awarding the so-called Wirkt-Siegel, which differs from the DZI donation seal primarily in that it carries out a “differentiated assessment of the potential for impact and the quality of the project”. On the one hand, PHINEO concentrates exclusively on projects that are active in Germany. In this way, the most effective approaches from the perspective of effektiv-spenden.org are excluded from start, although even more than in Germany might be achievable with every euro in very poor countries. On the other hand, PHINEO does not compare the audited organizations with one another, argues Sebastian Schwiecker.

If a donor does not want to be satisfied with contributing to positive change at all, but rather pursues the goal of moving as much as possible and as effectively as possible with the resources used, the Wirkt-Siegel offers little support, Sebastian Schwiecker points out, although he admits that he could not claim scientific objectivity for his approach. “But we are firmly convinced that ceterus paribus it is better to help more people than less. To do this,” reads his website, “one has to start by asking the right question, which is who should I support to maximize my impact? So far, nobody in Germany has done that. We want to change that!”

How A Credit Rating Agency Should Determine the Weights of ESG Criteria

Agencies, Criteria, Definitions, Methodologies, Read

Moody’s “General Principles for Assessing Environmental, Social and Governance Risks” relate to issues which may have greater downside risk than upside potential for rated issuers. The introduction of these principles is perceived by many issuers as an additional pressure that weighs on them in order to prove their sustainable management. This pressure is unsettling, especially since eco-activists seem uncessantly to come up with new ideas about what additional requirements companies should meet. However, Moody’s methodology shows what rational consideration is all about.

As an example, a company with a track record of health and safety violations may face litigation risks that pressure its operating income, whereas another company that demonstrates outstanding health and safety practices may not see a comparable credit benefit.

Environmental, Social and Governance (ESG) considerations are not always negative; they can be credit strengths. A company or government that has outstandingly strong governance is more likely to have a management culture of 360-degree risk assessment and informed decision-making, which support long-term creditworthiness. Due to the relatively low incidence of ESG strengths that are meaningful to credit profiles, they are also more likely to be considered in other rating considerations outside of a scorecard, but there are exceptions. An example is the business profiles and cash flow stability of renewable energy developers. They may benefit from supportive government policies.

The term ESG refers to a broad range of qualitative and quantitative considerations that relate to the sustainability of an organization and to the broader impact on society of its businesses, investments and activities. Examples include a company’s carbon footprint, or the accountability of a company’s management or a nation’s government.

The criteria used by ESG rating agencies vary widely. Investors as well as issuers complain about the different assessments. In particular, there are no standards by which the correctness of ESG ratings can be objectively checked. The arguments ultimately remain tautological: If arms production is deemed unethical, then companies receive a poor ESG rating if they manufacture weapons. The “performance” of the ratings of an ESG rating agency is good if it has correctly identified companies that manufacture weapons. But whether the underlying dogma is correct is not discussed.

The classification of ESG considerations across financial markets is imprecise, due largely to the multiple and diverse objectives of various stakeholders. Ethical judgments differ massively, even if they have common roots, as in the case of the three world-leading religions of Abraham. Leading credit rating agencies like Moody’s therefore do not get involved in the moral discussion. Instead, they are focused on the aspects of ESG that can have a material impact on the credit quality of an issuer.

Several institutions, notably the Principles for Responsible Investment and the Sustainability Accounting Standards Board, have sought to establish voluntary definitions for ESG, but at this point there is no single set of ESG definitions or metrics that is comprehensive, verifiable and universally accepted. It is not just Jewish, Muslim and Christian approaches that differ. There are thousands of differences among Christians alone. Arbitrary definitions of human rights, fundamental rights, etc. are the result. Legal definitions are therefore only the result of political negotiation or enforcement processes in a political trial of strength and should not be confused with something scientifically observable in nature.

Therefore, the definition of ESG issues is also dynamic because what society classifies as acceptable evolves over time, resulting from new information (e.g., the impact of carbon dioxide emissions) or changing perceptions (e.g., what constitutes privacy). The only way for serious credit rating agencies is therefore to provide transparency into their assessment of ESG risks and benefits by developping an ESG classification nomenclature that includes

  • components (E, S and G) and, for each component,
  • categories and
  • subcategories of the ESG considerations that rating analysts view as most likely to have credit implications across sectors.

“For the E component, the categories are the same for public- and private sector issuers,” writes Moody’s in its updated cross-sector methodology, “and for S and G components, there are different categories for public and private sector issuers.” The materiality, time horizon and credit impact of ESG risks vary widely. Issuers’ fundamental credit strengths or vulnerabilities can mitigate or exacerbate ESG credit impacts. In some cases, ESG-related benefits can be a credit strength. ESG considerations may inform forward-looking metrics or scenario analyses, or they may be incorporated qualitatively.

Given this background, a credit rating agency should seek to incorporate all material credit considerations, including ESG issues, into ratings and to take the most forward-looking perspective that visibility into these risks and related mitigants permits. An ESG rating methodology should only discuss the general principles underpinning the analysis of current and developing ESG risks that can affect credit quality for issuers and transactions in all sectors, because only defaults can be statistically recorded and counted and can thus prove the objectivity of the standards. In this way, credit rating agencies secure the trust of investors who expect rating analysts to provide clear assessments of default probabilities. Moody’s “General Principles for Assessing Environmental, Social and Governance Risks” delivers an example of this approach to ESG considerations.

Risk Culture as a Means of Mitigating Conduct Risk

Methodologies, Models, Read

Thomas Kaiser and Tatjana Schulz write in their contribution to the book “Social Credit Rating” about the similarities with and differences to the China Social Credit System: Banks around the world have been exposed to numerous cases of misconduct at individual as well as on a systemic level, inflicting harm on single customers and the society as a whole. This includes inappropriate product design (e. g. securitizations which led to the financial crisis), large-scale market manipulations (LIBOR and other reference rates) as well as other fraudulent activities (e. g. creation of accounts without the knowledge of the affected clients).

“Regulatory bodies have reacted with a broad range of requirements and recommendations. A key tool in fighting misconduct”, Thomas Kaiser and Tatjana Schulz write, “is the strengthening of risk culture as an institution’s norms, attitudes and behaviours related to risk awareness, risk-taking and risk management, and the controls that shape decisions on risks.”

They see implementing risk culture frameworks as a means of influencing behaviour of employees to mitigate those risks in individual banks and thus ultimately to improve the reputation of the banking sector as a whole. While banks have made progress in designing those frameworks, the maturity of this particular discipline is still at a moderate level and full-scale implementation is not yet common.

The China Social Credit System also aims at improving behaviour of individuals and corporations by setting clear expectations and measuring compliance with those, the authors say: “Chinese authorities have gathered substantial experience with this methodology during pilot implementations and are refining the approach further during the rollout throughout the country. A comparison of those two approaches leads to suggestions on what the two approaches could learn from each other.”

Prof. Dr. Thomas Kaiser has been working in risk management for more than 20 years. He is Director in the Financial Services division of KPMG AG Wirtschaftsprüfungsgesellschaft in Frankfurt / M. and honorary professor for risk management at the Goethe University Frankfurt. After studying business administration in Saarbrücken and completing a doctorate in the field of financial econometrics in Tübingen, Prof. Kaiser held a managerial role in risk controlling at four major German banks. He is co-editor of the Journal of Operational Risk and the author of numerous essays and books on risk management topics.

Tatjana Schulz works for KPMG AG Wirtschaftsprüfungsgesellschaft in Munich. As a psychologist with a focus on risk research and a banker with many years of experience in the financial services sector, she deals with the qualitative elements of risk management at KPMG. Among other things, she supports the audit teams in the areas of operational risk and risk culture and has valuable insights into the current state of implementation of the regulatory requirements in the German banking landscape.

An Economic Approach to China’s Social Credit System

Methodologies, Models, Read

In an effort to increase trustworthiness across society, the Chinese government has been building its Social Credit System since 2014. This system targets all natural and legal persons in China and consists of four major elements: a central data platform, a rating system for commercial creditworthiness, a propaganda system for educative purposes and a publicly available listing system with black- and redlists (for negative or positive behavior) as well as consequential joint punishments and rewards.

While most of the related academic discourse has focused on the system’s political implications, Theresa Krause and Doris Fischer provide in their paper to the book “Social Credit Rating” an economic perspective on the Chinese government’s rationale for setting up such a system. Transaction cost economics has shown that trust is an important factor for business transactions and economic growth.

“However, China’s rapid economic development and modernization has weakened societal trust, including the traditional trust-building approach via guanxi (interpersonal relationships). Hence,” Theresa Krause and Doris Fischer write in conclusion, “the Chinese government is using the Social Credit System as an alternative approach for trust-building. The system is supposed to strengthen institutional mechanisms and incentivize trustworthy behavior. It can be regarded as an add-on to the currently rather weak legal system and fragmented government enforcement apparatus.”

Theresa Krause is a doctoral candidate at the Chair of China Business and Economics at the Julius Maximilians University of Würzburg and researches the subject of “Compliance and the social credit system in China”. In 2010/11 she worked in NGOs in Shanghai as part of the BMZ’s weltwärts program and then studied in Karlsruhe, Taiwan and London with a focus on economics, politics and China. Before her doctorate, Theresa Krause was a consultant at an international consulting company.

Doris Fischer holds the chair for China Business and Economics at the Julius Maximilians University of Würzburg. She is chairwoman of the board of the German Society for Asian Studies and was chairwoman of the German expert group for the German-Chinese platform innovation on behalf of the BMBF from 2017-2019. She is currently cooperating with colleagues from the Technical University of Munich on a project funded by bidt on the effects of the Chinese social credit system on companies.

Leasing Company Rating

Agencies, Associations, Methodologies, Read, Systems

Leasing companies have been analyzed by leading US credit rating agencies for decades. In addition to these rating agencies, there are other rating approaches for leasing companies. Three of these are briefly presented here. The first relates to a joint initiative by Landesbanken and other credit institutions to operate bank-internal system for rating leasing companies. The second is the offer from a company from the organization of the Association of German Banks. The third is the rating offer from a Bulgarian rating agency, which also rates German banks.

RSU Rating Service Unit

The history of RSU Rating Service Unit GmbH & Co. KG started in 2001, when German Landesbanken and the DekaBank launched a joint project for the development of internal rating systems, to satisfy the regulatory requirements for what is referred to as the Internal Ratings-based Approach (IRBA). During 2002 through 2003, an interdisciplinary project teams developed the methodology for rating ten different exposure classes. Once ready for use, it was integrated into the “LB-Rating” application. The joint effort allowed to draw on the experience and the portfolios of all RSU partners. In December 2003 the Landesbanken became shareholders that participated in the project and/or their legal successors.

The rating indicates a Probability of Default (PD). The main measure of the quality of a rating system is what RSU refers to as “discriminatory power”, i. e. the system’s ability to distinguish between high-risk and low-risk obligors. Some rating systems also determine the Loss Given Default ratio (LGD), which is another area where accuracy is crucial. Essentially, RSU’s methodological work focuses on the validation of the PD and LGD estimates computed. This involves, in particular, considering the defaults actually observed. At the same time, ratings are kept strictly confidential and data protection is ensured.

When developing rating systems, models for estimating probabilities of default and loss ratios are created based on historical information and solid expertise. However, empirically determined functional relationships may change or become less stable over time. For this reason, rating systems must, by law, be reviewed on a regular basis. RSU’s methodology department promisses to validate the rating systems every year in consultation with the institutions that contribute to RSU’s data pool. Reviews are performed according to a defined validation policy using professional information and statistical computing technology.

Having received supervisory clearance for its rating systems, RSU has made them available to clients outside the group of shareholding banks since 2007. Currently, RSU claims to have clients including institutions from all three sectors of the German banking system, a number of financial service providers, international institutions, and institutional investors. LB-Rating was implemented using a modern Java architecture (Java EE) as well as IBM products and thus complies with a very common and well established industry standard. LB-Rating is a completely web-based application, which can be accessed using Internet Explorer. Once it has been individually configured and activated, it requires no additional local installation.

LB-Rating is a system designed for preparing, editing, validating and managing internal ratings in accordance with the Basel III/IV framework. It provides standardized and objective credit ratings for various types of obligors as well as for specialized lending.
There are twelve modules now. Clients only acquire licenses for the modules they need for their specific business.

  • One module is intended for rating leasing companies that apply German accounting standards (HGB). It performs a net asset value calculation to take the specific characteristics of these companies into account. The rating model is based on a scorecard approach.
  • The Special Purpuse Company (SPC) Real Estate Leasing module, which uses both scorecard and simulation elements, is designed for assessing real estate leasing projects. The residual value of the property is estimated by simulation. Transfer risk is included for offshore transactions.

Routinely reviewed every year since 2005, the statistical accuracy depends on a database of more than 17,500 ratings. In early 2007, the module received supervisory approval for use under the IRBA.

RSU provides one-year migration matrices and multiannual PD profiles for each of its twelve rating systems. The cyclical properties of the rating systems reflect in the migration matrices and PD profiles, which is essential for the institutions that use them. Information about rating transitions is crucial for banks in various areas of risk management. Once IFRS 9 takes effect, modelling long-term rating migrations will become even more important.

Methodological parameters such as score weights or calibration settings are stored separately and can be changed at short notice without modifying the software. The application is based on a thin-client concept, i.e. all necessary data is provided by the server to the extent possible. Installation and maintenance services are carried out centrally on the server without affecting the user. Changes made on the server, e.g. new releases or security updates, take effect at the same time for all clients. Communication with the system is by secure and encrypted SSL data transfer through dedicated networks. Technological modifications are performed twice a year at fixed dates. All related processes are based on ITIL, thus ensuring secure and high-quality IT workflows.

Since Rating-Flex is a solution for transferring existing rating systems to an audit-proof IT platform, leasing company ratings of different RSU users may differ.. RSU’s Rating-Flex allows to incorporate a client’s own rating algorithms into LB-Rating. WIth respect to all else, incorporated rating systems benefit from the complete functionality of LB-Rating.

GBB-Rating

Under the umbrella of the Auditing Association of German Banks, GBB-Rating Gesellschaft für Bonitätsbeütung mbH (hereinafter referred to as “GBB-Rating”) has been operating as an independent rating agency since 1996. GBB-Rating draws up its opinion on the future viability of a leasing company which is partly based on uncertain future events, their prediction and thus necessarily on estimates. Therefore it is not a statement of fact or a recommendation, but an expression of opinion.

Cologne-based GBB-Rating is a rating agency with particular expertise in the financial services sector. takes into account the requirements of the international standards for rating agencies of IOSCO (“Code of Conduct Fundamentals for Credit Rating Agencies”, the International Organization of Securities Commissions) when applying its rating methodology and when carrying out the rating process for the creation of commissioned and unsolicited credit ratings . In accordance with Regulation (EC) No. 1060/2009 of the European Parliament and of the Council, GBB-Rating was registered by the European Securities and Markets Authority in Paris (ESMA) on July 28, 2011 and has been subject to European supervision for rating agencies since then.

The GBB-Rating leasing company rating methodology is based on the fundamental question of the extent to which the company can meet its financial obligations in full and on time in the future. Determining this ability is the focus of the analysis. The holistic analysis of the GBB-Rating is carried out taking into account all available information classified as relevant. GBB-Rating makes its statements on the basis of the existing rating methodology, which combines quantitative and qualitative approaches.

The aim of the rating process is to arrive at an appropriate and reliable credit rating in a consistent manner. The procedure is based on ensuring the objective of objectivity, quality, impartiality as well as independence and confidentiality. As part of the rating process, the business model-related success and risk factors in particular are analyzed and condensed into a future-oriented, comprehensible overall assessment.

The basis for the ratings are documents on the asset, financial and earnings position as well as the business model, business strategy, the relevant markets, the risk management, the risk situation and the shareholder background. The basic documents and information required to carry out a rating are essentially business reports, as well as information from the companies in connection with a GBB-Rating questionnaire.

Information from ad hoc announcements or other publicly available information as well as information and documents in the context of management meetings are also taken into account. All available rating-relevant documents and information are checked for topicality, completeness and plausibility during the course of the rating process.

GBB-Rating provides both solicited and unsolicited ratings. A commissioned rating is based both on internal information provided by the company to be assessed and on publicly available data. Unsolicited ratings are generally based on publicly available data and information (further details can be found in the policy for the implementation and creation of unsolicited ratings). Unsolicited ratings can also be carried out purely for internal purposes (benchmarking), in which case it is not published.

Published ratings are continuously monitored by the leading analyst and a second analyst and updated at least once a year. The leading analyst presents the rating result with all analyzes and evaluations to an independent rating committee, which makes final decisions on the following issues:

  • setting the rating,
  • suspending a rating,
  • withdrawing a rating (“Withdrawal”).

Before each acceptance or continuation of an order, GBB-Rating checks whether the independence regulations of GBB-Rating are complied with, whether there is a risk of potential conflicts of interest or other order risks and whether sufficient resources are available to adequately take into account the special requirements of the order. In case of doubt, the order must be rejected or resigned. Required advance information, for example, in order to be able to assess the complexity of the company and the main features of the business model, is collected in an initial internal pre-analysis. If there are no reasons that prevent an order from being accepted, the rating process, the rating methodology and the conditions for a rating are explained to the company interested in a rating. In advance, GBB-Rating does not indicate a rating or a preliminary rating.

After the order has been placed in writing, the company to be assessed receives a list of information and documents required for the analysis in connection with a questionnaire. Additional requests for information and documents may be necessary during the course of the rating process. All data and evaluations received are treated confidentially by GBB-Rating. In order to guarantee the high level of confidentiality, GBB-Rating has set up supporting organizational measures (e.g. restrictive access authorizations, Chinese walls) and drawn up appropriate regulations. The rating is carried out by the leading analyst who is the contact for the rating customer. The implementation of the rating is accompanied by an independent second analyst.

Do not expect to talk always to the same analysts. Potential conflicts of interest are countered, among other things, through a rotation process. The leading analyst changes after four and the second analyst after five years at the latest. A resumption of the analysis activity can take place after two years at the earliest if the supervision period was previously fully used. In order to guarantee the continuity of the assessment, changes in the rotation of the leading analyst and the second analyst are generally delayed. When planning and assigning rating orders, the aspects of technical knowledge, availability and independence are taken into account.

The analysis is supported by IT-based rating models based on a comprehensive catalog of criteria. For the analysis and evaluation of both the qualitative and the quantitative criteria, there are extensive and detailed internal guidelines or specifications and process descriptions (rating manual). On the basis of the financial and business profile, taking into account defined internal rules and procedures, the leading analyst analyzes, assesses and evaluates the key figures and criteria. The second analyst controls, checks for plausibility and checks the credit rating of the leading analyst on the basis of internal guidelines and procedures of GBB-Rating. The leading analyst presents the rating result with all evaluations to an independent rating committee, which makes the final rating decision.

The leasing company will be informed in writing shortly after the final confirmation by the rating committee (“notification”). The modified procedure for the publication of unsolicited ratings can be found in the policy for implementing and creating unsolicited ratings. There must be a reasonable period of time between informing the institute and a possible publication or notification to subscribers (hereinafter “publication”) of the rating.

The leasing company is informed no later than one full working day (within business hours) before publication, so that there is an opportunity to point out factual errors or ambiguous formulations. In the case of a commissioned or solicited rating, the rating customer determines whether a rating result is published. Publications of rating results by the leasing company (e.g. press releases) must be coordinated with GBB-Rating.

If there is no follow-up rating already published on the GBB-Rating homepage prior to an unequivocal publication commitment or a publication revocation, the rating result to be updated is marked with the addition “in communication” after a reasonable period of time to indicate that a current rating action is still being coordinated with the rating customer. After a further ten working days at the latest, a final decision about the publication or, alternatively, a withdrawal of the rating from the homepage must be made. The rating list will be updated accordingly. A rating in which only the publication is withdrawn remains valid in relation to the client who pays the fee. There are no technical access restrictions in connection with the publication. A financial expense (fee, publication fee, access fee, etc.) in connection with a publication does not arise either for the rating customer or for interested third parties.

Along with the fee billed, a rating is generally valid for a period of twelve months after being announced. During this period, the development of the company and the industry is continuously monitored by the analysts. The aim is to ensure that a rating remains up-to-date in its statement. For this purpose, the leading analyst is in contact with the company and evaluates a. information and publications during the year. If events or developments occur during this observation period that could have a materially positive or negative effect on the company’s economic situation, the rating is reviewed and adjusted if necessary.

An Internal Review function – as required by the regulator – is responsible for developing and reviewing rating methods. The method committee as the approval body is the final decision-making body for the implementation and introduction of method adaptations or changes. Depending on the occasion, but at least once a year, the rating methodologies undergo a backtesting / validation process. In the event of changes to the rating methodology, the rating customers affected are informed about the planned changes and the possible effects as part of a four-week consultation. A review of the ratings concerned takes place within six months.

BCRA

The Bulgarian Credit Rating Agency (BCRA) provides an appraisal of the creditability of a leasing company. It intends to express an external, objective, and independent opinion for the capability of the Company to serve its liabilities in full, and on time. The short-term ratings present an opinion for the possibility that the rated Company fails to meet its liabilities, within the short term (up to 12 months), while all else is a long-term rating.7

In order to rate leasing companies, the historical development of the sector is reviewed, and its present state is analyzed. The main trends in the sector are analyzed, as well as the manner, in which these influence the scrutinized leasing company. Based on this analysis, a forecast is made for the future development of the leasing sector. BCRA also reviews the legal framework, regulating the activity of the companies in the sector and the risks, resulting from its current state, and possible changes in it.

BCRA makes a detailed analysis of the competitive position and financial strength of the main (direct or indirect) shareholders in the rated leasing company. A strong major shareholder can be a source of know-how and other support. BCRA assesses the ability of the main shareholder to adequately capitalize the analyzed leasing company.

The management is being analyzed from the viewpoint of its competency, of the management structure created, of the practices applied, and of the existing systems for leasing company management. When appraising the management, the leasing company strategy, the vision of the managers for their business at present, and their forecasts for the future are also reviewed.

BCRA analyzes the operating activity of the rated company in details. The portfolio of the leasing company, as well as the market share and competitive position of the company are reviewed. Reviewed are also the relations of the Company with its counterparts, as well as the risks, which can arise from the agreements made and from the practices applied.

The financial state of the leasing company is an indicator for the overall strength of their business but also a direct source of risk, analyzed in four main areas: Profitability, Operating effectiveness, Indebtedness, and Liquidity. With a view of the specific activity of the leasing companies, the main point in the analysis is set on the management of the interest, currency, liquidity and credit risk, as well as on the risk of the residual activity.

The result from applying the listed above analysis comprises the so-called base rating. The final stage of the calculation of the rating is the potential adjustment of the base rating due to the general sovereign-risk factors, as evaluated by BCRA using the Sovereign Rating Methodology.

The rating “ceiling” is the term used for the upper limitation on the rating caused by sovereign-risk factors. Slightly less limited are the ratings of those subsidiaries whose direct or indirect majority shareholder is a foreign legal entity able in one way or another to make up for the deleterious effects of the local environment. The ceiling of local subsidiaries would surpass the sovereign rating by one or more notches, which in turn cause their final rating to surpass the sovereign rating. BCRA could also issue a national-scale rating to entities or issues which is relative, in comparison to other rated entities in the country, taking into consideration only the specific risk factors of the entities and not the effect of the local environment on them.

Airport

Rating Airports

Criteria, Methodologies, Read

Credit ratings play an important role for airports and their operators, since in most cases the capital requirements for airports can only be met when bonds are issued. Ratings are used to assess airport liabilities both when issuing bonds and when trading bonds.

The rating system applies both to independent airports and to companies with several airports, which are usually in full operation with an active commercial service. It is important to have a sufficiently long company history that allows conclusions to be drawn about the management.

The airport criteria apply to both issuers and certain borrowings with a broad revenue pledge, for example, if the entire operating income of the airport company serves as collateral. Debts that can be repaid from limited sources of income such as rental contracts and independent project debts for fuel supply, rental car and cargo handling facilities are also subject to credit ratings.

Both new ratings and the monitoring of existing ratings are special cases of ratings for debts from infrastructure and project financing. Risks and limitations of the methodology, which are common to all infrastructure and project financing debts not discussed here, are therefore considered separately.

Qualitative guidelines were developed for the rating of airports, which are relevant for the assessment of project risks. The relative impact of qualitative and quantitative factors varies between companies, as there can be large differences between airports, not only in terms of technology, but also economically.

While airport analysis includes taking into account risks common to all infrastructure and project finance debt, earnings risk, as a general guideline, has the most direct impact on airport ratings. According to the “weakest link theory”, the weakest link can result in its stronger analytical weight.

The most important assessment factors for airports are the earnings risk and the volume: This takes into account the role of the airport as well as the socio-economic and demographic basis of the surrounding region and, if applicable, the exposure to competing alternatives, the breadth and variety of products and services offered by airlines at the airport influence.

In order to analyze the sales risk, passenger and freight volumes and prices and price developments are examined. The generation of revenue or cash flow is taken into account in accordance with the legal framework of the airport, including the provisions of the contractual or regulatory framework, which forms the basis for the cost recovery in the revenue generation from airlines and passengers.

The rating questions the development and renewal of the infrastructure: quality, planning, management and financing of the development and renewal of the infrastructure are taken into account.

From a purely financial perspective, the debt structure is recorded, the composition of financial instruments, security, additional leverage tests, distribution limits and financial triggers. The financial profile reflects the assessment of the financial and operating metrics on a historical and forecast basis, including sensitivity analysis, and the composition of the financial instruments, examined by additional leverage tests, distribution limits and financial triggers.

Across the entire airport portfolio in the world, ratings generally range from the lower end of the “AA” category to the “BB” category. In countries with a high country risk, the country rating may set an upper limit. The entire rating range is broad, but the vast majority fall into the investment grade categories “A” or “BBB”. In most countries, the operation of airports cannot simply be stopped without fear of consequences for the country rating. The ratings for states and airports are therefore to a certain extent interdependent.

Airports generally have a higher leverage than typical business units and deal with business partners with low credit ratings from “investment grade” to “speculation”. As is so often the case with infrastructure investments, their business is typically geographically concentrated and may be subject to jurisdictional issues or legal issues that may limit or support the underlying loan.

Because of these risks, it is unlikely that an airport can ever be rated in the highest rating categories. The current corona crisis has made it particularly clear for airports how a virus can practically change the sales outlook overnight.

However, there are several reasons why most airports worldwide remain financially sound and despite these risks have ratings in the “investment grade” categories. In general, competition is more restricted because the capital-intensive nature of airports in connection with the regulatory hurdles of a public supply industry creates strong entry barriers.

These entry barriers include the cost of land acquisition and airspace needs, significant environmental barriers and the resistance of the population affected by land acquisition and noise. In addition, airports generally operate on a cost recovery model that can help keep cash flow relatively stable. While the aerospace industry continues to go through profitable and unprofitable cycles, airports have a strong repayment history, so the rating assumes that this will continue.

Patent Rating

Definitions, Methodologies, Read, Systems

Innovation rating and patent rating have different tasks, but are interrelated. An innovation rating is used to assess a company’s ability to compete with other (innovative) companies through innovation. The patent rating, on the other hand, is a future-oriented judgment on the relative intrinsic value of a patent and requires a system of classification. The classification system is used to organize patent documents and many other technical documents in relatively small collections based on common topics.

When should a patent rating be issued, when should this assessment be reviewed and possibly updated? In large organizations, this is already an organizational issue if this task is performed by a formal patent committee. The patent committee reviews the decision to file a patent application.

In practice, patent management ranges from the invention, to the processing phase in a patent committee or committee, if set up, in which inventions are reviewed and decisions are made as to whether a patent application should be filed or not, to the patent application process from the first filing to the granting of the (foreign) registration, patent maintenance and patent portfolio management. Patent ratings are particularly an instrument of patent portfolio management because it helps to analyze the structure of the portfolio.

Different technology areas can have different priorities depending on the technology and business strategy of the company. The maturity of the invention may result in some delay in the process. Certain cases may offer options for additional divisional applications.

Transparency is crucial for the qualification of the rating inputs. If a rating is repeated within a very short time, it should reliably deliver a comparable and verifiable result. As with any other rating system, validity and reliability must be checked.

A rating agency is committed to a code of conduct. The person submitting the rating should conduct the rating free of any biased assessment. Possible conflicts of interest must be disclosed. Any changes to the assessment of a particular case should be recorded, indicating the new assessment, who made the change, and the reasons for making the change, along with supporting material.

The fact that technology, companies and industries change over time is an important argument to justify why assessments should be reviewed at key points in the patent process and updated as necessary.

In addition to the perception on the market, patenting should be dealt with at all other milestones in the patent process and should be dealt with as needed, e.g. For example, if the patent examiner requests “official actions”, if the case takes place in another country and the patent application becomes due.

The importance of intangible assets is increasing. The concept of ratings, as it has been known since the 19th century for assessing the reputation of corporate partners and the quality of securities, can also be used in the world of intellectual property. If an asset cannot have any value, it is not an asset. Even air is an asset, because air can also become an asset paid for when it becomes scarce.

The nature of innovation means that inventions can vary from incremental to radical, can refer to products, services, processes or business models. The innovation process includes ambiguity, controversy and non-linearity, and this is also reflected in the inventiveness. The importance of each invention is a crucial question that needs to be answered.

The diversity of such intellectual property, both in terms of its maturity, geographic coverage and applicable technology, means that a rating scheme should bring benefits. The variety of patent applications ranges from semiconductor and computer technology, electrical machines, telecommunications, life sciences including the analysis of biological materials and biotechnology, optics, medical technology and pharmaceuticals to environmental-related technologies.

Patents give their holder freedom of action and protect product differentiation. Used in an entrepreneurial way, patents allow to generate income and grant business influence. Patents often enable technology to be put into practical use, bring cost competitiveness and support technology out-licensing. Patents help to organize the division of labor in the economy.

At this point it is not to be discussed whether the legal figure of the patent brings any economic benefit at all. There are strong arguments that costs and benefits are cancelling out. This is especially true if one takes into account not only the officials involved, but also the considerable resources that have to be kept in the company for this.

Patenting can be expensive, so costs need to be carefully considered. Patents need to be managed well. In companies that have thousands of patents, rating systems are imperative to keep track of these company assets. Cost management includes planning, coordination, control and reporting of all cost-related aspects. Identifying all costs and making informed decisions about options is not an easy task, especially in large companies. When purchasing patents, it is important to check which ones offer the best value for money. Systematization can also be carried out using a rating system.

The simplest rating system for any company is a black and white system. For example, a very simple two-step scheme is to label cases as either strategic or tactical, or even “in use” or “not in use”. If, in addition to “black” and “white”, the “grayscale” is also taken into account, one can speak of a rating system.

A number of questions arise for companies with patents or patentable inventions. Should the invention be implemented in “our” products or services? Is the invention likely to be implemented by a third party? Does the case offer licensing options? Does the invention relate to a unique selling proposition or a central function of the company? What is the possible use of the invention in the future, especially when it is linked to basic research?

In many companies, the establishment of a professional rating system for patents overwhelms the resources available. The rating of patents is therefore assigned to specialized rating agencies. The choice of rating approach should be formally documented and made available to the key players in the process of inventing and patenting. Each rating scheme that is designed and implemented must be consistently maintained over a certain period of time in order to ensure comparability.

As with any other rating system, the patent rating must also consider the conditions under which a methodology is changed and the standards of the assessment adjusted. A few decades ago, recording the data alone was a tremendous challenge. However, the assessment of cases is recorded today in the IP data management system. The associated data fields of the rating have to be treated with the same professionalism as all other key data fields that support the most important patenting processes. The rapid development of information and communication technology gives users of rating systems decisive competitive advantages.

Innovation Rating

Methodologies, Processes, Read, Systems

The basic idea was already known to the Romans: the word “innovation” is developed from the Latin verb innovare (renew). As a noun, it means “newness” or “renewal”. The term is used in everyday language in the sense of “new ideas and inventions” and for their basic relationships.

An innovation rating traditionally includes the expectation following an investment budgeting decision that a new product or a new service will generate revenues. Relevant innovation ratings deal not only with products or services, but also assess process innovations and concept innovations (business and organizational innovations, business model innovations).

The number of employees, the geographic areas of activity of the company, the location of company headquarters, the sales and earnings in relation to research and development spending are indicators which matter.

Successful companies are run so that they generate ideas through their employee management. Not only their staff play a role in this analysis, but also consultants and freelance employees. However, the expenses for advice can be a deceptive indicator if other additional aspects are not used to measure performance.

Innovation and management culture in a company are closely related. The scope of customer feedback is just as relevant here as complaint management, whether from customers or employees. The question of which channels the management of a company uses to resonate with customers and employees, whether through targeted surveys, work groups, social media or big data analysis, can be instructive.

Rating analysts can use interviews with management to determine the industry and company-specific obstacles to innovation management. These obstacles range from legal barriers to technological difficulties. A number of criteria are used for the evaluation of internal as well as external obstacles.

The share of new products and services in earnings is broken down chronologically by cohort. In addition to data from external accounting, data from internal accounting can also be used to, for example, forecast innovation-related cost savings. To map innovation cycles, plans are analyzed in a target and actual comparison.

The Inventor’s Patent Dilemma

An increasing number of registered patents is an indicator of strong innovation activity. Filing a patent is not recommended for every invention, even if the patentability conditions are basically met. If the company cannot defend its patent after it has been granted or if the costs of the defense cannot be borne (should the patent be attacked by a third party), waiving the patent may make sense. It can be expensive if an unauthorized use of an invention shall be prohibited.

The innovation rating examines the extent to which inventions by the company can be circumvented: if the inventions can be exchanged using similar procedures that are not protected or cannot be protected, patent protection simulates but vulnerable strength, since imitation in a similar way by third parties must be expected, especially in profitable markets.

Companies often refrain from any disclosure, as is enforced when filing a patent, if the disclosure only enables a third party to reproduce and copy the invention: Confidentiality can mean better protection. For large companies, however, keeping knowledge secret in light of natural employee turnover can be a particular challenge. Therefore (as for other reasons) the company size also plays a role in the innovation rating.

Too high complexity of inventions can also speak against patent applications. If inventions consist of a multitude of elements that would have to be individually protected, patent protection would generate disproportionate costs. Protecting only certain, particularly important parts of a product with a patent can be a sensible strategy here, but it requires corresponding specialist knowledge in the management of patent applications and exploitation. The innovation rating therefore examines what conditions the company has created to meet these challenges. and which combinations with alternative protection mechanisms it can also use.

Successful Innovation Requires Taking Smart Risks

Innovation ratings require the management of the company to be profiled. The profiling helps to understand to what extent the management is willing to take risks in order to increase the innovative strength of their company. The extent to which employees and management are able to bring about and implement innovations in terms of corporate culture is of central importance.

Organizational-theoretical considerations as well as empirical surveys can help to reflect the suitability of virtual teams, the project or matrix organization as well as functional organization. Innovation rating is therefore also based on the company’s human resources. The human resources department provides figures on employees working in research and development, on the level of education and the use of further training measures, the professional experience of employees and employee satisfaction. The company’s internal methods of personnel and management rating are to be examined with regard to the extent to which priority is given to innovation goals in the assessment and incentive systems.

The innovation rating is not just the result of a point evaluation process or a simple computer model, but has to be understood as a committee-based process which is aimed at the integration of all aspects that are decisive for the ordinal classification of a company’s innovation success. The term “innovation rating” therefore designates both the assessment process and the result of the rating process in the form of a “grade”. The innovation rating provides both relative – namely in comparison to other companies – and absolute information, for example if a low rating indicates the complete lack of ressources for innovation.

Equity Rating Repair

Criteria, Definitions, Methodologies, Models, Performance, Read, Regulations, Repairs, Scales, Symbols, Systems

Stock instruments issued or to be issued and / or traded on certain stock markets may be the subject of ratings. Stock ratings reflect the risks associated with the creditworthiness of the issuer and the stock market liquidity of an instrument. However, they do not address the risk of loss associated with price changes and other market conditions, nor do they consider the reasonableness of prices for their market value. Ratings assigned at national level cannot be compared across borders and are assigned using national rating scales.

Such equity ratings are usually the result of regulatory intervention by the state to prevent investors and issuers from being harmed by malpractice on the stock exchanges. The requirement to issue equity ratings is therefore to be understood in some states as a reaction to regulatory requirements. To the extent that such requirements do not currently exist or are not applicable, share ratings are based on market practice.

Financial instruments affected by equity ratings include, but are not limited to, common shares issued by financial and non-financial companies. The equity rating method does not apply to shares issued outside of a public offer by private funds or other investment instruments, or to preference shares, as these are accessible through their own methodologies.

Stock ratings are about the elements to be valued as part of the stock rating process. Stock ratings are supplemented by analytical considerations regarding the issuer’s credit rating. The equity rating methodology should therefore not be viewed in isolation, but should be read in the context of the global criteria reports of ratings for financial and non-financial companies.

Share ratings are also referred to as buy, sell or hold recommendations. A strong buy recommendation can be expressed, for example, by a double plus ++ and a simple buy recommendation by a simple plus +, vice versa in sales recommendations minus – and double minus –. If the rater gives neither a recommendation to buy nor to sell, the recommendation “hold” e.g. can be expressed by a circle symbol o.

Analyst opinions expressed as buy and sell recommendations are as fast-paced as the stock market itself, as the Corona crisis recently showed: If the price of a share falls, the sell recommendation can quickly turn into a buy recommendation.

Because buy and sell recommendations depend on daily market price fluctuations, equity rating repair does not refer to the question of whether a stock is over- or undervalued.

Rating repairs therefore relate to the awarding of share ratings, which give investors an independent opinion on the creditworthiness of the issuer and the liquidity risk associated with their shares. The purpose of such stock ratings is to provide an estimate of the liquidity risk an investor takes when purchasing a particular stock security in order to measure, in a timely manner, how easy or difficult it will be to sell those instruments if the investor so decides.

The analysis includes evaluating the stock’s historical stock market behavior in relation to presence and traded volumes, as well as the relationship between the movements of the stock and the financial situation of the company and the industry in which it operates.

Creditworthiness and market liquidity risk are the most important factors in the equity rating for which evidence can be produced. At national level, equity ratings are therefore based on two types of analysis: issuer creditworthiness and market liquidity risk. The combination of these two factors leads to the determination of a company’s equity rating.

The purpose of a stock rating is not to assess the risk of default on such stocks. Shares are equity securities and they represent ownership, not just a claim. Therefore, they cannot be in default. Because stocks do not have specific payment obligations, the stock rating is about the likelihood that the issuer will continue to operate. Conceptually, equity ratings indicate that the more creditworthy an issuer is, the greater the likelihood that its shares will continue to be traded throughout the business cycle. In the current case of the bankruptcy of Wirecard, a company listed in the German stock index DAX, it would have been the task of a stock rating to signal the probability of such an event by a low rating.

Stock ratings reflect risks related to the creditworthiness of the issuer and the market liquidity of the stock. For the reasons outlined, however, they do not deal with the risk of losses associated with changes in share prices and other market conditions, nor with the adequacy of the market price of a particular security. Equity ratings are therefore not suitable as trading signals, for example to buy and sell a stock within a few hours. Equity ratings are also not the basis for trading Contracts for Difference (CFDs). Under no circumstances does such analysis result in a recommendation to buy or sell a particular security. Share ratings are therefore not a special form of share price estimates, nor are share prices used to determine forecasts of liquidity risk.

The information required to carry out the risk analysis and assign ratings is obtained from various sources such as the issuer, industry data and other relevant sources. For the specific analysis of the liquidity of the share, the statistical data are obtained from market sources that are required to be able to calculate the relevant stock market indicators.

The analysis usually includes five years of company history and financial data. The information required to assess the creditworthiness of the issuer can be requested directly from the issuer or obtained indirectly through agencies. Once the necessary information has been collected and checked, an analysis can be carried out using a uniform method.

Forensic Rating

If criminal energy is involved – as allegedly in the case of the Wirecard company – the stock rating cannot easily detect the counterfeit. Rating agencies emphasize that the information received from the issuer or its representatives will not be reviewed or verified (again). While ratings look to the future, auditors’ attestations are there to confirm that the company’s report agrees with the facts it finds.

In order to counter fraud cases like WorldCom, Enron and now apparently also at Wirecard and to give warning signals to investors, a forensic rating is required. Forensic ratings typically deal with individual offenses, unlike criminology, which examines the basics of criminal behavior. The concept of “forensic science” – like the concept of “credit rating” – often does not meet the criteria for scientific research in the narrower sense. It is understandable that forensic ratings are predominantly carried out using methods that are well established, standardized and as undisputed as possible. Innovation and creativity must be severely restricted for reasons of comparability and fairness. The scientific principles of objectivity, reliability and validity also apply to criminal investigations. It is very important to ensure the highest possible quality standard as with every rating.

Auditing

Rating also does not replace the work of the auditor, because the auditor’s report is the overall opinion of an auditor after the audit of the annual financial statements. In it, the auditor assesses the conformity of the annual financial statements and the management report with the accounting regulations applicable to the company. An assessment is only made as to whether the situation of the company has been correctly represented, but no prognosis of the company’s creditworthiness and the liquidity of the share is given. A holistic assessment of the economic situation, which also requires a considerable degree of industry knowledge, is generally not carried out. The auditor’s report may only be issued after the material examination has been completed.

For securities without historical stock market information such as a first stock offer or with insufficient information, the analysis can practically only be based on the creditworthiness of the issuer. After approximately one year of trading and records of stock exchange transactions, equity liquidity is included in the analysis.

The issuer’s creditworthiness is expressed in its issuer default rating or its long-term national scale rating. Depending on the type of company, these are calculated according to the respective methods for non-financial – e.g. Chemical companies, technology companies) and financial companies (e.g. banks and insurance companies).

As with credit ratings, the purpose of credit analysis is to classify the likelihood that a company will meet its financial obligations (or in other words, the risk of default). The company’s operational and financial profile, its overall creditworthiness and thus the long-term rating of the issuer are good approximations of the risk of a company’s future cash generation capacity.

The equity rating includes qualitative and quantitative variables to measure the operational and financial risks of an issuer and to determine its credit profile in accordance with the concepts contained in the global rating methods for financial and non-financial companies.

As already indicated, an ex-post analysis is carried out to assess exchange liquidity, which is naturally dynamic and is based on the monitoring of certain relevant market indicators for measuring the liquidity of a share.

The world’s stock exchanges are very different. What is relevant for investors is the quality of the paper on the stock exchange where it can trade. Therefore, stock ratings are placed in the context of the country’s stock exchange. The analysis may include elements that reduce liquidity, e.g. for example, the series of a particular share that grants greater rights to another series of that security. The relative importance of the individual risk factors can vary. As a rule, indicators that indicate the low liquidity of a particular stock limit their rating to the lowest range on the scale.

The trading history of the share, the percentage of free float and the development of market capitalization and daily trading volume are factors that influence the assessment of the liquidity level of the share. The liquidity of a security is measured by the recent development of these and other stock market indicators, but essentially by the presence of the security on the market. Although the rating depends on the recent performance of the equity liquidity indicators, the track record of the indicators being assessed is critical to determining a rating.

  • The market presence is the main measure that is taken into account when determining market liquidity. The number of days on which an instrument has been processed in relevant amounts within the last 180 working days plays a role here. This indicator provides a measure of the number of days on which transactions relevant to a share were registered.
  • The number of days on which an investor would have been able to get out is important for assessing the liquidity of a share. Companies in which transactions are recorded almost every day have a high stock exchange presence, which speaks for a high level of liquidity.
  • Market capitalization – and thus indirectly the share price – also plays a role in the share rating, because it reflects the market value of a stock corporation at a certain point in time. The market capitalization is calculated by multiplying the share price by the number of shares. By looking at the market capitalization, there is a ranking that the companies rank according to their market size. Rapid, frequent and unilateral changes in market capitalization reflect the trend and volatility of market value over a period of time.
  • The free float relates to shares that are not held by majority or long-term shareholders. Free float in stock corporations means the total number of shares available for exchange trading. The higher this percentage, the more liquid the share should be. When the trading volume is recorded, the total value of the transactions in a share is taken into account.
  • The average daily trading volume is determined by the presence on the stock markets and the market capitalization and reflects the monetary value of the average daily transaction volume for a specific security in a specific period. The trading volume is calculated by the number of securities traded in a period multiplied by the price of each transaction. The total volume traded by an issuer is compared to the total volume traded by the entire market.

Share ratings express the “option character” of a company’s shares. According to the option price theory, the shareholder can also be modeled as a buyer of a purchase option. By paying a premium – the share price – the buyer receives the right, but not the obligation, to continue operating the company. If the value of all the assets of a company falls below the value of the creditors’ claims against the company, the shareholder does not have to replenish equity, but can leave the company to the creditors for liquidation as part of an insolvency procedure.

Since the company’s credit rating also includes the risk of default, it characterizes the option character of the share. The lower the share rating, the greater the option character of the share.

Assets

Rating Assets

Definitions, Methodologies, Read

Is a musical work a rateable asset? Or is just a metal like gold a rateable asset? RATING EVIDENCE and RATING©REPAIR relate to the evidence and to the repair of ratings for specific assets or counterparties. In the following the focus will be on the definition of assets. Since the word “asset” plays an important role in the differentiation of rating types such as “credit rating”, “fund rating”, “real estate rating”, “start-up rating”, “commodity rating”, here are some ideas on how to identify things which are accessible to a rating methodology. Since the first bond ratings were devised as forward-looking opinions of the relative credit risks of financial obligations issued by non-financial corporates more than a century ago, rating systems have evolved in response to the increasing depth and breadth of the global capital markets. Much of the innovation in rating systems has been in response to market needs for increased clarity around the components of investment risk, for inclusion of new assets classes or for finer distinctions in rating classifications.

An “asset” is in its broadest sense a useful or valuable thing or person. More specifically an asset is an item of property owned by a person or company, regarded as having value and available to meet debts, commitments, or legacies.

While a “tangible asset” is an asset that has a physical presence, is touchable and measurable in meters, square meters, kilograms, e.g. property, equipment, “intangible” is an asset that has no physical presence, such as patents, copyrights, goodwill and trademarks. Intangible assets are no less “real” than tangible assets, but the latter are also called “real assets”.

In financial accounting, an asset is any resource owned by a business or an economic entity. The monetary value of anything that can be owned or controlled to produce positive economic value can be recorded in a balance sheet. Long-lived assets such as buildings, equipment and furniture that cannot be easily converted into cash are called “fixed assets”, while cash and assets that are expected to be consumed or expended or converted into cash within the current operating period are called “current assets”. To develop a single set of high-quality, understandable, enforceable and globally accepted accounting standards, an asset has been defined as a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

Since so called “wasting assets” irreversibly decline in value over time, this may be accounted for by applying depreciation under accounting regimes. Vehicles and machinery, mines and quarries in use are tangible wasting assets, while expiring options and insurance policies are intangible wasting assets.

An asset that has a value based on a contract such as deposits, stocks, bonds and derivatives is called a “financial asset“. Financial assets are opposed to non-financial assets. These are property rights which include both tangible property such as land, real estate or commodities and intangible assets such as intellectual property. Whether a financial asset is “held for trading” (acquired or incurred principally for the purpose of selling, or is part of a portfolio with evidence of short-term profit-taking) or “held-to-maturity” (the owner is willing and able to hold it till maturity) are subject-related aspects and are not included in an object-related rating approach. Profiling mirrors subject-related issues, while rating mirrors object-related issues.

The law selectively “codes” certain assets, endowing them with the capacity to protect and produce wealth. With the right legal coding, almost any object, claim, or idea can be turned into an asset. To pick and choose among different legal systems and legal devices is a key competence for creating an asset, which is in turn accessible to an evidence-based rating methodology. Since codability is given for almost anything, ratings can help under many more circumstances than just decisions about bond investments.

An evidence-based rating method for assessing an asset can be developed mainly under the following conditions:

  • The investor can choose from various alternatives in the relevant asset class. He can acquire one or the other asset within the asset class. It is not critical whether the asset can be sold again: a pension or life insurance policy, for example, can be inalienably linked to a specific person. At the time of purchase, however, there might be various alternatives to consider. If there is no choice, for example in the case of a coercive system of compulsory levies, no ratings are required to decide, since there is nothing left but to follow the applicable rule. The freedom to choose is an inalienable prerequisite for any meaningful rating.
  • The economic benefit of the asset can be measured by a counting unit – numéraire – such as euros, dollars or grams of gold. The numéraire is a basic standard by which value is computed. While usually the legal tender, the numéraire can be any tradable economic entity in terms of whose price the relative prices of all other tradables can be expressed. There are considerable problems with the choice of this computing unit, especially when viewed over the long term. Currencies can be reformed and gold can be banned.
  • There has to be a legal framework for an asset, a set of promulgated rules or procedural steps, in common law established through precedent or in a code jurisdiction made explicit in statutory or regulatory law through which judgments can be determined in a legal case. An asset-relevant doctrine comes about when a judge makes a ruling where a process is outlined and applied, and allows for it to be equally applied to like cases. When a credit risk is rated, the risk that an entity may not meet its contractual financial obligations as they come due and any estimated financial loss in the event of default or impairment is evaluated. The contractual financial obligations addressed by a credit rating are those that call for, without regard to enforceability, the payment of an ascertainable amount, which may vary based upon standard sources of variation (e.g., floating interest rates), by an ascertainable date.
  • It is not enough to know about rules. It is equally important to form an opinion on how likely it is that there is a willingness to play by the rules. A credit rating addresses not only the issuer’s ability to obtain cash sufficient to service the obligation, but also its willingness to pay.

An “asset” is a resource with economic value that an individual, organization, or country owns or controls with the expectation that it will provide a future benefit. A “rating” classifies the probability that expectations will be met. Consequently, “rating evidence” is about the evidence, reliability and validity of the classification of this probability. In addition to assets, contractual partners can also be the subject of a rating. If counterparties are rated, a rating classifies the probability that they will meet the expectations placed on them.

While rating assets involves a specific interest of a decision maker to choose among investments and to allocate ressources, a social credit rating calls for the establishment of a unified record system for individuals, businesses and the government to be tracked and evaluated for trustworthiness.

KYC Risk Rating

Compliances, Methodologies, Procedures, Read, Regulations, Systems

Under strict Anti-Money Laundering (AML) regulations put in place by national governments, the European Union (EU), the Financial Action Task Force (FATF), and the United Nations (UN), all financial institutions and many types of companies are required to closely monitor their clients’ accounts and report any suspicious activity. These legal requirements often take the form of Know Your Customer (KYC) policies and KYC risk ratings, which are essential in preventing and reducing financial crime.

Excluded from the general test are “standard small customers” who do not wish to undertake particularly extensive or extraordinary business transactions and who have been classified by your rating system in advance in a correspondingly safe risk class. Nevertheless, the origin of funds and assets must generally be clarified. The details of the planned customer relationship such as scope and payment transactions must be rated and recorded.

KYC risk ratings are also important from the perspective of a variety of anti-terrorism and compliance laws and regulations. In particular, various national laws and regulations by international organizations prohibit doing business with certain persons and countries. For example, failure to comply with United States special regulations threatens financial penalties, from fines for executives to the removal of all business licenses in the United States. In addition, the reputational risk that can result from negative headlines in the absence of control is not to be underestimated.

In financial institutions characterized by limited resources and siloed solutions, the response to this has very often been to throw people at the effort. However, this has only added cost and complexity to the process and is not a long-term, sustainable solution. Therefore, there is a need in most organizations for a single, integrated technology platform that efficiently manages all KYC policies and regulatory compliance requirements from initial take-on right through the entire client lifecycle, including regular, ad-hoc and event-triggered reviews, as well as data and documentation refreshes.

All kinds of ratings can be affected, from credit ratings to sustainability ratings.

With a requirement to ensure lifecycle compliance to KYC regulations both on a local and global level, financial institutions and many other companies are necessitated to perform regular client reviews based on assigned risk ratings. KYC touches on the process you put customers through to engage with your business. KYC is considered as the future of the client onboarding process since an efficient identity verification solution helps institutions meet regulations, generate new revenue streams, and reduce risks and costs.

Global regulations highlight KYC as fundamental to a strong AML compliance program. With an appropriate KYC risk rating tool you are gathering the data you need to effectively structure your AML program and take a risk-based approach, comply with regulations and prevent financial crime. Ratings serve as the backbone of global anti-money laundering efforts.

Conducting KYC checks is a process that takes place at onboarding, i.e. identifying your customer and verifying that identity. KYC risk ratings help since KYC is an ongoing process to help you comply with requirements and continuously feed back into risk management and business strategy. You need to ensure that you know who your customer is, what activity you should expect from him, and the overall risk he presents to your organizaiton. KYC risk ratings enable you to monitor that risk and mitigate it.

In the case of legal persons, the type of company, activity, industry, sector code, number of employees, ownership and corporate structure, as well as the most important (expected) financial ratios must be recorded.

In the case of natural persons, in particular the nature of the profession and the purpose of the business relationship must be recorded. In the case of Politically Exposed Persons (PEP), the function and the place of exercise must also be recorded.

Take the System for Award Management (SAM) for an example. Both current and potential government vendors are required to register in SAM in order to be awarded contracts by the Government. In the United States of America, vendors are required to complete a one-time registration to provide basic information relevant to procurement and financial transactions. Vendors must update or renew their registration annually to maintain an active status. SAM allows Government agencies and contractors to search for your company based on your ability, size, location, experience, ownership, and more. In this way, fulfillment of KYC requirements becomes a marketing tool.

The exact meaning of KYC and related acronyms can change across geographies, with some regulators preferring one set of terminology over another.

  • US regulators refer to Customer Identification Program (CIP) when it comes to a check against relevant sanctions lists and gathering basic customer information (name, address, date of birth for an individual and an ID number) to form a „reasonable“ belief that the true identity of the customer is known.
  • Identity Verification (IDV) tools can be used to verify the identity of a customer, usually by using electronic and non-documentary means to do this.
  • A Customer Due Diligence (CDD) is said to provide more information regarding the individual or entity, the line of business they are in or more details about their management or corporate structure and whether there is an politically exposed person (PEP).
  • An Enhanced Due Diligence (EDD) is specifically designed for dealing with high-risk or high-net worth customers and large transactions. Because these customers and transactions pose greater risks to the financial sector, they are heavily regulated and monitored in order to ensure that everything is above board. Companies and financial institutions were first compelled to conduct EDD by the USA PATRIOT Act in 2001, a provision which is still in effect today. The Patriot Act also requires that offshore banking institutions, private banking organisations, and correspondent accounts abide by EDD regulations and laws. There are several characteristics that distinguish regular KYC policies from EDD policies. EDD policies are considered to be “rigorous and robust”, meaning that they require significantly more evidence and detailed information to be collected. The entire process of EDD must be documented in detail, and regulators should be able to have immediate access to the data. Professionals are often hired in order to analyse data that is collected regarding clients, and the reliability of information sources is of utmost importance.

By setting transaction monitoring scenarios accordingly, a rating helps to react to the expected activity from that client, for example, the volume, value, and frequency of payments across an account. Throughout the relationship, when those thresholds are breached, rating upgrades or downgrades alert you about

  • where this unusual behavior is coming from,
  • report it if suspicious, and
  • realign expectations if this is to be a new normal for that customer.

All persons involved in the creation of the KYC and subsequent changes to the KYC master document must also be logged.

Key to achieving a reasonable assurance in KYC discovery is acknowledging that, no matter the quality of information used or effort spent on research, it is impossible to be certain that any customer is entirely free from risk. It is always a matter of grades as expressed in ordinal rating scales.

Realising that 100% certainty is not attainable forces compliance officers to take realistic, risk-based approaches to KYC consideration. The prevention of financial crime is a matter of probabilities. By acknowledging that risk can never be eliminated entirely, you can craft anti-money laundering policies by using rating technologies that are both as effective and as unburdensome as possible.

Even when using rating technologies you must still periodically check up on low-risk clients and accounts to ensure that nothing is unusual or out of place. You need to be aware that the risk of criminal financial activity cannot be entirely eliminated.

Reasonable Assurance

A “reasonable” assurance varies depending on various factors, including different national anti-money laundering legislations and the type of financial institution involved, and pertains to how much information should be collected about a customer. Rating whether or not particular customers are high risk and which processes or investigations must be completed if they are, allows a financial institution a reasonable assurance. They must then decide how much is an appropriate amount of information to gather. A good rating allows the financial institution to determine how much time they should spend monitoring the customer’s account, if any.

KYC Remediation

The different ways to go about KYC remediation are pivotal for preventing your company from getting involved in corruption, the terrorist financing, and money laundering. A rating-based KYC remediation tactic could be to screen, verify, and identify customers according to its KYC risk rating. There are many rating products that a company can use to accomplish this efficiently, and it may also be done manually. The remediation process is where they clear up any contradictory data, organize the information they have acquired, and determine what else is left for them to find out about the client.

If a client might be able to launder money or partake in other corrupt activities without any red flags being raised by your rating system your company could get in serious legal trouble down the line, possibly leading to fines and even jail time for employees. Because of their central role in the financial sector, financial institutions are most strictly regulated in regards to appropriate rating systems. They have the responsibility of reporting suspicious activity and helping the government to ensure that money laundering does not occur. Being fully aware of what is going on with your clients’ ratings is the first step towards being protected against backlash from illegal transactions.

As soon as the KYC remediation has been successfully completed, the company can then determine the risk that the client poses and continue to add to their portfolio. This step helps to decide whether the company or financial institution must report the client to authorities for suspicious activity or potential corruption.

KYC Risk Rating

A KYC risk rating is simply a calculation of risk: either that posed by a specific customer or that which an institution faces based on its entire client portfolio. It makes sense to calculate both of these risk ratings as each of them is equally important.

KYC risk ratings might take the following data into account:

  • Global sanction lists
  • Narrative sanctions
  • Indirect bans
  • Politically Exposed Persons (PEP)
  • Family members and related persons
  • State-owned or publicly-owned enterprises
  • Global law enforcement lists
  • Negative reporting
  • Iranian economic interest
  • Ship information
  • System for Award Management (SAM)

Institutions gather as much data as they can about their customers, and they then compile this into a portfolio. Once the portfolio is completed, they closely analyse the information that they have obtained, and they determine the KYC risk rating of that specific client. If the risk rating is high, that client will be consistently and closely monitored. If the risk rating is low, the client will still be monitored, but not as diligently.

Millions of transactions occur every day throughout the world, meaning that institutions constantly receive vast amounts of data that need to be analyzed in rating systems. KYC risk ratings allow for institutions to quickly and efficiently sift through this information. Many of the KYC risk rating tools are technology-based and at least partly automatized, as manually organizing large quantities of data is ineffective and takes far too long.

A KYC risk rating is also essential for another important reason: it allows institutions to make a evidence-based prediction of what they believe a client’s account should look like in the future. A KYC risk rating is useful for determining whether something is unusual, out of place or suspicious. If a client’s transactions begin to diverge significantly from the institution’s predictions, you will be notified and will be able to further analyze the transactions for suspicious behavior.

If you wish to keep your company free from involvement with corruption and money laundering, it is vital that your KYC risk rating system consistently calculates the KYC risk rating of all your customers. Assigning rating symbols is the surest way to determine which clients present a higher risk to your company, thus allowing you to avoid liability and ensure that these clients are monitored appropriately.

Relevant Adverse Information

Relevant adverse information is simply any information that may cause officials to suspect an individual of being involved in a financial crime and can be acquired from any source. Although one source may appear to be more valid than another, all pieces of information may be looked at. Common sources include the Internet, the media, and other assorted databases. Specific individuals may even provide authorities with relevant adverse information such as proof of previous crimes, drug smuggling, fraud, scams, embezzlement, and theft, or evidence that a person is currently involved in tax evasion or even terrorist financing. Even if the information does not appear to be directly related to the scheme or suspect that is under evaluation, it can still certainly be relevant adverse information. Relevant adverse information does not need to necessarily be proven true, and it can include suspicions.

All relevant adverse information must be taken into consideration by financial institutions and governments when they are trying to track down financial crime and those who are responsible for it. While one piece of information may not seem as important as another, it can still wind up being the key for arresting money launderers and terrorist financers. Because of this fact, many financial institutions that are heavily regulated by KYC policies are required to constantly be on the look out for relevant adverse information in order to discover any hints or tip offs that may aid their investigations.

One of the most common types of relevant adverse information is the past criminal activity of an individual. If it is suspected that a person may be involved in financial crime, and authorities discover that that person has been previously caught for committing another crime, this gives authorities even more reason to suspect that individual to be involved. In contrast, if a person has no criminal history and is not known for associating with individuals who do, they are then at a much lower risk of being involved in something such as a money laundering scheme.

Another type of relevant adverse information that individuals oftentimes look at is if a person is on a sanction watch list. KYC risk ratings would go done since chances are that it is not for a good reason, and that authorities should be on the lookout for them being involved in any financial crime.

Find Help

Meet the legal requirements and make informed decisions to prevent financial crime and corruption in your company:

  • Rate the size of risk presented to your institution from a financial, regulatory and reputational perspective
  • Achieve top compliance ratings with evolving legislation and ensure a timely and efficient client onboarding
  • Implement a rules-driven, evidence-based rating approach to KYC compliance that efficiently focuses resources on higher risk clients
  • Automate risk-scoring processes throughout the lifetime of the client, minimizing overall risk to your institution
  • Understand the true nature and purpose of the account being set up, investigate sources of wealth and define ultimate beneficial ownership
  • Lower the cost of ownership with a flexible solution that can be adapted to respond to a changing regulatory environment
  • Make use of a standalone module or a fully integrated one with your client lifecycle management solution
  • Have access to a sophisticated rules engines which automatically puts your clients into low, medium or high risk rating categories to gain a clear view of the size of risk presented to your institution from a financial, regulatory and reputational perspective

There is a world-check risk intelligence database which provides accurate and reliable information for substantiated decision-making. Hundreds of specialist analysts around the world gather information from trusted sources such as watchlists, government sources and trusted media. Strict research guidelines are followed.

With our possible partners we are glad to help you find an out-of-the-box, rules-driven solution for all Know Your Customer policy requirements to support regulatory needs across multiple jurisdictions and business lines.

Simplify your business partner screening process with state-of-the-art technology combined with expert knowledge. The world check data is completely structured, aggregated and deduplicated. With flexible deployment methods, you can easily integrate data into a wide variety of in-house screening platforms, cloud-based, or other third-party solutions.

Let us help you with our relevant partners determine all of the client and counterparty data and documentation that is required to support the KYC and regulatory compliance obligations. Make use of dynamic decision tree intelligence to determine the regulatory journey of the client including all the regulations, KYC questionnaires, classifications and risk assessments that need to be adhered to and performed.

KYC Risk Rating

Compliances, Methodologies, Procedures, Regulations, Systems

Under strict Anti-Money Laundering (AML) regulations put in place by national governments, the European Union (EU), the Financial Action Task Force (FATF), and the United Nations (UN), all financial institutions and many types of companies are required to closely monitor their clients’ accounts and report any suspicious activity. These legal requirements often take the form of Know Your Cutomer (KYC) policies and KYC risk ratings, which are essential in preventing and reducing financial crime.

Excluded from the general test are “standard small customers” who do not wish to undertake particularly extensive or extraordinary business transactions and who have been classified by your rating system in advance in a correspondingly safe risk class. Nevertheless, the origin of funds and assets must generally be clarified. The details of the planned customer relationship such as scope and payment transactions must be rated and recorded.

KYC risk ratings are also important from the perspective of a variety of anti-terrorism and compliance laws and regulations. In particular, various national laws and regulations by international organizations prohibit doing business with certain persons and countries. For example, failure to comply with United States special regulations threatens financial penalties, from fines for executives to the removal of all business licenses in the United States. In addition, the reputational risk that can result from negative headlines in the absence of control is not to be underestimated.

In financial institutions characterized by limited resources and siloed solutions, the response to this has very often been to throw people at the effort. However, this has only added cost and complexity to the process and is not a long-term, sustainable solution. Therefore, there is a need in most organizations for a single, integrated technology platform that efficiently manages all KYC policies and regulatory compliance requirements from initial take-on right through the entire client lifecycle, including regular, ad-hoc and event-triggered reviews, as well as data and documentation refreshes.

All kinds of ratings can be affected, from credit ratings to sustainability ratings.

With a requirement to ensure lifecycle compliance to KYC regulations both on a local and global level, financial institutions and many other companies are necessitated to perform regular client reviews based on assigned risk ratings. KYC touches on the process you put customers through to engage with your business. KYC is considered as the future of the client onboarding process since an efficient identity verification solution helps institutions meet regulations, generate new revenue streams, and reduce risks and costs.

Global regulations highlight KYC as fundamental to a strong AML compliance program. With an appropriate KYC risk rating tool you are gathering the data you need to effectively structure your AML program and take a risk-based approach, comply with regulations and prevent financial crime. Ratings serve as the backbone of global anti-money laundering efforts.

Conducting KYC checks is a process that takes place at onboarding, i.e. identifying your customer and verifying that identity. KYC risk ratings help since KYC is an ongoing process to help you comply with requirements and continuously feed back into risk management and business strategy. You need to ensure that you know who your customer is, what activity you should expect from him, and the overall risk he presents to your organizaiton. KYC risk ratings enable you to monitor that risk and mitigate it.

In the case of legal persons, the type of company, activity, industry, sector code, number of employees, ownership and corporate structure, as well as the most important (expected) financial ratios must be recorded.

In the case of natural persons, in particular the nature of the profession and the purpose of the business relationship must be recorded. In the case of Politically Exposed Persons (PEP), the function and the place of exercise must also be recorded.

Take the System for Award Management (SAM) for an example. Both current and potential government vendors are required to register in SAM in order to be awarded contracts by the Government. In the United States of America, vendors are required to complete a one-time registration to provide basic information relevant to procurement and financial transactions. Vendors must update or renew their registration annually to maintain an active status. SAM allows Government agencies and contractors to search for your company based on your ability, size, location, experience, ownership, and more. In this way, fulfillment of KYC requirements becomes a marketing tool.

The exact meaning of KYC and related acronyms can change across geographies, with some regulators preferring one set of terminology over another.

  • US regulators refer to Customer Identification Program (CIP) when it comes to a check against relevant sanctions lists and gathering basic customer information (name, address, date of birth for an individual and an ID number) to form a „reasonable“ belief that the true identity of the customer is known.
  • Identity Verification (IDV) tools can be used to verify the identity of a customer, usually by using electronic and non-documentary means to do this.
  • A Customer Due Diligence (CDD) is said to provide more information regarding the individual or entity, the line of business they are in or more details about their management or corporate structure and whether there is an politically exposed person (PEP).
  • An Enhanced Due Diligence (EDD) is specifically designed for dealing with high-risk or high-net worth customers and large transactions. Because these customers and transactions pose greater risks to the financial sector, they are heavily regulated and monitored in order to ensure that everything is above board. Companies and financial institutions were first compelled to conduct EDD by the USA PATRIOT Act in 2001, a provision which is still in effect today. The Patriot Act also requires that offshore banking institutions, private banking organisations, and correspondent accounts abide by EDD regulations and laws. There are several characteristics that distinguish regular KYC policies from EDD policies. EDD policies are considered to be “rigorous and robust”, meaning that they require significantly more evidence and detailed information to be collected. The entire process of EDD must be documented in detail, and regulators should be able to have immediate access to the data. Professionals are often hired in order to analyse data that is collected regarding clients, and the reliability of information sources is of utmost importance.

By setting transaction monitoring scenarios accordingly, a rating helps to react to the expected activity from that client, for example, the volume, value, and frequency of payments across an account. Throughout the relationship, when those thresholds are breached, rating upgrades or downgrades alert you about

  • where this unusual behavior is coming from,
  • report it if suspicious, and
  • realign expectations if this is to be a new normal for that customer.

All persons involved in the creation of the KYC and subsequent changes to the KYC master document must also be logged.

Key to achieving a reasonable assurance in KYC discovery is acknowledging that, no matter the quality of information used or effort spent on research, it is impossible to be certain that any customer is entirely free from risk. It is always a matter of grades as expressed in ordinal rating scales.

Realising that 100% certainty is not attainable forces compliance officers to take realistic, risk-based approaches to KYC consideration. The prevention of financial crime is a matter of probabilities. By acknowledging that risk can never be eliminated entirely, you can craft anti-money laundering policies by using rating technologies that are both as effective and as unburdensome as possible.

Even when using rating technologies you must still periodically check up on low-risk clients and accounts to ensure that nothing is unusual or out of place. You need to be aware that the risk of criminal financial activity cannot be entirely eliminated.

Reasonable Assurance

A “reasonable” assurance varies depending on various factors, including different national anti-money laundering legislations and the type of financial institution involved, and pertains to how much information should be collected about a customer. Rating whether or not particular customers are high risk and which processes or investigations must be completed if they are, allows a financial institution a reasonable assurance. They must then decide how much is an appropriate amount of information to gather. A good rating allows the financial institution to determine how much time they should spend monitoring the customer’s account, if any.

KYC Remediation

The different ways to go about KYC remediation are pivotal for preventing your company from getting involved in corruption, the terrorist financing, and money laundering. A rating-based KYC remediation tactic could be to screen, verify, and identify customers according to its KYC risk rating. There are many rating products that a company can use to accomplish this efficiently, and it may also be done manually. The remediation process is where they clear up any contradictory data, organize the information they have acquired, and determine what else is left for them to find out about the client.

If a client might be able to launder money or partake in other corrupt activities without any red flags being raised by your rating system your company could get in serious legal trouble down the line, possibly leading to fines and even jail time for employees. Because of their central role in the financial sector, financial institutions are most strictly regulated in regards to appropriate rating systems. They have the responsibility of reporting suspicious activity and helping the government to ensure that money laundering does not occur. Being fully aware of what is going on with your clients’ ratings is the first step towards being protected against backlash from illegal transactions.

As soon as the KYC remediation has been successfully completed, the company can then determine the risk that the client poses and continue to add to their portfolio. This step helps to decide whether the company or financial institution must report the client to authorities for suspicious activity or potential corruption.

KYC Risk Rating

A KYC risk rating is simply a calculation of risk: either that posed by a specific customer or that which an institution faces based on its entire client portfolio. It makes sense to calculate both of these risk ratings as each of them is equally important.

KYC risk ratings might take the following data into account:

  • Global sanction lists
  • Narrative sanctions
  • Indirect bans
  • Politically Exposed Persons (PEP)
  • Family members and related persons
  • State-owned or publicly-owned enterprises
  • Global law enforcement lists
  • Negative reporting
  • Iranian economic interest
  • Ship information
  • System for Award Management (SAM)

Institutions gather as much data as they can about their customers, and they then compile this into a portfolio. Once the portfolio is completed, they closely analyse the information that they have obtained, and they determine the KYC risk rating of that specific client. If the risk rating is high, that client will be consistently and closely monitored. If the risk rating is low, the client will still be monitored, but not as diligently.

Millions of transactions occur every day throughout the world, meaning that institutions constantly receive vast amounts of data that need to be analyzed in rating systems. KYC risk ratings allow for institutions to quickly and efficiently sift through this information. Many of the KYC risk rating tools are technology-based and at least partly automatized, as manually organizing large quantities of data is ineffective and takes far too long.

A KYC risk rating is also essential for another important reason: it allows institutions to make a evidence-based prediction of what they believe a client’s account should look like in the future. A KYC risk rating is useful for determining whether something is unusual, out of place or suspicious. If a client’s transactions begin to diverge significantly from the institution’s predictions, you will be notified and will be able to further analyze the transactions for suspicious behavior.

If you wish to keep your company free from involvement with corruption and money laundering, it is vital that your KYC risk rating system consistently calculates the KYC risk rating of all your customers. Assigning rating symbols is the surest way to determine which clients present a higher risk to your company, thus allowing you to avoid liability and ensure that these clients are monitored appropriately.

Relevant Adverse Information

Relevant adverse information is simply any information that may cause officials to suspect an individual of being involved in a financial crime and can be acquired from any source. Although one source may appear to be more valid than another, all pieces of information may be looked at. Common sources include the Internet, the media, and other assorted databases. Specific individuals may even provide authorities with relevant adverse information such as proof of previous crimes, drug smuggling, fraud, scams, embezzlement, and theft, or evidence that a person is currently involved in tax evasion or even terrorist financing. Even if the information does not appear to be directly related to the scheme or suspect that is under evaluation, it can still certainly be relevant adverse information. Relevant adverse information does not need to necessarily be proven true, and it can include suspicions.

All relevant adverse information must be taken into consideration by financial institutions and governments when they are trying to track down financial crime and those who are responsible for it. While one piece of information may not seem as important as another, it can still wind up being the key for arresting money launderers and terrorist financers. Because of this fact, many financial institutions that are heavily regulated by KYC policies are required to constantly be on the look out for relevant adverse information in order to discover any hints or tip offs that may aid their investigations.

One of the most common types of relevant adverse information is the past criminal activity of an individual. If it is suspected that a person may be involved in financial crime, and authorities discover that that person has been previously caught for committing another crime, this gives authorities even more reason to suspect that individual to be involved. In contrast, if a person has no criminal history and is not known for associating with individuals who do, they are then at a much lower risk of being involved in something such as a money laundering scheme.

Another type of relevant adverse information that individuals oftentimes look at is if a person is on a sanction watch list. KYC risk ratings would go done since chances are that it is not for a good reason, and that authorities should be on the lookout for them being involved in any financial crime.

Find Help

Meet the legal requirements and make informed decisions to prevent financial crime and corruption in your company:

  • Rate the size of risk presented to your institution from a financial, regulatory and reputational perspective
  • Achieve top compliance ratings with evolving legislation and ensure a timely and efficient client onboarding
  • Implement a rules-driven, evidence-based rating approach to KYC compliance that efficiently focuses resources on higher risk clients
  • Automate risk-scoring processes throughout the lifetime of the client, minimizing overall risk to your institution
  • Understand the true nature and purpose of the account being set up, investigate sources of wealth and define ultimate beneficial ownership
  • Lower the cost of ownership with a flexible solution that can be adapted to respond to a changing regulatory environment
  • Make use of a standalone module or a fully integrated one with your client lifecycle management solution
  • Have access to a sophisticated rules engines which automatically puts your clients into low, medium or high risk rating categories to gain a clear view of the size of risk presented to your institution from a financial, regulatory and reputational perspective

There is a world-check risk intelligence database which provides accurate and reliable information for substantiated decision-making. Hundreds of specialist analysts around the world gather information from trusted sources such as watchlists, government sources and trusted media. Strict research guidelines are followed.

With our possible partners we are glad to help you find an out-of-the-box, rules-driven solution for all Know Your Customer policy requirements to support regulatory needs across multiple jurisdictions and business lines.

Simplify your business partner screening process with state-of-the-art technology combined with expert knowledge. The world check data is completely structured, aggregated and deduplicated. With flexible deployment methods, you can easily integrate data into a wide variety of in-house screening platforms, cloud-based, or other third-party solutions.

Let us help you with our relevant partners determine all of the client and counterparty data and documentation that is required to support the KYC and regulatory compliance obligations. Make use of dynamic decision tree intelligence to determine the regulatory journey of the client including all the regulations, KYC questionnaires, classifications and risk assessments that need to be adhered to and performed.

Recovery Rating

Criteria, Methodologies, Notching, Processes, Read, Repairs, Systems

Credit risk is a function of an issuer’s probability of default and the loss given default on a specific debt instrument. For noninvestment grade corporate issuers, some rating agencies assign separate ratings for these two components of credit risk. An issuer rating is a rating agency’s assessment of the probability that an issuer will default on its debt. A recovery rating, on the other hand, considers the value of assets (or enterprise value) that would be available to an investor for a specific debt instrument, in accordance with its ranking and legal rights, at the time of an assumed emergence from a reorganization or liquidation process that might occur between, for example, six and 18 months after default.

Recovery ratings can be assigned to specific instruments for corporate non-investment-grade issuers, i.e., those issuers with a speculative grade issuer rating. They are assigned because non-investment-grade bonds have a greater likelihood of default, investors have a greater interest in the outcome of a potential default scenario and an assumed default scenario can be more reliably constructed.

Criteria do not typically apply ratings on public finance transactions or financial institutions, and also not to preferred share securities that are by definition low recovery instruments. Since commercial paper or short-term instruments have by definition shorter maturity durations and a higher reliance on liquidity considerations, commercial paper is also not eligible for recovery ratings.

While the underlying security affected by a recovery rating will have a rating trend unless its status is under review, recovery ratings themselves have no trends and are not placed under review. In most cases, a recovery rating will not be maintained for very long on a security that has downgraded to Default or Selective Default.

There are five stages in the determination of a recovery rating and final instrument rating: Determination of a path to default scenario, valuation of the issuer upon emergence from default, determination of claims against the defaulted entity, distribution of value from the defaulted entity and assignment of a recovery rating and notching of the issuer rating to determine a final instrument rating.

A recovery rating necessarily assumes that a default will occur; the actual probability of default is addressed solely by the issuer rating. It is important to consider the distinction between companies that have issuer ratings in the B-category or lower and companies with issuer ratings in the BB range, since lower default risk makes it more difficult to construct a scenario for both a path to default and asset or enterprise values at default.

For BB-range issuers, a rating agency might be more restrictive in terms of the degree of notching uplift it will permit between the issuer rating and the recovery rating, so as to limit the possibility of non-investment-grade issuers having instruments rated well into investment-grade territory. The final instrument rating, determined by notching up or down from the issuer rating in accordance with the recovery rating essentially blends the two elements of credit risk — probability of default and loss given default — giving investors an additional measure of the expected performance of a non-investment-grade bond.

Determining Recovery Ratings

Criteria, Methodologies, Notching, Processes, Systems

Credit risk is a function of an issuer’s probability of default and the loss given default on a specific debt instrument. For noninvestment grade corporate issuers, some rating agencies assign separate ratings for these two components of credit risk. An issuer rating is a rating agency’s assessment of the probability that an issuer will default on its debt. A recovery rating, on the other hand, considers the value of assets (or enterprise value) that would be available to an investor for a specific debt instrument, in accordance with its ranking and legal rights, at the time of an assumed emergence from a reorganization or liquidation process that might occur between, for example, six and 18 months after default.

Recovery ratings can be assigned to specific instruments for corporate non-investment-grade issuers, i.e., those issuers with a speculative grade issuer rating. They are assigned because non-investment-grade bonds have a greater likelihood of default, investors have a greater interest in the outcome of a potential default scenario and an assumed default scenario can be more reliably constructed.

Criteria do not typically apply ratings on public finance transactions or financial institutions, and also not to preferred share securities that are by definition low recovery instruments. Since commercial paper or short-term instruments have by definition shorter maturity durations and a higher reliance on liquidity considerations, commercial paper is also not eligible for recovery ratings.

While the underlying security affected by a recovery rating will have a rating trend unless its status is under review, recovery ratings themselves have no trends and are not placed under review. In most cases, a recovery rating will not be maintained for very long on a security that has downgraded to Default or Selective Default.

There are five stages in the determination of a recovery rating and final instrument rating: Determination of a path to default scenario, valuation of the issuer upon emergence from default, determination of claims against the defaulted entity, distribution of value from the defaulted entity and assignment of a recovery rating and notching of the issuer rating to determine a final instrument rating.

A recovery rating necessarily assumes that a default will occur; the actual probability of default is addressed solely by the issuer rating. It is important to consider the distinction between companies that have issuer ratings in the B-category or lower and companies with issuer ratings in the BB range, since lower default risk makes it more difficult to construct a scenario for both a path to default and asset or enterprise values at default.

For BB-range issuers, a rating agency might be more restrictive in terms of the degree of notching uplift it will permit between the issuer rating and the recovery rating, so as to limit the possibility of non-investment-grade issuers having instruments rated well into investment-grade territory. The final instrument rating, determined by notching up or down from the issuer rating in accordance with the recovery rating essentially blends the two elements of credit risk — probability of default and loss given default — giving investors an additional measure of the expected performance of a non-investment-grade bond.