ESMA highlights potential conflicts of interest risks in changes to Collateralised Loan Obligation rating methodologies

The report highlights potential conflicts of interest risks that were observed in the dialogue between Credit Rating Agencies (CRAs) and market participants, and the potential influence these may have had on the CLO methodology development and rating process of the concerned CRAs from 2017 to 2021. 

CRAs must have sound controls over their market outreach activity to ensure the accuracy, objectivity, and independence of credit ratings, as well as the independent development of rating methodologies. 

Main findings of the report:

The CLO market and the role of CRAs

CLOs are sophisticated securitisation products. Given their complexity and opacity, CLO market participants continue to use credit ratings to support their decision making. In the CLO market, the arrangers, managers and investors, rather than the issuers, have an influential role in determining which CRA will be chosen for the deal. It is common practice that analysts employed by CRAs and responsible for methodology development also participate in market outreach activities involving those market participants. 

Organisational aspects of market outreach activities

Analytical market outreach to industry plays an important role for CRAs, and ESMA recognises the benefits of this interaction. At the same time, without adequate controls in place, there is a risk that the CLO methodologies developed by CRAs could be unduly influenced by commercial feedback, and by the type of information provided by market participants. Analytical outreach and the boundaries of that outreach need to be carefully safeguarded and communicated to the staff of CRAs.

Sharing of non-analytical information

In some instances, market outreach included the sharing of information that ESMA considers not appropriate. This included, on occasion, market participants sharing with CRAs feedback on the commercial perception of a methodology. Such information could provide rating analysts with commercial information that results in a perception of, or actual, conflict of interests. This could impair the accuracy, objectivity and independence of CLO credit ratings.

Next steps

ESMA has informed each CRA of its findings and will develop individual remedial action plans to ensure appropriate safeguards and controls are in place. 

ESMA will continue to monitor the developments in CLO markets, including changes in CLO credit ratings, rating practices and rating methodologies. 

Further information:

Sarah Edwards 

Senior Communications Officer
@ press@esma.europa.eu