EU watchdog tells top credit raters to review CLO controls

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LONDON (Reuters) – The European Union’s securities watchdog said on Thursday ratings agencies must ensure their assessments of collateralised loan obligations (CLOs) are accurate and independent after an investigation flagged the risk of undue market influence.

The European Securities and Markets Authority (ESMA) said its investigation focused on Fitch Ratings, Moody’s (NYSE:MCO) and S&P – referred to as the Big Three – given that they account for most CLO ratings.

CLOs are securities backed by a pool of loans, often linked to companies with lower credit ratings.

“ESMA has informed each CRA (credit rating agency) of its findings and will develop individual remedial action plans to ensure appropriate safeguards and controls are in place,” the watchdog said in a statement.

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

Fitch Ratings said it noted ESMA’s report, and that it does and will continue to use robust criteria for the CLO and other markets, and maintain strong controls to prevent undue influence on its ratings.

“We are confident in the quality of our CLO ratings, and changes to the underlying methodology have been driven solely by analytical considerations,” Moody’s said.

S&P had no immediate comment.

ESMA, which directly regulates rating agencies operating in the 27-country bloc, said CLOs are complex and opaque, and market participants use ratings to help determine which to buy.

It was “common practice” for analysts at raters to discuss with market participants the rationale of methodologies used to compile a rating, ESMA said.

Changes to methodologies should be based on objective reasons, it said, adding there was a risk they could be unduly influenced by commercial feedback from market participants.

“In some instances, market outreach included the sharing of information that ESMA considers not appropriate,” the watchdog said.

This included market participants sharing with the agencies feedback on the commercial perception of a methodology, which could impair the “accuracy, objectivity and independence” of CLO credit ratings, it added.