Fitch has finalised an update to its counterparty criteria for covered bonds, setting out today (Thursday) how it dealt with feedback received on aspects such as netting of collateral positions, treatment of termination payments, and extended rating eligibility thresholds.

A six week consultation period on an exposure draft ended on 12 July, with Fitch noting that it received comments from a range of market participants. It said that it had invited market participants to provide comments in particular regarding netting of collateral positions, treatment of termination payments and extended rating eligibility thresholds, and that it had proposed to adopt all changes incorporated in updated structured finance counterparty criteria.

The rating agency said that it does not expect the covered bond criteria update to have any direct rating impact on programmes, but that it may have limited indirect impact in some scenarios.

If previously documented triggers are set higher than Fitch’s criteria and the documented triggers are breached, it said, as long as a counterparty’s arrangements continue to be consistent with Fitch’s criteria the agency would not expect to downgrade the covered bonds’ ratings exclusively due to the breach of any triggers specified in programme documentation that no longer reflect Fitch’s current criteria.

“Nevertheless, the consequences under the programme documentation of such a breach would be a matter for the parties to the programme to address as a matter of contract,” it said. “Fitch would expect to be notified of any action taken by the programme parties in response to such a breach and what future actions might be expected to be taken in response to breaches of the new criteria thresholds.”

It said that it will not take rating actions on covered bonds where parties to a programme choose to amend existing documentation to incorporate aspects of the updated criteria as long as the programme remains consistent with criteria. The rating agency expects to be notified of any such amendments, but will not expect to provide programme-specific rating confirmations with respect to proposed changes.

With respect to the feedback it received on the proposed criteria change, Fitch said that comments concerning netting of collateral positions supported the assumption that netting might hamper individual replacement prospects for privileged asset and liability swaps concluded with internal counterparties, and that in these cases it might lead to increased default risk of the covered bonds after an issuer default.

The rating agency said that it responded to feedback by clarifying the treatment of volatility cushions (VCs) and liquidity adjustments in an example.

Respondents agreed with Fitch’s proposal to primarily view pari passu or senior-ranking termination payments as a potential liquidity stress, according to the rating agency.

“Additionally, feedback requested that Fitch should clarify the difference between the treatment of termination payments in a scenario where only the counterparty defaults and in a scenario where the cover pool is liquidated, which has been done in the updated criteria report,” it said.

The majority of respondents, added Fitch, agreed with a proposal to extend rating eligibility thresholds to below AAA because it would offer more flexibility for counterparty selection while maintaining sufficient protection.

No negative feedback was registered on a proposal to adopt all changes incorporated in updated structured finance counterparty criteria from 30 May, according to Fitch, such as changes to collateral posting formulas including an updated approach for determining VCs for cross-currency swaps.