Moody’s launched a covered bond RFC proposing new changes to its methodology today (Thursday) to take into account the planned introduction of bank counterparty risk ratings, and it expects more programmes to be positively than negatively affected by these becoming the basis for covered bond anchors.

The rating agency has already amended its covered bond rating methodology to take into account bail-in frameworks such as the EU Bank Recovery & Resolution Directive (BRRD), having in September 2013 launched a request for comment (RFC) on changes that went on to affect ratings from March 2014.

The latest proposals comes on the back of an RFC Moody’s also launched today for the introduction of counterparty risk (CR) ratings. That RFC comes alongside other changes to Moody’s bank rating methodology.

The last changes to Moody’s covered bond rating methodology took into account the exclusion of covered bonds from resolution regimes such as the BRRD, allowing for a greater notching differential between their ratings and those of liabilities, such as senior unsecured debt, that could face bail-in. Under the latest methodology, covered bond ratings are notched up from a covered bond “anchor” that is based upon either the senior unsecured rating or an adjusted Baseline Credit Assessment (BCA).

Moody’s is proposing today that covered bond anchors be based on the new counterparty ratings. It said that counterparty ratings will be distinct from debt, deposit or issuer ratings in that they will consider only the risk of default rather than both the likelihood of default and the expected financial loss suffered in the event of default.

“We expect that banks in resolution will often maintain certain functions and operations and continue to honour certain payment or funding obligations even while losses are being imposed on senior unsecured debt or deposits,” Moody’s said in its counterparty rating RFC. “Therefore, the probability of failing to maintain such key operations or of defaulting on such payment obligations (for example, covered bonds and derivatives) could be lower than indicated by the senior unsecured debt ratings and, in some cases, deposit ratings.

“As a result, the CR rating may be higher than the senior unsecured debt and deposit ratings, reflecting the likelihood that in a banking resolution regulatory authorities will take steps to preserve operations, honour certain obligations and minimise the risk of contagion to other banks.”

The starting point for counterparty ratings will, as for other bank instruments, be BCAs, which Moody’s noted represent its view of a bank’s probability of failure, incorporating affiliate support.

“The position of the CR rating relative to the adjusted BCA will depend on the degree to which capital and debt instruments shield counterparty obligations from loss,” it said. “This protection will in turn depend on a jurisdiction’s insolvency and resolution legislation – in other words, the CR rating could have a higher relative ranking (or position in the liabilities waterfall) in some jurisdictions than in others.

“The CR rating will also incorporate potential government support, which could also result in uplift relative to the BCA,” it added.

Moody’s said in its covered bond RFC that for the majority of covered bonds in Europe, the covered bond anchor will be expressed as the CR rating plus one notch.

“In European covered bond markets authorities are particularly likely to take steps to ensure the continuity of covered bond payments when the bank supporting the bonds is in resolution,” it said. “This is because of the strength of the legislative framework of European resolution regimes in relation to covered bonds, and is supported by the history and characteristics of the covered bond market.”

Moody’s expects more covered bond ratings to be positively than negatively affected by the proposed covered bond changes, but said that in light of the related RFCs it is not in a position to fully assess and disclose their exact impact.

The deadlines for the two new RFCs are 9 February.