The ECBC has asked for more clarity on changes proposed by Fitch to its covered bond methodology, stating that the impact of a new approach to determining IDR uplift is unclear and that other aspects are “not entirely comprehensible”, although the industry body generally supports the proposals.

In an exposure draft published on 29 June, Fitch proposed changes to its methodology that would modify the different uplift factors above Issuer Default Ratings (IDRs) that lead to the potential maximum covered bond rating, with the aim of “making some rating steps more focused on the most relevant credit aspects”.

The proposals include changes to the calculation of IDR uplift, the replacement of Discontinuity Caps (D-Caps) with a new Payment Continuity Uplift (PCU) focussing on liquidity protection, and a move towards a loss-driven assessment of recoveries given default.

The rating agency requested feedback from market participants on the proposed amendments, with the deadline for submissions 29 July.

The European Covered Bond Council’s rating agency approaches working group said today (Friday) that overall it supports Fitch efforts to try to make its covered bond rating criteria more transparent and simple to understand, as the D-Cap approach was sometimes considered a “black box”.

Luca Bertalot, secretary general of the EMF-ECBC, said the industry body had been consulted by Fitch and that the working group had discussed the proposed changes in a conference call with the rating agency.

“Our general feeling is that the ECBC’s members are very supportive of the changes proposed,” Bertalot told The CBR. “This is seen as an improvement.

“However, the common view of the working group is that some clarification is needed on specific points. These are the major issues we have identified in discussions with our members.”

The ECBC response said that on certain points the exposure draft does not clearly identify what the exact changes are and how programmes would be affected.

In particular, the response said that more information is needed on:

• How the proposed change in approach to determining uplift above the IDR will affect all programmes, especially with regard to the integration of an issuer with its parent in the same group in the IDR uplift approach.
• How refinancing spread level (RSL) assumptions for government bonds, sub-sovereign assets and residential and commercial real estate mortgage loans are derived, and how the existence of an active RMBS market in the countries is taken into account.
• How foreign exchange risk and hedging are taken into account.
• What exactly the differences are between the new more loss-driven approach to assessing recoveries given default and the current approach, as the information on the proposed changes regarding the recovery uplift could be viewed as vague.

On the new approach to assessing recoveries given default, the response said the members of the working group “consider that neither the new approach nor the reasons for the changes are entirely comprehensible”.

The members of the working group also said that in recent years Fitch has changed its methodology or relevant parts of its approach “quite often”, and expressed a preference for more stability going forward.

“It is important on the one hand to improve rating methodologies when there are changes to markets or regulatory frameworks, but on the other hand it is very important to maintain rating stability,” said Bertalot. “Changing too frequently can really jeopardise the stability of the market.

“This was a common view.”

Following the review period and consideration of responses received, Fitch expects to finalise and publish the criteria in the third quarter of 2016.