Standard & Poor’s plans to reflect protection afforded certain liabilities under resolution with new resolution counterparty ratings (RCRs), and yesterday (Tuesday) launched a request for comment (RFC) on how this will affect its covered bond methodology, saying 3% of programmes could be cut a notch.

The RCRs will typically be assigned to liabilities such as collateralised debt, certain types of deposits, repurchase obligations and certain derivative counterparty obligations, according to the rating agency, which said the proposed methodology – which is also subject to an RFC – addresses how post-crisis developments in bail-in resolution regimes and in the stances of some resolution authorities affect the default risk for such liabilities.

“An RCR is a forward-looking opinion of the relative likelihood of default in certain senior liabilities for some financial institutions whose treatment in a bail-in resolution scenario, in the context of an effective resolution framework, leads to a distinctly lower default risk than that of the remaining senior unsecured liabilities,” said S&P.

RCRs may typically be up to two notches above the respective issuer credit rating (ICR), depending on the ICR level, but, the rating agency added, the uplift could be higher if an institution is approaching non-viability and there is sufficient clarity that the likelihood of the RCR liabilities not defaulting is commensurate with a higher uplift.

Regarding covered bonds, the RCR will affect the determination of the reference rating level (RRL) that was introduced in the last major update to S&P’s covered bond methodology, which was also to reflect developments including those related to bail-in frameworks. The RRL, hitherto based on a resolution regime analysis, allowed for an uplift of up to two notches from the ICR to the RRL – something that will be possible under the proposed RCR-related criteria.

For covered bond issuers assigned RCRs and with ICRs of BBB- to AA-, the RRL will be able to be up to one notch above an RCR that may be up to one notch above the ICR.

“In general, for issuers rated BBB- to AA-, we consider that covered bonds that we believe are subject to legal, regulatory, or contractual overcollateralisation requirements as well as ongoing monitoring requirements of the collateral in cover pools provide an enhanced degree of visibility about the effect of a resolution scenario on covered bonds as a type of senior secured debt, compared with other RCR liabilities (including other senior secured liabilities), which may not be subject to such requirements,” said S&P.

“The existence of these requirements lessens the uncertainty regarding how resolution would be handled in an extreme or severe stress scenario for issuers that are currently so far from potential distress. In this case, the RRL may be one notch above the RCR, unless the conditions described in paragraph 32 of the proposed RCR criteria are relevant to the covered bond issuer and no RCR uplift is assigned above the ICR.”

For issuers with an RCR and an ICR of AA or above, the RRL will be aligned with the RCR, which will be the same as the ICR. For those with an RCR and an ICR of BB+ or below, the RRL will be aligned with the RCR, which may be up to two notches above the ICR except in certain circumstances.

S&P noted that caveats in the new criteria – applicable to some of the above typical rules – will allow it to make more issuer-specific rating-relevant decisions, and that it will no longer be taking a uniform view of resolution regimes within the EU.

It also expects it to be less likely that RRLs will exceed the foreign currency rating of the respective sovereign.

S&P said that from testing the impact of the proposed criteria it expects – all other things being equal – the ratings of the “vast majority” of covered bond programmes to be unaffected, with up to 3% of programmes being downgraded by one notch.

“These downgrades would affect issuers with no resolution counterparty ratings (RCR) and whose available credit enhancement is insufficient to support additional collateral-based uplift under our covered bonds criteria to compensate for a reduction in uplift under the resolution regime analysis,” it said.

Barring the expected impact on covered bond ratings, S&P does not expect the introduction of RCRs to have any impact on any outstanding ratings of financial institutions, nor a material impact on financial institutions’ debt ratings.

Responses to the covered bond RFC and the RCR RFC are sought by 28 March.

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