Scope Ratings today published its Rating Methodology for Counterparty Risk in Structured Finance Transactions. The proposed methodology describes how Scope analyses whether additional credit risk is introduced into a structured finance transaction by financial or operational counterparty exposures. Generally, counterparties being financial institutions with a BBB/S-2 credit quality or higher, combined with appropriate risk substitution triggers, can support AAA and AA rating categories on a structured finance transaction. The trigger levels identified by Scope build on post-crisis realities including the new regulatory and supervisory framework for banks such as bail-in and stronger prudential metrics, resulting in lower likelihood of banks defaulting within a short timeframe.

Counterparty methodology highlights

Materiality of counterparty risk: Scope proposes a clear and transparent analytical framework focused on the materiality of counterparty risks and the efficiency of structural remedies to those risks.

Remedies are seen in context. The methodology highlights how “one size fits all” is often inadequate to capture the complexity of counterparty risks. We differentiate between financial and operational exposures. Their risk mitigation has to be assessed in the context of each transaction. Analysts are asked to challenge whether proposed remedies can e.g. in a market context become provided as documented.

Credit risk replacement triggers drawing from post-crisis realities. Replacement trigger levels mark the minimum credit quality of a counterparty where Scope deems replacement to be early enough to shield a transaction from a counterparty’s credit risk. In order to establish these levels, we build on post-crisis realities, including the new regulatory and supervisory framework for banks – such as bail-in and stronger prudential metrics – and the resulting limited likelihood for banks to default in the short term.

Operational remedies can substitute credit-based triggers for nonfinancial counterparties. Other remedies including pre-arranged operational remedies or structural protections can also act as adequate risk mitigants.

Area of application: The methodology applies to structured finance transactions, covered bonds as well as other debt ratings that rely on structured finance techniques to be rated higher than the supporting counterparty.

Today’s implementation of the counterparty methodology will not have a rating impact on outstanding structured finance ratings.

For more information please download the ‘Rating Methodology for Counterparty Risk in Structured Finance Transactions’ published today. Scope has also today a summary of the feedback received during the ‘call for comment’ period “Feedback report: Counterparty Risk – Call for comments” .