ESMA highlights potential conflicts of interest risks in changes to Collateralised Loan Obligation rating methodologies

ESMA released a report on EU credit ratings for Collateralised Loan Obligations (CLOs), highlighting potential conflicts of interest risks observed in the dialogue between CRAs and market participants from 2017 to 2021. The focus is on the CLO methodology development and rating process of CRAs. The report emphasizes the influential role of arrangers, managers, and investors in the CLO market, and how their selection of a CRA is based on factors like methodology favorability, flexibility, and rating stability.
ESMA found that CRAs often participate in market outreach activities with these influential market participants, and there is a risk that methodologies may be unduly influenced by commercial feedback. Some instances of sharing non-analytical information, such as feedback on the commercial perception of a methodology, were deemed inappropriate by ESMA. The report emphasizes the importance of safeguarding and clearly communicating the boundaries of analytical outreach.
ESMA has informed CRAs of its findings and will develop individual remedial action plans to ensure appropriate controls are in place. The report also states that CRAs should have safeguards to ensure changes to methodologies are based on objective reasons and directs CRAs to make remediations where necessary.
ESMA will continue to monitor developments in CLO markets, including changes in credit ratings, rating practices, and methodologies. The publication is part of ESMA’s ongoing efforts to address potential conflicts of interest and maintain the accuracy, objectivity, and independence of credit ratings in the financial markets.