Following the recent downgrading of credit ratings for a number of financial institutions by Moody’s Investor Services, the Central Bank of Ireland (the “Central Bank“) has clarified its position regarding breaches of its minimum credit ratings requirements for prime brokers and other counterparties.
Guidance Note 2/11 “Professional collective investment schemes: Appointment of prime brokers and related issues” (the “Guidance Note”) provides that a prime broker, or its parent company, must have a minimum credit rating of A-1 (from Standard and Poor’s) or equivalent. In the event of a downgrade of a prime broker to A-2 or equivalent (but not lower), the Central Bank has indicated that it will permit the relationship with the prime broker to remain in place where net exposure of the fund to the prime broker is less than 40% of net asset value (or 20% / 30% in the event that the fund is a professional investor fund). This requirement will apply in addition to any existing contractual limits on re-hypothecation of fund assets by the prime broker.
Other OTC counterparties
The Guidance Note also provides that a non-UCITS fund may enter into collateral arrangements with OTC counterparties whereby assets of the fund are passed outside of the control of the trustee / custodian where such assets may be pledged, lent or re-hypothecated by the counterparty. Any such counterparty must have a minimum credit rating of A-2 (from Standard and Poor’s) or equivalent. Where such an existing OTC counterparty is downgraded to below A-2 or equivalent, the Central Bank has indicated that the fund must consider as a priority objective the remedying of the situation, taking into account the best interests of unitholders. Where the fund determines to maintain an existing position with such a counterparty it must continue to actively monitor the creditworthiness of the counterparty by conducting internal rating assessments and must inform the Central Bank of any breach and the proposed remediation plan.
Investment funds entering into new OTC derivative transactions, efficient portfolio management techniques or prime brokerage arrangements must adhere to the rating requirements in the Central Bank’s Notices and Guidance Notes and so may not enter into an arrangement with entities rated below the relevant thresholds.