A European government authority required access to a credit assessment capability to enable tax officers to assess the credit scores of individual companies that are included in periodic reviews. The scores would be used to compare intercompany interest rates and guarantee fees with market rates, through which arm's length prices are determined. The arm's length principle requires two related companies to set the same transfer price for an intercompany transaction as if they were unaffiliated firms working in a competitive marketplace.

In February 2020, the OECD published the Transfer Pricing Guidance on Financial Transactions (“Guidance”) to clarify the application of the principles of the 2017 Guidance for corporate taxpayers, auditors and tax authorities. The transfer pricing group at this government authority needed to ensure that intercompany interest rates were in line with the guidance.

Pain Points

The transfer pricing group had to ensure that intercompany  loans were being appropriately priced and needed access to trusted data and analytical tools to evaluate potential credit risks and proposed interest rates.

The transfer pricing group was accessing data from a third-party provider, but needed more extensive information and a pricing tool that was in line with the Guidelines. In particular, team members wanted to be able to:

• Access detailed financial data on both public and private companies.
• Easily assess the creditworthiness of subsidiaries and affiliates considering:
  • Qualitative information, such as diversification and the quality of management.
  • The credit rating of the particular debt issuance.
  • The financial health of the parent company and whether the support expectation was positive, negative, or neutral.
• Benchmark peer organizations to conduct comparable analysis.
• Identify the associated market interest rate that subsidiaries or affiliates would pay if they borrowed independently in the market.

The group contacted S&P Global Market Intelligence (“Market Intelligence") to discuss relevant capabilities.

The Solution

Market Intelligence discussed its recently launched Credit Risk Pricing capability as part of Credit Analytics, on the S&P Capital IQ Pro platform, a streamlined tool to help fast-track the pricing of credit transactions. A four-step approach lets users easily assess a company's creditworthiness, create a stand-alone credit score,^[1] and find comparable yields and a defensible interest rate in a manner that aligns with the Guidelines.

Some of the underlying data and tools in Credit Risk Pricing:

How Credit Risk Pricing works:

Step 1: Input financial data for the subsidiary or affiliate

The analysis starts by leveraging Market Intelligence's comprehensive database of company financials to automatically create company credit scores in the credit scoring interface.

Alternatively, users can manually input their own proprietary financials. This section of the interface also provides risk factors by country and industry, to capture any country-industry combination being analyzed. These inputs can be adjusted if users have an alternative perspective.

Step 2: Input additional information as desired

Four areas are considered here that can positively or negatively impact the credit score that will be created:

Qualitative Factors: The Guidance suggests adding qualitative information, where available. For example, this could include how diversified a subsidiary is by country/product line/customer base, the quality of its management, and its payment behavior.

Parental & Government Support (PGS): The Guidance acknowledges that PGS can affect the creditworthiness of the borrower, and this feature factors in the financial health of the parent company.

Loss Given Default (LGD): The Guidance states that when both an issuer and issue rating^[3] are available, the issue rating is more appropriate to price the transaction. This can require looking at the LGD for the issuance and factoring that into the credit score. The solution features the LossStats approach, which returns loss and recovery estimates for companies’ debt obligations globally. It takes into account the seniority structure (i.e., senior secured, unsecured, subordinated loans, or the actual capital structure characteristic), including potential collateralizations and industry riskiness, which are factored into an LGD-adjusted credit score.

Macroeconomic Factors: The solution provides current data on a wide range of economic factors, and a stress-testing capability offers the opportunity to look at a range of situations to see how a positive or negative environment could impact credit risk.

Step 3: Click to generate a stand-alone credit score

Once the financials and optional adjustments have been entered, users simply click to generate a probability of default in percentage terms and the associated letter grade credit score, which are generated using Market Intelligence's Credit Analytics models. In addition, if information mentioned in Step 2 is entered, users will receive an LGD-adjusted credit score along with macroeconomic impacted values for the subsidiary or affiliate.

Step 4: Construct a yield curve and produce the final interest rate

The final credit score is utilized to determine the Comparable Uncontrolled Price (CUP), which is considered to be the most appropriate approach in the context of intercompany loans. S&P Capital IQ Corporate Bond Yield Curves are automatically used in this benchmarking exercise. For simplicity, the final interest rate is also generated alongside the credit score, so analyzing the underlying yield curves is optional.

Key Benefits

Members of the transfer pricing group saw many benefits to subscribing to the Market Intelligence offering, and are now relying on:

• A well-recognized information provider trusted by companies around the world.
• The robust Capital IQ Pro platform —a one-stop solution for essential intelligence, offering unrivaled data, tech-forward productivity tools, news, and research.
• S&P Global Ratings credit ratings and research delivered through RatingsDirect.
• A streamlined step-by-step approach to assess transfer prices that aligns with the OECD Guidelines and draws on time-tested data and models.
• A transparent approach to understand where the risk lies in a company's fundamentals, and where to focus attention for analysis.
• Similar transparency on the bond constituents, prices, and z-spreads used in the construction of each yield curve, as well as minimum/maximum ranges, average and median yields/spreads, and inter-quartile ranges.
• Rigorous benchmarking capabilities.
• Detailed user guides and technical documentation for the models, plus access to a 24x7 support group.
• Unrivalled support, including access to credit specialists and in-depth training sessions.

Click here for more information on some of data and tools discussed in this Case Study.