We rarely assess subsidiaries as inherently stronger from a stand-alone credit perspective than their parent group. With fewer than 100 cases globally in financial services (FS), this scarcity reflects our assessment that subsidiaries typically draw support and strength from, or are exposed to the performance of, their broader groups. This indicates the typical strong financial and operational interlinkages and the ability of parent undertakings to control the subsidiary's strategy and financial policy. In addition, the benefits of a group's scale and diversification, as well as its access to deeper and fungible pools of capital and liquid resources, mean that subsidiaries tend to derive credit strengths or support from being part of a broader group, not the other way around.

However, we believe that a combination of operational independence and strong regulatory and governance frameworks can insulate the creditworthiness of a subsidiary to various extents from that of the rest of the group, particularly in the case of cross-sector and/or cross-region groups.

In this Credit FAQ, S&P Global Ratings discusses observed rating outcomes and analytical considerations when we assess FS subsidiaries and subgroups to be not only intrinsically stronger, from a credit perspective, than their broader group, but also likely to be less influenced by parental stress. In this respect, our ratings on these issuers reflect characteristics contained within our Group Rating Methodology (GRM or the methodology), published July 1, 2019, and associated guidance. For brevity we refer to "subsidiaries", but the methodology, guidance, and analytical considerations described below apply equally to subgroups within a larger group.

The methodology offers two routes to assign a higher credit rating to a subsidiary than the parent group credit profile (GCP; our view of the creditworthiness of the broader group):

• "Insulation" where we cap the rating one, two, or three notches above the GCP or can even delink the ratings from those on the parent (see paragraphs 65-69 of the GRM). This assessment focuses on two aspects--financial/operational separateness, and constraints on parental control; or
• Recognition of the potential for external support, based on the systemic importance of a financial institution (FI), that would reinforce the FI's own creditworthiness and limit the extent of negative influence from its parent (see paragraph 70 of GRM for more details). There is no explicit cap on the possible differential between the subsidiary's issuer credit rating (ICR) and the parent GCP, although in practice the gap tends to be modest.

S&P Global Ratings rates more than 1,500 financial services groups globally and has assigned issuer credit ratings to many more legal entities. Among them, we currently assess only about 50 subsidiaries to be insulated, in addition to which we would rate about one-third that number above the GCP (under paragraph 70 of the GRM). If a subsidiary is classified as insulated under paragraphs 65-69 then it is eligible to be rated either one, two, or three notches above the GCP (or de-linked in some cases). The rating will still be constrained, though, by the subsidiary's stand-alone creditworthiness (as reflected in the SACP). In some cases, we might therefore not rate the subsidiary higher than the GCP despite its insulation, but its insulated status could be relevant to our outlook on the subsidiary.

See the tables at the end of this report for examples of financial institution and insurance subsidiaries that we currently, or could in future, rate above the parent under either of the routes described above.

Frequently Asked Questions

Why is it relatively rare that S&P Global Ratings rates subsidiaries higher than the parent operating entity?

We don't have any mechanistic limits on how often we can rate a subsidiary higher than other members of its group. There are three key reasons why a subsidiary tends not to have stronger creditworthiness than its group.

First, we rarely assess subsidiaries as inherently stronger from a stand-alone credit perspective than their parent group. Generally, the benefits of scale and diversification for a group, the access to deeper and fungible pools of capital and liquid resources, and brand name mean that subsidiaries tend to derive credit strengths or support from being part of a broader group, not the other way around.

Second, it's rare that subsidiaries are sufficiently separated from their parent operationally, financially, or in terms of control and governance, that we would see them as insulated. Rather, these linkages mean that financial stress within the group would tend to constrain the creditworthiness of group entities. This is notable because:

• The group could transfer assets from one group entity to another during financial stress, contributing to credit stress at other group entities;
• The distress at the group could trigger business or financial difficulties for the group member, such as reputational damage and a consequent loss of business;
• The group member might rely on operational support from the group on an ongoing basis; and
• In some jurisdictions, a bankruptcy petition by one group entity could include other group entities or cause them to go into bankruptcy or similar measures.

Finally, we may assess a subsidiary to be insulated under two sets of features: (i) based on structural features that mean we can rate it above the parent even when stress is remote; or (ii) based on a combination of some structural features and observed or anticipated behavior (by the parent, directors, or regulators) that are likely to enhance the resilience of the subsidiary but may only be sufficiently predictable in an emerging stress scenario. Most surveilled groups are not under such stress so we rarely factor this set of potential behaviors into our ratings.

What types of FS businesses lend themselves to insulation in practice? What trends do you see in the rating outcomes?

Of the roughly 50 FS "insulated" subsidiaries we rate: 60% are in the insurance sector and 40% are financial institutions. Of these, half have FS sector parents and half nonfinancial corporate parents. For two-thirds of them, their ICR is differentiated from the GCP by at most two notches, and almost all these subsidiaries are subject to meaningful prudential regulation (see charts 1 and 2).

Chart 1

Chart 2

The FI subsidiaries that we rate above the GCP (based on paragraph 70) are all licensed banks. In most cases, the ICR is above the GCP not because we see the subsidiary as inherently stronger than the group but rather because we expect that extraordinary government support would accrue only to the bank, not to the wider group, and would limit the impact of extraordinary negative group intervention.

While these entities share some common features and all reflect the principles in our criteria, we note that insulated entities and groups in our rated universe are also rather idiosyncratic in their specifics, such as group structure, governance and oversight structures, and different financial and operational linkages. Insulation therefore remains a case-by case, qualitative assessment that considers the specific features at play.

It is notable that we rate very few bank subsidiaries above a bank parent, even if they are in different jurisdictions. This reflects the analytical reasons that we describe in the previous section, but notably the highly confidence-sensitive nature of banks, the groupwide branding that international banking groups tend to employ, and the funding and liquidity linkages that usually exist between the parent bank and its subsidiaries. These factors tend to reinforce the impact of the parent bank's performance and credit quality of its subsidiaries.

In the insurance sector, insulated subsidiaries are often insurers owned by corporate groups. Typically, prudential insurance regulation safeguards capital within the insurance group for insurance policyholders. Thus, any capital upstreaming involves regulatory oversight and approval, and the stand-alone creditworthiness of the regulated insurance subsidiary can often be stronger than that of the unregulated corporate parent. Fungibility of capital within insurance groups is sometimes much higher than in cross-sector groups. For example, we observe that insurance groups that are subject to group supervision may pool capital and cash at the group level so that they are available to be invested in subsidiaries if needed.

What are the analytical considerations around assessing constraints on parental control?

In our GRM, we identify a series of increasingly demanding characteristics that can lead to a one-notch differential above the GCP to a complete delinkage from the GCP (see paragraphs 65-68). We classify entities along a spectrum from operational separateness, to limited group control, to structural safeguards, to an effective loss of group control (sometimes resulting from a parental deep stress scenario). Notably, paragraphs 66-68 focus on identifying impediments or constraints on parental control, covering influences such as:

• Regulation (whether prudential or based on stock exchange requirements or other regulations);
• The legal and practical influence of independent non-executive directors (iNEDs);
• Trust structures;
• Shareholder agreements that give expanded rights to minority interest (MI) shareholders; or
• Government/policymaker intervention.

Generally, the maximum notching differential, versus the GCP, increases as the constraints on parental control strengthen. For example:

• iNEDs and MI shareholders: Paragraph 66 looks for the existence of MI and independently minded NEDs who behaviorally can modify the influence of the parent where it could undermine the strength of the subsidiary. Paragraph 67 looks for something stronger than this--such as MI shareholders and iNEDs or a trustee potentially being able to block or reject parental demands. This might be because their rights are codified (e.g., in a shareholder agreement or stock exchange rules), or they have a majority of Board votes; or
• Government intervention: Paragraph 67 refers to the authority and willingness to strip ownership from the parent. A regulator could also do this (e.g., by threatening to remove recognition of the parent as a fit and proper owner).

In short, paragraph 66 looks mainly on expected or observed behavior. To be able to rate the subsidiary more than one notch above the SACP, as in paragraph 67, we look for something more substantial, possibly codified. Paragraph 68(a) anticipates that the parent is no longer effectively a parent in that it no longer has de facto control, even though it is still formally the economic owner.

We observe that trust structures are unusual, as are government interventions and regulatory prohibition that would effectively separate the subsidiary from its parent. Outside of situations where a parent is under substantial financial stress, the higher categories of insulation tend to be supported by a combination of features and not just by the potential for such intervention.

Is there a potential feedback loop to the GCP if the subsidiary is insulated?

The extent of insulation varies and can extend to complete protection from events at the broader group. But there are also situations where this has implications for the broader group, and we recognize influences that could sustain the creditworthiness of the subsidiary, though these can undermine the creditworthiness of the parent group. For example, they may imply ringfenced or trapped capital or liquidity resources at the insulated subsidiary, and/or constrained ability of management to influence or direct parts of the group's operations. This is particularly true where insulation moves beyond operational separateness (up to one notch of insulation), toward stronger constraints such as matters of constrained control (up to two notches of insulation) and structural safeguards (up to three notches of insulation).

In paragraphs 27 and 28 of the GRM, we recognize this feedback loop of insulation to the GCP. We can recognize many of these constraints and impediments in our consolidated analysis of the group stand-alone credit profile (group SACP), as our methodologies envisage assessments that blend quantitative metrics and a qualitative overlay. However, where we determine that the consolidation of an insulated group member does not adequately capture the impact on the group SACP of any material restrictions on cash flows or financial resources within the group, we either:

• Adjust the group SACP down (typically by one or two notches); or
• Treat an insulated group member as an equity affiliate and reflect this deconsolidated approach in determining the group SACP.

In practice, we observe that there are already structural features in the way we undertake our quantitative analysis for cross-sector groups that can deconsolidate the subsidiaries or acknowledge restricted transfer of cash flows. For example:

• For corporate groups, FS subsidiaries are deconsolidated for financial risk profile assessment purposes;
• For FI groups, insurance subsidiaries are deconsolidated for liquidity/funding analysis and for risk-adjusted capital analysis, except that insurance over/undercapitalization may be captured in certain cases;
• For insurance groups, FI subsidiaries are deconsolidated for insurance capital analysis (subject to adjustments for over/under capitalization), and also for liquidity analysis; and
• The blended GCP analysis that we carry out for some mixed groups, such as some bancassurance groups, acknowledges potential barriers, i.e., it is not simply a weighted average of its component parts (see paragraph 22 of the GRM for more details).

We occasionally fully deconsolidate a subsidiary in our GCP analysis, whether for a cross-sector group or even a group where the subsidiary is in the same sector as the parent, but this is typically when the insulation factors can constrain movement of resources and these factors are particularly strong. In these cases, deconsolidation also depends on the quality of financial disclosure. More frequently, we don't deconsolidate but rather apply an additional analytical overlay that recognizes the constraints on resource movements. For example:

• We can make a qualitative adjustment to the capital and earnings assessment under our insurance and financial institutions methodologies; and/or
• We may set tighter than normal tolerance thresholds for key consolidated ratios.

In what ways can potential external support for FI subsidiaries reinforce their creditworthiness and limit the potential negative influence of the parent?

We address this type of situation in paragraph 70 of the GRM. While there is no explicit cap on the possible differential between the subsidiary's ICR and the GCP, in practice the gap tends to be modest. This is because:

• We see very few of these subsidiaries as intrinsically stronger than their parent, not least because parental influence is typically moderated but not negated; and
• We recognize only a limited number of support notches in an FI rating based on potential extraordinary support from a government or resolution action that could be facilitated by additional loss-absorbing capacity (ALAC) resources.

Nevertheless, we see these sources of support as a potential benefit to the creditworthiness of the subsidiary.

For banks where we uplift the ratings based on potential extraordinary government support, some of the influences are likely to be present even without the parent being under stress--not least due to strong regulatory oversight that could be more demanding than is normal for smaller banking groups. In a parental stress scenario, this oversight could become more interventionist in nature to avoid a risk to the systemic bank subsidiary and so to financial stability.

For FI groups where we apply ALAC uplift, most of them are targeted for a single point of entry (SPE) resolution. As a result, many of their rated bank subsidiaries would likely benefit from a resolution action on the parent thanks to the "prepositioning" of recapitalization resources at the subsidiary (or a similar mechanism) and related resolution planning that seeks to ensure operational continuity of critical banking operations across the group. In this scenario, the subsidiary becomes financially dependent on the parent (for recapitalization resources, which may also be a funding source), and is also likely to be quite operationally dependent. The parent retains a strong controlling influence before and after such a resolution action.

However, there are some circumstances that align with our approach outlined in paragraph 70, such as where systemic banks are owned by nonbanks, or else expected to be resolved using the multiple point of resolution (MPE) concept (see "Multiple Point Of Entry Resolution: Analytical Considerations For Groups Designed To Fragment In Crisis," published Aug. 11, 2022). Here, resolvability preparations should enable a separate resolution action on the subsidiary that would recapitalize it and allow it to continue to operate, irrespective of what happens to the parent. In this scenario, the subsidiary is likely to have limited or no financial or funding dependence on the parent or group affiliates, limited or no operational dependence, and at the point of failure the parent is likely to lose economic control. These circumstances can strengthen the resilience of the subsidiary both in the event of stress at the parent level and even beforehand by building structural protections based on the additional regulatory considerations that the subsidiary has to address.

Related Criteria

• Group Rating Methodology, July 1, 2019

Annex

Table 1

Table 2

Table 3