(Editor's notes: These criteria have been superseded by the article titled "Criteria | Financial Institutions | General: Group Methodology," published on April 22, 2009)

Standard & Poor's and Taiwan Ratings have developed criteria for assigning counterparty credit ratings to Taiwan financial holding companies (FHCs) in response to the Taiwan government's enactment of the Financial Holding Company Act in July 2001 and subsequent encouragement of the formation of FHCs. The FHC initiative is expected to lead to significant corporate reorganization in the broader financial services industry. Each FHC is likely to have two or more wholly owned subsidiaries involved in banking, insurance, securities, and other related activities. In general, FHCs are rated lower than their strongest subsidiary or subsidiaries because the creditors of each subsidiary legally have preferential access to that subsidiary's resources compared with creditors of the FHC. However, the extent to which this affects the rating of an FHC can vary depending on the credit quality, business mix, and number of subsidiaries under the holding company, and the nature of the ties between the FHC and its group companies. In cases where the default risk of an FHC is believed to be identical to that of its group subsidiaries, the ratings on the FHC may be equalized with those of its group companies.

The following is an attempt to summarize Standard & Poor's and Taiwan Ratings' current approach to rating FHCs in Taiwan. This approach may be revised to reflect changes in the market environment, particularly with regard to regulations and regulatory intent.

Rating FHCs
In rating an FHC, Standard & Poor's and Taiwan Ratings initially assign individual credit ratings, either on a public or confidential basis, to key subsidiaries and, when there is effective control and responsibility, associate companies of an FHC group. These ratings are based on each group member's existing credit profile, which excludes the impact of the FHC's existence.

Such existing ratings would be individually weighted depending on the rated subsidiary's credit standing within the overall group. To help determine each subsidiary company's importance, Standard & Poor's and Taiwan Ratings assess the following factors:
· Each company's normalized expected earnings; and
· The likely capital needs required to maintain capitalization at an adequate level (investment-grade level for insurance entities) under a normal stress scenario.

The obvious measures of assets and revenue are regarded as less appropriate given the differences in the nature of the operations of FHC subsidiaries, such as banks and insurance companies. Banks and life insurance companies are asset accumulators, and thus a weighting that employs an asset measure would unduly favor such entities over other types of group members, such as nonlife insurance companies.

Taking into consideration the weightings assigned to the ratings on individual companies, a notional rating is then assigned to the consolidated FHC group, which effectively treats group members as if they were divisions of a single entity rather than separate legal entities.

Notching down.
Because of the structural subordination of creditors of an FHC compared with those of its subsidiaries, the FHC rating must be lower than that of the notional group rating, except in exceptional cases. To reflect such structural subordination, Standard & Poor's and Taiwan Ratings would rate the FHC lower than the group rating by a degree that would depend on the group's mix of business activities. Where a group is predominantly engaged in banking and finance, the FHC rating assigned would be one rating notch below the notional group rating for investment-grade groups, and two notches for noninvestment-grade groups. In cases where a group's dominant activity is not banking and finance, or insurance, the FHC rating would be two notches below the notional group rating for investment-grade groups and three notches for noninvestment-grade groups. Finally, when a group's activities are predominantly insurance-related, the FHC rating would be three notches below the group rating. In instances where there is sufficient diversification of group earnings and both the FHC and the group are not aggressively leveraged, the difference may be narrowed by one notch.

Standard & Poor's and Taiwan Ratings' general practice for rating holding companies with a single operating subsidiary is to rate the holding company one notch below the rating on a bank operating subsidiary for investment-grade subsidiaries, and two notches for noninvestment-grade subsidiaries. If the operating subsidiary is an insurance company, the rating would likely fall a full category (i.e. three notches) below that of the subsidiary.

Rating FHC Group Members
The strengthened ties between group members under an FHC structure, compared with a non-FHC arrangement, imply some, although not necessarily total, fungibility of resources among group members. In many cases, this would lead to a convergence of the ratings on group members towards the group rating. Subject to the circumstances of each FHC group, Standard & Poor's and Taiwan Ratings would consider lowering the ratings on stronger group members and raising the ratings on weaker group members.