EU Consults Further On Credit Rating Agencies

by Ulrika Lomas, LawAndTax-News.com, Brussels

10 November 2010

As part of its work on improving the region’s financial system, the European Commission (EC) has launched a further consultation on the role of credit rating agencies (CRAs) and their impact on financial markets.

On December 7, 2010, a new European Union (EU) regulatory framework for CRAs will come into force. New rules will require CRAs that would like their credit ratings to be used in the EU to apply for registration. They will need to comply with rules of conduct in order to minimize potential for conflicts of interest and ensure higher quality ratings, and will have to be more transparent as they will need to disclose the methodology, internal models and key assumptions they use to make their ratings.

However, in addition to those new rules, the EC now says that, “whilst credit rating agencies are important actors in the financial markets, recent developments during the euro debt crisis have shown that there may be a need to re-examine certain aspects of the current regulatory framework. There are growing concerns that financial institutions and institutional investors may be relying too much on external ratings and do not carry out sufficient internal credit risk assessments, which may lead to volatile markets and instability of the financial system.”

The purpose of a new round of consultation is therefore to open up a wider debate to obtain opinions on possible future CRA legislation. The deadline for replies is January 7, 2011, and the EC will then decide on the need for any additional measures.

Internal Market and Services Commissioner, Michel Barnier, said: "We need to learn all the lessons of the crisis. We have already introduced EU-wide rules for better supervision and increased transparency in the credit rating market. This was an important first step. But we need to think about step two: the role of ratings themselves and the impact they can have on markets."

The consultation the EC has launched asks a series of questions, including whether the recent euro debt crisis indicated that financial institutions and institutional investors may be relying too much on external credit ratings. The EC asks which measures could reduce this possible over-reliance and increase disclosure by issuers of structured finance instruments in order to allow investors to carry out their own additional due diligence on a well-informed basis.

Further, it is considering if further measures should be applied to sovereign debt ratings, which play a crucial role for the rated countries. Such measures could be introduced to improve transparency, monitoring, methodology and the process of sovereign debt ratings in EU.

It also reflects on competition within the CRA sector, which is made up of only a handful of big firms and where there are high barriers to entry. Concerns have been expressed, it says, that the rating of large multinationals and structured finance products is concentrated in the hands of only a few CRAs, and that this lack of competition could negatively impact the quality of credit ratings. The EC therefore asks what options exist to increase diversity in the sector.

Furthermore, the EC wants to look at whether and under which conditions civil liability claims by investors against CRAs are possible. The applicability of such claims currently vary greatly between member states, and it is possible that these differences could result in CRAs or issuers shopping around, choosing jurisdictions under which civil liability is less likely. The EC therefore asks whether there is a need to consider introducing a civil liability regime in the EU regulatory framework for CRAs.

Finally, it reflects on whether the "issuer-pays" model raises questions of conflict of interest. As rating agencies thereby have a financial interest in generating business from the issuers that seek the rating, this could lead to assigning higher ratings than warranted in order to encourage the issuer to more business with them in the future. It could also lead to practices of "rating shopping" – when an issuer chooses a CRA on the basis of its likely rating. The EC asks what evidence there is for such practices and whether alternative models would be possible.

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