EU Proposes Comprehensive Financial Reforms

by Ulrika Lomas, for LawAndTax-News.com, Brussels

09 June 2010

As part of its work aimed at preventing a future financial crisis and strengthening the financial system, the European Commission (EC) has put forward amendments to the European Union (EU) rules on credit rating agencies (CRAs), and launched a public consultation on reforming corporate governance in financial institutions.

On CRAs, the EC pointed out that it has two main objectives: ensuring efficient and centralized supervision at European level, and increased transparency on the entities requesting the ratings so that all agencies have access to the same information. These changes would improve supervision, increase competition in the CRA market and improve investor protection.

The Internal Market and Services Commissioner, Michel Barnier, said: "The changes to rules on CRAs will mean better supervision and increased transparency in this crucial sector. But they are only a first step. We are looking at this market in more detail.”

The EC has already established new EU-wide rules that put in place a common regulatory regime for the issuance of credit ratings. Under those rules, which will become fully applicable in December 2010, all CRAs that would like their credit ratings to be used in the EU now need to apply for registration. CRAs will also have to be more transparent as they will need to disclose the methodology and internal models and key rating assumptions they use to make their ratings.

However, as rating services are not linked to a particular territory and the ratings issued by a CRA can be used by financial institutions all around Europe, the EC is now proposing a more centralized system for supervision of CRAs at EU level. Under the proposed changes,a  new European supervisory authority – the European Securities and Markets Authority – would be entrusted with exclusive supervision powers over CRAs registered in the EU. This would include also the European subsidiaries of well-known CRAs such as Fitch, Moody's and Standard & Poor's.

It would have powers to request information, to launch investigations, and to perform on-site inspections. Issuers of structured finance instruments such as credit institutions, banks and investment firms will also have to provide all other interested CRAs with access to the information they give to their own CRA, in order to enable them to issue unsolicited ratings.

In the EC’s opinion, these changes mean that CRAs would operate in a much simpler supervisory environment than the existing varied national environments and would have easier access to the information they need. Users of ratings would also be better protected as a result of centralized EU supervision of all CRAs and increased competition among CRAs.

The EC's proposal will now pass to the EU Council of Ministers and the European Parliament for consideration. If adopted, the new rules would be expected to come into force during 2011.

With regard to the reform of corporate governance in financial institutions, the EC says that it has committed itself to its improvement. The EC wants to ensure that the interests of consumers and other stakeholders are better taken into account, businesses are managed in a more sustainable way and bankruptcy risks are reduced in the longer term. It is, therefore, as a first step, now launching a public consultation that details possible ways forward.

That consultation will deal with: improvements to the functioning and composition of the boards of financial institutions in order to enhance the supervision of senior management; the establishment of a risk culture at all levels of a financial institution in order to ensure that the long-term interests of the business are taken into account; enhanced involvement of shareholders, financial supervisors and external auditors in corporate governance matters; and the changing of remuneration policies in order to discourage excessive risk taking.

The consultation is open until September 1, 2010. Any future legislative or non-legislative proposals would be adopted in the course of 2011.

However, the EC has been convinced by recent market turbulence that there is a need to move swiftly in completing necessary reforms to ensure a safe and sound European financial system. It has, therefore, also committed itself to table the remaining financial reform proposals needed to implement fully its G-20 commitments in the next six to nine months from now.

Those key proposals include proposals to improve transparency in the derivatives markets. In order to restore further confidence in financial markets, the EC will propose appropriate measures on short selling and credit default swaps, including 'naked short-selling'. The Commission will also table improvements in order to strengthen pre- and post-trade market transparency and bring more derivatives onto organized trading venues.

Furthermore, in order to better protect investors and depositors, the EC will propose a revision of the Deposit Guarantee Schemes Directive and the Investor Compensation Schemes Directive. Also, legislative proposals on packaged retail investment products will be presented to promote consumers' interests in the sales process. The Market Abuse Directive will also be revised in order to extend its rules beyond regulated markets and to include derivatives in its scope of application.

The EC will, in addition, come forward with amendments to the Capital Requirements Directive to improve the quality and quantity of capital held by banks, introduce capital buffers and ensure the build up of capital in good times which may be drawn on in more adverse economic conditions. The EC will also work towards global convergence on one set of high quality international accounting standards.

The EC’s President, José Manuel Barroso, said: "The Commission is launching the final push to complete the EU's financial services reform. This is part of our wider agenda to stabilize, consolidate and restore sustainable growth to the European economy".

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