Rating agencies face new Brussels probe

The European Commission has unveiled plans to conduct a review into the involvement of the rating agencies in the summer turmoil, but market participants sense some bandwagon-jumping

The European Commission is to investigate the US credit rating agencies in light of the volatility sparked this summer by the US subprime mortgage market's nosedive. The Commission's response to the crisis came on the same day that French president Nicholas Sarkozy wrote to Angela Merkel, German chancellor and currently head of the Group of Eight industrial nations, about the turmoil in the credit markets. In the letter, he questioned the "exact role" of the rating agencies in identifying risk.

An annual review of the agencies conducted by the Committee of European Securities Regulators examines the industry. This year the CESR review is looking specifically at structured finance ratings, and is expected to conclude in April next year. The Commission is also looking at the agencies and how they comply with a code of conduct devised by the International Organisation of Securities Commissioners (Iosco) in the wake of the Enron collapse in 2001 to help them negotiate conflicts of interest.

"It's not clear if this is part of the CESR review or something else entirely," says an analyst at an investment bank in London. "The language being used by the Commission is certainly quite strong and clearly inspired by this summer's events. It looks to me like the Commission has identified a bandwagon to boost its profile and is looking for a scapegoat. The rating agencies came in for the same kind of flak after Enron and WorldCom."

'Intensive review'

According to a Commission spokesman, the body is planning "an intensive review of credit rating agencies". This, he says, "will be conducted in parallel with - and will be part of - the CESR report on the industry and the review of the Iosco code".

The new review will encompass topics including governance, the management of conflicts of interest and the way agencies are resourced. It will focus in particular on segments of the securitised mortgage asset and subprime market.

"The Commission regards a review as necessary in light of widespread questions about the accuracy of some ratings," says the spokesman. "Also of concern is the credit rating agencies' timing of placing relevant securitisation issues on watch, taking into consideration the material market evidence of deterioration in the US subprime market since mid-2006." Another source at the Commission has been widely quoted as saying that legislation is not being ruled out.

A spokesman for Standard & Poor's simply confirmed that the company was participating fully in the CESR review, while his counterpart at Moody's said his agency is subject to regulatory oversight from authorities in all of the markets in which it has a presence, and is committed to constructive dialogue.

"Whatever the agencies say, the way the Commission has seized on subprime and issued statements is not positive for them," says the London-based analyst. "It does rather invite the question, 'why not just wait for the people working on the current study to report their findings?'"

The EC would not comment on what kind of recommendations it might make, nor how they might be enforced in the wake of the review, but many in the market questioned the usefulness of its intervention. A debate is already being conducted within the markets about the agencies' culpability for this summer's events.

"The Commission's report has to be seen against the very significant problems in the market at the moment," says Harald Berlinicke, senior portfolio manager at New Bond Street Asset Management in London. "The blaming has started, and it is clear that the agencies do carry part of the responsibility: they were too close to arrangers and the fees generated by the collateralised debt obligation business.

"Whether the Commission's intervention is positive is harder to judge. The market has a lot of news to digest, and this could just be additional noise. Whatever the findings of this investigation, it will not change the way people in the markets work: the Commission does not have the relevance to change things that way."

Another buy-side source was more blunt: "This is none of the Commission's business. Nothing it says can add anything to the debate about the rating agencies we are already having in the markets."

See also feature on p. 40

Matthew Attwood.