Commission out with two rating agency consultation papers

Two new papers aim to tackle supervision of credit rating agencies and industry’s excessive reliance on ratings

BRUSSELS – The European Commission has published two consultation documents on credit rating agencies (CRAs). The first relates to the conditions for the authorisation, operation and supervision of credit rating agencies. The second proposes policy options to tackle what is felt to be an excessive reliance on ratings in EU legislation.

Commissioner Charlie McCreevy said: “I have been listening to many advisory bodies to the Commission and watching developments in the industry and in other jurisdictions for the last year. I am convinced, like others in Europe of the need to legislate in this area at EU level. CRAs will have to comply with exacting regulatory requirements to make sure ratings are not tainted by the conflicts of interest inherent to the ratings business. The crisis has shown that self-regulation has not worked. I am also convinced that excessive reliance on ratings in EU legislation might have discouraged banks and other financial institutions from exercising their own due diligence. They should not be encouraged by law to rely solely on ratings for their risk assessment processes.”

Comments are requested by September 5, after which McCreevy will submit his proposals to the Commission for adoption this autumn.

It is generally accepted that the rating agencies underestimated the credit risk of structured credit products and failed to reflect early enough in their ratings the worsening of market conditions, thereby sharing a large responsibility for the current market turmoil. The Commission is convinced that the current crisis demonstrates that the existing framework for the operation of rating agencies in the EU (mostly based on the Iosco Code of Conduct for CRAs) needs to be significantly reinforced. The move to legislate in this area was recently welcomed by the Ecofin Council at its meeting in July.

The Commission was keen to point out that the documents aim at ensuring the highest professional standards for rating activities and do not intend to interfere with rating methodologies or rating decisions that will remain the sole responsibility of CRAs. The envisaged proposals also take account of existing standards and developments at international level. The US has had rules on CRAs since the mid-seventies, and is currently considering changes to them.

The consultation paper suggests the adoption of a set of rules introducing a number of substantive requirements that rating agencies will need to respect for the authorisation and exercise of their rating activity in the EU. The main objective of the Commission proposal is to ensure ratings are reliable and accurate pieces of information for investors. CRAs will be obliged to deal with conflicts of interest, have sound rating methodologies and increase the transparency of their rating activities.

The document also proposes two options for an efficient EU oversight of CRAs: the first is based on a reinforced co-ordination role for the Committee of European Securities Regulators (CESR) and strong regulatory co-operation between national regulators. The second option would combine the establishment of a European Agency (either CESR or a new agency) for the EU-wide registration of CRAs and the reliance on national regulators for the supervision of CRA activities.

The consultation document on reliance on ratings identifies the references made to ratings in existing EU legislation and looks at possible approaches to the issue of excessive reliance on ratings.

You can access the documents by clicking here