Credit rating agencies under scrutiny again

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BRUSSELS – the Committee of European Securities Regulators (CESR) held more talks with the European Union’s internal markets commissioner, Charlie McCreevy, on September 11. The CESR’s 2006 questionnaire of credit rating agencies and the recent subprime mortgage crisis have placed the agencies’ conduct and role under increased scrutiny. McCreevy has asked the CESR to further analyse the process that agencies use to rate structured finance products.

The CESR has been asked to consider a number of conflict-of-interest issues revealed by the 2006 report. The report suggests that interaction and negotiation between rating analysts and arrangers in the design of structured financial products presents an obvious conflict of interest. The independence of the rating process is further compromised by issuers’ payment for ratings. So the CESR is assessing the agencies’ adherence to the Iosco Code of Conduct Fundamentals for Credit Rating Agencies and the effectiveness of the code in addressing conflicts of interest in securitisation and structured credit.

The transparency of the methodologies employed to produce the agencies’ credit ratings is also under scrutiny. This particularly concerns the assumptions by which the methodologies operate, whether they can be improved, and whether investors are sufficiently warned of their limitations. Provisions were discussed for the publication of reviews for all structured finance ratings.

Also under analysis is the agencies’ ability to keep pace with the rapid evolution of the complex structured finance market and the growth of securitisation issues over the past decade. The quality, status and timing of rating decisions are also being reviewed.

McCreevy has asked the CESR to consult the US Securities & Exchange Commission in addition to its meeting with the credit rating agencies at the beginning of October. He has also requested the CESR’s preliminary views and policy advice on these points before the release of its 2008 annual report in April of the role of agencies and their compliance with the Iosco Code.

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