The European Commission has welcomed the respective approvals from the European Parliament and from the Council on the proposed Regulation on credit rating agencies (CRAs). The Regulation will have a major impact on the activity of credit rating agencies, which issue opinions on creditworthiness of companies, governments and sophisticated financial structures. Credit rating agencies will be expected to comply with strict standards of integrity, quality and transparency and will be subject to ongoing supervision of public authorities. Users of credit ratings in the EU will be in a better position to decide if the opinions of a specific credit rating agency are trustworthy and to what extent those opinions should impact their investment choices.
Commission president José Manuel Barroso said: "Today’s approvals of the Commission’s proposals on credit rating agencies are the latest example of the EU leading the world in responding to the economic and financial crisis, restoring confidence and preventing a repeat. Our G20 partners agreed in London to move in the same direction the EU has taken today. The Regulation will help give investors the information, integrity and impartiality they need from credit rating agencies if they are to make prudent investment decisions that create growth and jobs instead of bubbles of excessive risk."
Internal Market and Services Commissioner Charlie McCreevy said: “The Commission has long insisted that profound changes were necessary to the framework in which the credit rating industry operates. With this Regulation, the EU is setting an example to be followed and matched. Today we are satisfied that as a result of intense cooperation between the European Parliament, the Council and the Commission this state-of-the-art regulatory regime has been adopted swiftly. We expect the conduct of the credit rating agencies to be significantly improved as a result of this Regulation, with clear benefits to the integrity and stability of the financial markets.”
This directly applicable Regulation puts in place a common regulatory regime for the issuance of credit ratings thus responding to the need for restoring market confidence and increasing investor protection.
As a rule, all credit rating agencies that would like their credit ratings to be used in the EU will need to apply for registration. The applications will be submitted to the Committee of European Securities Regulators (CESR) and decided upon in a consensual manner by the relevant securities regulators grouped in a college. The college of regulators will also be involved in the day-to-day supervision of credit rating agencies.
Specific, albeit sufficiently exacting, treatment is envisaged and may be extended, on a case-by-case basis, to credit rating agencies operating exclusively from non-EU jurisdictions provided that their countries of origin have established regulatory and supervisory frameworks as stringent as the one now put in place in the EU.
Registered credit rating agencies will have to comply with rigorous rules to make sure (i) that ratings are not affected by conflicts of interest, (ii) that credit rating agencies remain vigilant on the quality of the rating methodology and the ratings, and (iii) that credit rating agencies act in a transparent manner. The Regulation also includes an effective surveillance regime whereby regulators will supervise credit rating agencies.
New rules include the following:
Credit rating agencies may not provide advisory services.
They will not be allowed to rate financial instruments if they do not have sufficient quality information to base their ratings on.
They must disclose the models, methodologies and key assumptions on which they base their ratings.
They must differentiate the ratings of more complex products by adding a specific symbol.
They will be obliged to publish an annual transparency report.
They will have to create an internal function to review the quality of their ratings.
They should have at least two independent directors on their boards whose remuneration cannot depend on the business performance of the rating agency. They will be appointed for a single term of office which can be no longer than five years. They can only be dismissed in case of professional misconduct. At least one of them should be an expert in securitisation and structured finance.
The new rules are largely based on the standards set in the International Organisation of Securities Commissions (IOSCO) code. The Regulation imposes rules which have a legally binding character.
Background
CRAs contributed significantly to the current problems in the financial markets. They clearly underestimated the risk that the issuers of certain more complicated financial instruments may not repay the debts. As they gave the highest possible ratings to many of those complex instruments, inexperienced investors felt encouraged to purchase them, even without assessing properly the risks. As market conditions were worsening, CRAs failed to reflect this promptly in their ratings. These failures by CRAs were combined with an imprudent approach of the investors. As a result, credit was granted even if it would not be justified by economic fundamentals.
In October 2007 EU Finance Ministers agreed to a set of conclusions on the crisis (the ‘Ecofin Roadmap’) which included a proposal to assess the role played by credit rating agencies and to address any relevant deficiencies. The European Councils of 20 June and 16 October 2008 called for a legislative proposal to strengthen the rules on credit rating agencies and their supervision at EU level, considering it a priority to restore confidence and proper functioning of the financial sector.
