Brussels, 12/11/2008 (Agence Europe) - On Wednesday 12 November, the European Commission submitted a draft regulation for introducing a Community registration system for Credit Rating Agencies (CRA). This goes even further than the International Organisation of Securities Commissions (IOSCO), this legislative initiative imposes strict rules on: tackling potential conflicts on interest that arising from the credit agency models and the quality and transparency of ratings given. The question of CRA supervision is also tackled and includes the possibility of sanctions, central role to the (CESR). The Council and EP will attempt to reach an agreement in codecision by March in view of applying the rules by autumn 2009. The commissioner in charge of the internal market, Charlie McCreevy said, “Having considered the matter carefully - and taking account of the difficulty in getting all of the major CRAs to "step up to the plate" with adequate self regulatory proposals - I decided it was necessary to move forward with the preparation of this legislative proposal”. He added that, “the proposal is in my view well balanced - it ensures the analytical independence of credit rating agencies while at the same time ensuring that they are subject to effective oversight to ensure that professional standards are applied, agreed procedures and policies are enforced to ensure that the integrity of the rating process is upheld and that conflicts of interest are adequately managed and mitigated”. He said that it would be unfair for the agencies to bear all responsibility for the financial crisis. The draft regulation is part of a range of measures: approximation of banks' own funds, rise in deposit guarantee threshold, modification to accounting rules etc. for strengthening the stability of the financial system. The Commissioner did say, however, that the CRA had an undeniable de facto role in investor decision making, who are no longer making sufficient risk assessment. McCreevy said that the CRA were doing their work for them and they were only expressing an opinion on the probability of a rated entity not being able to repay its debts. He pointed out that the essential factor for rating agencies was its “reputation” and affirmed that new rules would enable the CRA to inform investors that they are suitably regulated.
Conflicts of interest. Rating agencies are generally paid by the financial players using their services to rate the products they issue. This model can generate conflicts of interest that may compromise the objective character of the rating agency. The draft regulation aims to make agencies minimise these conflicts of interest and manage them efficiently if they arise. Commercial and rating activities will be strictly separated: an employee participating in a rating will not be able to negotiate the price of a rating and his pay will not depend on the volume of the rating made. A rating cannot be issued (or will have to be withdrawn) when an agency analyst has financial assets in the entity rated. Providing consultancy services to a company will also be banned. McCreevy explained, “We have included strong corporate governance rules which exist nowhere else in the world to deal with the conflicts inherent in the issuer countries' model”: the management committee of a rating agency should include at least three independent members whose specific task will be to guarantee the quality of the internal inspection system and will be appointed for a single mandate not exceeding five years. CRA will be obliged to publish the identity of financial actors form who they receive more than 5% of their annual income.
Quality and transparency. The regulation aims to improve rating quality. CRA will have to ensure that they systematically use all information they have and take measures to say whether the quality of information and sources used are sufficiently high. If the information available is insufficient, they will not be allowed to rate the products in question. CRA will be obliged to communicate the methods used to help increase transparency. In the event of changes to methodology, they will proceed to a re-assessment of ratings made with a maximum deadline of six months. Finally, the presentation of ratings will have to include” a certain number of elements (ex: methodology, explanation of risk linked to analysis, extent of information provided by the company rated) without, however, creating a single presentation standard. CRA will produce a transparency report every year.
Supervision. Rating agencies which want to do business in the EU will have to establish and register in at least one member state. Once established, they will have to submit an application for authorisation to the CESR, which, the Commission says is best placed to provide a one-stop shop for requests and a national regulators' central information and coordination point. The supervision authority of the member state in which an agency has its legal headquarters will be responsible for deciding whether or not to grant authorisation, on which the ESRC will provide a non-binding opinion. Registration could be withdrawn if no ratings have been issued in the previous six months or in the event of an infringement of European law. Member states will also be able to set up a sanctions scheme. In addition to the three US agencies which dominate the market (Moody's, Standard & Poor's, and Fitch), the Commission is making provision for the registration of five others from five member states (Cyprus, Poland, Portugal, the United Kingdom, and Slovakia), and perhaps a sixth which is being formed in France. The future regulation also aims to encourage the arrival of new entrants onto the market.
Under no circumstances should supervision by competent authorities interfere with the content of ratings. Supervision will relate to compliance with the rules on the internal organisation of the agencies, methodology and the presentation used for ratings. The competent authority of the country where the agency is established will have first responsibility for day-to-day supervision. Cooperation mechanisms between national supervisors are also planned for information exchange and consultation, with the CESR playing the role of mediator. If necessary, information may also be exchanged with third country authorities. (M.B./transl.rh/rt)