01.17.2013
By Terry Flanagan

Brussels Agrees Crackdown on Credit Rating Agencies

The European parliament has agreed new rules aimed at tightening regulation of credit rating agencies.

Earlier this week, MEPs agreed a compromise text which is aimed at preventing conflicts of interest, increasing competition and reducing the reliance of businesses and governments on credit ratings.

“We are making progress with this new regulation: having a ban on ratings which could influence policies carried out by governments, more transparency and accountability regarding the methodologies used for ratings,” said Leonardo Domenici, an Italian center-left MEP who is the designated rapporteur for the regulation.

Credit rating agencies have been under fire since the financial crisis for attributing triple-A ratings to U.S. sub-prime mortgages that were, in effect, only junk status, as well as giving banks overly-generous ratings following the onset of the financial crisis.

They have also been accused of creating speculation around the break-up of the euro in January 2012 when a series of downgrades on nine eurozone nations sent markets into a frenzy.

The three main agencies—Standard and Poor’s, Moody’s and Fitch—currently rate 95% of the world’s bonds but MEPs want to see this figure reduced and that, in the future, financial institutions must not be obliged to sell assets in the event of a downgrade.

“The new rules aim at reducing the dominance of the big three credit rating agencies Standard and Poor’s, Moody’s Investor Services and Fitch Ratings who account for 95% of the world market, by injecting much needed competition into the market,” said Arlene McCarthy, a left-of-center U.K. MEP who is also vice-chair of the European parliament’s influential Economics and Monetary Affairs Committee.

From 2014, when the new rules come in, credit rating agencies will only be able to issue unsolicited sovereign debt ratings on set dates and private investors will have the ability to sue them for negligence. Agencies’ shareholdings in firms will also be capped to avoid conflicts of interest.

Financial instruments will also need to be rated by at least two agencies from 2014 and MEPs are also forcing the ratings agencies to provide clear guidance as to how they derived their assumptions, as well as ask firms in general to develop their own internal ratings capabilities, all in a bid to reduce the reliance of rating agencies.

“Credit rating agencies will have to be more transparent when rating sovereign states and will have to follow stricter rules which will make them more accountable for mistakes in case of negligence or intent,” said Michel Barnier, the European Union’s financial services commissioner.

“The new rules will contribute to increased competition in the rating industry dominated by a few market players. Furthermore, the new rules will reduce the over-reliance on ratings by financial market participants, eradicate conflicts of interest and establish a civil liability regime. This matters because ratings have a direct impact on the financial markets and the wider economy and thus on the prosperity of European citizens.”

However, the new rules will mean that issuers will still pay the bills and get to pick which agency rates their debt, and stripping credit ratings of their central role in financial regulation is proving complicated. And a proposal to set up a new public European rating agency, as a counterbalance to the ‘big three’, was abandoned due to the potential costs involved in setting up the agency.

The European Union Council of Ministers has already provisionally approved the measures.

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