So far, rating agencies in Europe have been subject to loose self-regulation, which according to the Commission "broadly failed". After several announcements (EurActiv 17/07/08), Brussels thus yesterday proposed a set of immediately-applicable rules aimed at closely monitoring rating agencies and avoiding conflicts of interest. "I think credit rating agencies have led a charmed existence," said Internal Market commissioner Charlie McCreevy during a conference in Brussels.
With the new regulation in place, credit rating companies will be forced to register in a central European database, established by the Committee of European Securities Regulators (CESR), which brings together national authorities. The database will gather historical performance information about rating agencies operating in the EU, allowing users of their services - such as investors - to quickly verify the accuracy of their economic predictions and compare them with competitors.
Until now, it has been not easy to judge the validity of past ratings. This system should instead increase the interest of agencies in properly assessing the debt of their clients so as "not to stay behind their competitors".
Conflict of interest
Potential conflicts of interest are also dealt with at first hand by the Commission. Brussels requested credit rating agencies to abide by a range of new rules, among which an obligation to disclose the names of rated companies that contribute to more than 5% of an agency's revenue. This is to prevent biased ratings driven by financial interest.
Rating agencies will also be forbidden to rate companies in which their analysts own shares or financial products. The consulting and advisory role of rating agencies will also be dismissed for companies which are themselves subject to rating. Moreover, at least three independent directors must be nominated to the board of each agency to prevent potential conflicts of interest.
To increase the transparency of the rating process, agencies will have to reveal their methodologies, models and rating assumptions. This should give investors a better understanding of the conclusions reached by the agencies.
This is one of the most controversial issues as it can affect the independence of rating. Supervisors might indeed end up modifying the rating process, as agencies fear. For its part, the Commission will ensure that supervisors "do not interfere in the content of the ratings," according to a document published yesterday (12 November).
Supervision also poses a problem in terms of coordination. It remains a national activity. In case of cross-border supervision, it is not yet clear whether member states will approve the Commission's approach, which is based on a stronger role for the supervisor in the country where the agency is based: the same problem that has already emerged for supervision of the banking and insurance sectors (EurActiv 17/10/08). McCreevy again ruled out the idea of a single European supervisor for rating agencies.
European rating agency?
Finally, credit rating agencies are concerned about the consistency of European rules with international regulation. The more consistent the rules, the better for rating. But the Commission, despite underlining that the international IOSCO code was the reference point, pointed out that it had "gone beyond these standards in those areas where we felt that more exacting measures would be appropriate".
McCreevy again reacted positively to the idea of a European rating agency. "It would be welcome," he said, before stressing the difficulty of the task. At the moment, the main rating agencies operating in Europe and the rest of the world are from the US. Many would see brand new European agencies as an important step forward in terms of increasing competition in the EU.