Brussels to propose curbs on sovereign debt ratings

Michel Barnier 22 June 2011_Picnik.jpg

Michel Barnier, the EU's internal market commissioner, has announced draft EU laws aimed at bringing more transparency to how credit rating agencies assess sovereign debt, days after Moody's downgraded Portugal, which is benefiting from an EU/IMF bailout.

Barnier, the EU's financial services chief, said he will make the proposals as part of his reform to bring EU bank capital requirements in line with a global accord known as Basel III that will increase the size of capital buffers.

"To limit overreliance, we will be strengthening the requirement for banks to carry out their own analysis of risk and not rely on external ratings in an automatic and mechanical way," Barnier said in a speech.

"We will also make other concrete proposals before the end of the year to limit over-reliance to deal with insurance, asset management and investment fund sectors," Barnier also told the European Securities and Markets Authority (ESMA).

The draft law is due to be published on 20 July.

Peter De Proft, director-general of the European Fund and Asset Management Association (EFAMA), told Reuters many investment firms already do their own credit analysis. "It will be more difficult for the smaller ones," De Proft said.

Moody's angered the EU this month by downgrading Portuguese debt despite the country securing an EU bailout.

Barnier said the "absolute minimum" must be to improve transparency in how agencies reach such decisions.

"That is why we should ask ourselves […] whether it is appropriate to allow sovereign ratings on countries which are subject to an internationally agreed programme," Barnier said.

Such a ban will be discussed by EU finance ministers shortly, he added.

Sharon Bowles MEP, the UK Liberal Democrat chairman of the European Parliament's economic affairs committee, cautioned against seeing ratings agencies as the "fount of all evil" in the euro zone's debt crisis.

"I just think they are being shot as the bringer of bad news during the sovereign debt crisis. I am not entirely convinced the system is broken," Bowles told the ESMA meeting.

The continued zero-weighting of all sovereign debt when it comes to calculating bank capital has played a much more damaging role in the crisis by not allowing markets to discipline weaker debt, Bowles said.

Global action

The United States' Dodd-Frank Act is also forcing US regulators to remove references to the use of credit ratings in determining bank capital.

It is part of a wider effort by the world's 20 leading economies (G20) to regulate credit rating agencies, whose reputation was tarnished in the financial crisis for failing to warn investors in 'toxic' securitised products fast enough.

Barnier will also sound out the G20 to see if it could also take fresh initiatives to regulate credit rating agencies due to the international nature of the business.

"We need to be more demanding when it comes to how credit rating agencies rate sovereign debt," Barnier said.

The EU has already approved two sets of laws to regulate the sector, forcing agencies to obtain authorisation to operate in the 27-nation area. ESMA is expected to need several more months to issue licences to the 'Big Three' – Moody's, Fitch and Standard & Poor's.

Barnier may also propose forcing agencies to allow a government to check the accuracy of the data used by an agency in advance of any downgrading.

"European regulation could allow for investors to take agencies to court when there has been negligence or violation of applicable rules," Barnier said. "We have not closed the door to going further."

EURACTIV with Reuters

Credit rating agencies entered the EU's firing line when agency Standard & Poor's decided to downgrade Greek debt to 'junk' status, spreading widespread gloom across EU markets.

Credit rating agencies have been widely blamed for their role in the financial crisis which has been sweeping the world since 2007.

They stand accused of over-evaluating borrowers' capacity to pay back their household loans in the so-called sub-prime crisis. They were also accused of potential conflicts of interest, because they are paid as consultants by the very banks whose debt they rate.

  • 20 July: Barnier to table draft laws on credit rating and Basel III.

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