EU raises heat on rating agencies and managers

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"This is not the end" and "we all have to do better" were European Commission President José Manuel Barroso's main messages at a press conference yesterday (2 June) announcing more EU measures to prevent risk-taking in the financial sector. 

The Commission president endorsed several new measures that were unveiled yesterday, including attempts to put credit rating agencies under the EU's thumb and an overhaul of corporate governance in the financial sector.

The European Commission has been busy drafting new rules for credit rating agencies which would see them answer to a new European body, the European Securities and Markets Authority (ESMA), to monitor the agencies' rating models and methodologies (EURACTIV 18/05/10).

This idea was announced by Internal Market Commissioner Michel Barnier last month, but Barroso yesterday restated the EU executive's intention to examine the need for an independent European Credit Rating Agency after downgrades of Greek sovereign debt had sent markets into a tailspin.

Overhauling boards

In addition, a Commission inquiry is looking at how corporate governance at financial firms could provide the necessary checks and balances to prevent bankers from taking the kinds of excessive risk that brought many of them to their knees in 2008 and 2009.

Current suggestions would see board directors limited to seats on a maximum of three boards and risk committees introduced to vet the firms' investment behaviour.

Commission officials said that during the crisis company boards were either not aware of the risks – in sub-prime mortgages for example – or were fooled by high and quick returns on investments.

Moore: A case in point

But what happens when the risk manager him- or herself is concerned that banks are putting too much money into an asset bubble and those concerns fall on deaf ears at board level and even at the national regulator?

This was the case with Paul Moore, the former head of global risk at HBOS, a bank that has since been swallowed up by Lloyds TSB, who produced evidence of emails to the company's director arguing that their lending policy had become too dangerous to sustain.

Moore claimed he was unfairly dismissed from HBOS for raising the alarm on risky assets, especially in the American sub-prime market.

"I feel genuinely sorry that people who are so senior are so unable to see things as ordinary people see them," Moore told the UK Treasury's select committee at a hearing on the case.

A Commission official admitted that its draft rules were imperfect and that supervisors would have to prevent the kinds of communication breakdown they had with banks such as HBOS.

"This may mean that supervisors will need more resources. In principle, we want them to pay more attention in future," the official added.

Though the Commission released a Green Paper outlining its strategy for corporate governance yesterday, the new rules will first be subjected to a wider consultation, which ends in September.

Credit rating agencies have been widely blamed for their role in the financial crisis which has swept 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.

In addition, the Commission has been examining why company boards did not vet the company directors enough -  perhaps for lack of time or expertise - and how this may have exacerbated the financial crisis.

The executive has been using studies from the Chicago and Harvard business schools in the US to understand how corporate governance in the financial sector began to decay as the sector ballooned.

"The root cause of the crisis lies in the breakdown of shareholder monitoring and ill-conceived managerial incentives," according to a theory put forward in a joint paper from the universities (EURACTIV 13/10/09).

  • Sep. 2010: Consultation on corporate governance closes.
  • Oct. 2010: Commission to propose legislation on corporate governance.
  • 1 Jan. 2011: Planned entry into force of new rules for credit rating agencies.

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