Wednesday, June 2, 2010

Commission proposes improved EU supervision of Credit Rating Agencies

As part of its work on preventing a future financial crisis and strengthening the financial system, the European Commission has today put forward amendments to the EU rules on Credit Rating Agencies (CRAs). Furthermore, in order to advance swiftly in completing the necessary reforms... the Commission has adopted a more general Communication where it commits itself to table the remaining financial reform proposals in the next six to nine months from now. Following discussion and hopefully strong support from all heads of State and government at the forthcoming European Council, the Commission will present all these proposals – together with its recent ideas on bank resolution funds (see IP/10/610) – at the G-20 Summit in Toronto on 26-27 June 2010. On CRAs, the Commission has two main objectives: ensuring efficient and centralised supervision at European level, and increased transparency on the entities requesting the ratings so that all agencies have access to the same information. These changes would improve supervision, increase competition in the CRA market and improve investor protection.

Internal Market and Services Commissioner Michel Barnier said: "The changes to rules on Credit Rating Agencies will mean better supervision and increased transparency in this crucial sector. But they are only a first step. We are looking at this market in more detail."

As rating services are not linked to a particular territory and the ratings issued by a CRA can be used by financial institutions all around Europe, the Commission is proposing a more centralised system for supervision of Credit Rating Agencies at EU level. Heads of State and government had called the Commission to come forward with proposals on this in June 2009.

Under the proposed changes, the new European supervisory authority – the European Securities and Markets Authority (ESMA, see IP/09/1347) – would be entrusted with exclusive supervision powers over CRAs registered in the EU. This would include also the European subsidiaries of well-known CRAs such as Fitch, Moody's and Standard & Poor's.

It would have powers to request information, to launch investigations, and to perform on-site inspections. Issuers of structured finance instruments such as credit institutions, banks and investment firms will also have to provide all other interested CRAs with access to the information they give to their own CRA, in order to enable them to issue unsolicited ratings.

These changes mean that CRAs would operate in a much simpler supervisory environment than the existing varied national environments and would have easier access to the information they need. Users of ratings would also be better protected as a result of centralised EU supervision of all CRAs and increased competition among CRAs.

The Commission's proposal, which amends Regulation 1060/2009, will now pass to the EU Council of Ministers and the European Parliament for consideration. If adopted, the new rules would be expected to come into force during 2011.

Background: CRAs issue opinions on the creditworthiness of companies, governments and sophisticated financial products. They contributed to the financial crisis by underestimating the risk that the issuers of certain more complicated financial instruments might not repay their debts. In response to the need to restore market confidence and increase investor protection, the Commission put forward new EU-wide rules that put in place a common regulatory regime for the issuance of credit ratings. Under these rules, which will become fully applicable in December 2010 (see IP/09/629), all CRAs that would like their credit ratings to be used in the EU now need to apply for registration. Registrations open this month. The risks of conflicts of interest affecting ratings are also addressed (for example, a CRA cannot also offer consultancy services) CRAs will need to be more transparent as they will need to disclose the methodology and internal models and key rating assumptions they use to make their ratings. This should allow investors to perform better their due diligence.

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