New Credit Rating Agency Rules

The European Commission has proposed a new regulatory body to oversee credit rating agencies as part of its effort to tighten supervision of the financial system.
 
According to a new proposal, which would amend the existing regulation on credit rating agencies, a new body called the European Securities and Markets Authority (ESMA) will be responsible for the registration and date-to-day supervision of credit rating agencies.
 
The ESMA will also have the authority to temporarily prohibit the agencies from issuing credit ratings, suspend use of their ratings, and request the Commission to impose fine on rating agencies if they intentionally or negligently breach the regulation.
 
The new initiative to clamp down on credit rating agencies follows their perceived role in exacerbating the Greek credit crisis.
 
The proposal on credit rating agencies is part of a package of measures aimed at creating a safer and more stable financial system in Europe. It would amend the existing Regulation 1060/2009 on credit rating agencies. It will now pass to the EU Council of Ministers and the European Parliament for consideration. If adopted, new rules regarding credit ratings would be expected to come into force during 2011.

Background

Investors rely on rating agencies to provide information on the risks of assets. Credit rating agencies issue opinions on the creditworthiness of companies, governments and sophisticated financial products. The agencies are important to the stability of the financial markets and have a huge impact on the availability and cost of credit. They have drawn criticism for a perceived contribution to the financial crisis by underestimating the risks, and, more recently, for acting in a way that is considered to have worsened the Greek debt crisis.
Objectives
 
The Commission has two main objectives as far as credit rating agencies are concerned: ensuring centralised supervision at European level, and increased transparency of the information supplied by banks, credit institutions and investment firms so that all agencies have access to the same information.
 
Until now, most financial supervision has been done at the national level. As rating services are not linked to a particular territory and the ratings issued by a credit rating agency 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.

A European System of Financial Supervisors (ESFS)

If adopted, the proposal would set up a European System of Financial Supervisors (ESFS) consisting of a network of national financial supervisors working in tandem with new European Supervisory Authority, a European Insurance and Occupational Pensions Authority (EIOPA) and a European Securities and Markets Authority (ESMA).
 
The European supervisory authority would have the role of overseeing securities and markets. This new body would have direct and exclusive oversight of credit rating agencies registered in the EU, including European branches of agencies based outside the EU. (Three of the most popular agencies - Fitch, Moody’s and Standard & Poor’s – have headquarters in New York). The new European supervisory authority would have powers to request information, to launch investigations, and to perform on-site inspections.
 
Under the proposed changes, the securities authority, expected to be up and running by 2011, would also have the power to propose fines and even prohibit them from operating in the EU Credit institutions.  Banks, credit institutions and investment firms would have to make information available to agencies they do not use, so that those agencies could produce independent ratings on their products.

European Systemic Risk Board (ESRB)

The Commission also proposed the creation of a European Systemic Risk Board (ESRB) which would be meant to monitor and assess potential threats to financial stability that arise from macro-economic developments and from developments within the financial system as a whole. In order to achieve this, the ESRB would provide an early warning of system-wide risks that might be building up and, where necessary, issue recommendations for action to deal with these risks.
 
The Commission claims that centralised supervision of the agencies would improve supervision, increase competition in the credit rating agencies market and improve investor protection.
The Commission also launched a public consultation on corporate governance rules for the financial sector, including insurance companies. The consultation is seeking views on how to improve the functioning and composition of corporate boards for the purpose of supervising senior management and how to involve shareholders, financial supervisors and external auditors in corporate governance. The consultation is open until 1st September 2010. Any future legislative or non-legislative proposals will be adopted in the course of 2011.