Brussels seeks to shake up credit rating agencies

Credit ratings agencies, blamed for the world recession and hammering debt-burdened EU states, are in Brussels regulators’ sights

Markets & Finance|Companies
Chris Johnstone | 10.11.2011
Michel Barnier wants to foster competition for Moody’s, S&P’s, and Fitch Ratings

Never in the history of the financial world has so much damage been done by so few to so many — that, with apologies to British statesman Winston Churchill, who was also an unfortunate former finance minister, sums up the view of credit ratings agencies from the Brussel’s offices of Internal Market and Services Commissioner Michel Barnier.

The Frenchman and his officials charge the big three ratings agencies (Moody’s, Standard and Poor’s, and Fitch Ratings) with being behind much of the world’s and Europe’s current economic and financial woes.

And on Tuesday (Nov. 15) it will be payback time, when Barnier unveils a far-reaching proposal aimed at weaning Europe and the world off their addiction to the use of credit agency ratings and subjecting them to more rules and competition.   

Barnier’s charge sheet against the credit agencies reads as follows:

  • They did not see and warn about the 2008 world economic crisis;
  • They fueled the crisis by continuing to give top ratings for issues and then financial institutions loaded with US subprime mortgage products (specifically, they gave good evaluations to investment bank Lehman Brothers on the eve of its collapse);
  • And, more recently, they have enraged European politicians and the European Commission for their perceived role in exacerbating the current crisis of debt-burden countries.
Low Commission credit

“One can pose serious questions about the role they [credit rating agencies] have played in the crisis which affect certain countries in the euro zone,” Barnier declared.

“One one hand, one can ask if they take account of the efforts of these countries to redress their fiscal situation, limit their public spending and make structural reforms. On the other hand, one can ask if they take into account the existence of a European solidarity based on considerable financial means. This solidarity has been manifested month after month by loans but the agencies seem to think that these countries are outside the European Economic and Monetary Union,” the Commissioner complained.

Given the hesitation of the EU’s main paymaster, Germany, to dig into its pocket month after month — and doubts about the depth of European solidarity — perhaps Barnier’s complaints are a bit exaggerated, but his proposal for far-reaching steps to curb the credit agencies do not look like they will pull any punches.

Hard on the heels of a previous set of rules targeting the credit rating agencies, which only took effect in December 2010, the right-wing Frenchman’s new round of proposals call for:

  • curbing the institutional demand for credit agency ratings wherever possible;
  • encouraging financial companies and firms to carry out more of their evaluations with stepped up supervision from regulators if necessary;
  • more competition should be encouraged with the big three agencies, perhaps by encouraging networks of small credit agencies or by urging companies seeking ratings to make more information public so that the ratings’ role is not so paramount.

‘We have given ratings a quasi institutional standing in legislation, which is too prominent or strong.’

“We have given ratings a quasi-institutional standing in legislation, which is too prominent or strong,” Barnier’s spokeswoman, Chantal Hughes, told Czech Position, adding that the agencies should continue to exist and “provide excellent information.”

One of the key criticisms leveled at the agencies is a closed and cozy relationship with the companies or institutions for whom they provide their services. The agencies are usually paid by those same institutions and companies and, the charge goes, might angle their final ratings with a view to pleasing the customer and keeping up a future flow of business and fees.

To break up that cozy situation and encourage competition, Barnier’s officials in Brussels have been mulling the imposition of a far reaching demand that credit rating agencies are rotated after serving the same customer for a certain period of time or issues. A final decision on the wording of this radical change in the rating agencies environment has still to be settled on, spokeswoman Hughes explained.

Debate is still raging ahead of the Nov. 15 proposal about another game changing idea: introducing civil liability for credit agencies in the case of gross malpractice or negligence. In short, the agencies  would become liable to being sued for their worst shortcomings.

The current state of play on such civil liability is mixed across European countries, with ratings agencies usually putting up the argument that they are just offering an opinion, which can be taken or left, and or not offering the sort of services provided by a professional investment service or portfolio manager.

More supervision of the ratings agencies themselves should come in the form of a stepped up role for the EU-wide regulator, the European Securities and Markets Authority (ESMA). The idea at one stage floated in Brussels of fostering a European credit rating agency or getting national central banks to carry out more independent in house credit ratings appears to have collapsed at this stage and is not expected to be included in the proposal.

“I get the impression that they have perhaps backed down on that,” commented Martin O’ Donovan, deputy policy and technical director at the British-based Association of Corporate Treasurers (ACT), a professional body grouping for company treasurers who are frequently some of the main users of the credit agencies’ services and which has come out as one of the biggest defenders of the current status quo.

ACT’s basic message is that the Commission’s latest moves to tackle the credit agencies could end up causing more problems than they solve and end up with financial decision makers getting worse information than before. The EC, the argument seems to run, is seeking to shoot the messenger who is merely delivering the bad news.

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