EU Commission wants to obligate rating agencies
EU Internal Market and Services Commissioner Michel Barnier, speaking in Straßburg on 15 November 2011, declared that ratings must no longer be allowed to aggravate market volatility. He presented EU Commission proposals for a directive as well as a regulation for the stricter control of rating agencies. No business is conducted on the bond market without a credit rating from a rating agency. This is not only a long-standing practice, but also demanded by government regulation in some countries – for example the provisions of the SEC regulatory authority in the USA.
At the latest since the Lehman crisis, when it turned out that banks were receiving a good rating in spite of their bad loans packaged in financial products, the three rating agencies based in New York and dominating the world market have been facing criticism. They are Moody's and Standard & Poor's with a total of 80 percent of the global market share, as well as Fitch with approximately 15 percent. That their influence on the capital markets remains unbroken is proven by turbulence triggered by an erroneous announcement that the French credit rating was being downgraded.
In the opinion of the EU Commission, current developments have shown that regulations implemented at the European level in 2009 and 2010 are insufficient as a regulatory framework. The new proposals are therefore intended to achieve four future objectives in particular. One is to ensure that financial institutions do not base their investment activities exclusively on ratings. Agencies will also be subject to recourse for incorrect ratings in the future, at least in principle. To date the ratings merely constitute recommendations, notwithstanding their impact, so they are legally treated as non-binding expressions of opinion. Furthermore, country ratings are to be issued more often and with greater transparency.
The fourth objective is aimed at the big three: it strives to achieve a greater diversity and stricter independence of the agencies. Small providers currently have minimal chances against the big three. Rotation is proposed as a means to rectify this. Accordingly the agency would have to be switched after no more than three years.
Supervision of the rating agencies is to be realised by the European regulatory authority ESMA. The suggestion to found an EU rating agency as a counterweight was not included in Barnier's proposals.
However, the extent to which the EU Commission can actually realise its goals is going to depend on legislative proceedings over the coming months. In any case, a prohibition on country ratings is already off the table.