Commission plans to get tough with rating agencies

Detailed ideas to be presented in September, to be followed by possible draft legislation.

The European Commission today (2 June) presented plans for tougher controls on credit rating agencies in response to concerns that they have contributed to the economic and financial crisis.

“There is an emerging view in Europe and internationally that the deficiency in the current rating processes has not yet been sufficiently addressed,” José Manuel Barroso, the president of the European commission, said.

The Commission adopted draft legislation that would give it the power to fine credit rating agencies (CRAs) up to 20% of their annual income or turnover if they are guilty of conflicts of interest. It would also place CRAs under the supervisory control of an EU-wide authority, and require them to share information with potential rivals. The Commission hopes that this information-sharing requirement will spur competition on the ratings markets.

The Commission is considering further reforms to the CRAs market. Its ideas include creating a European ratings agency to take on the ‘big three’ market incumbents (Fitch, Moody’s, Standard & Poors), and empowering export credit agencies (ECAs) and credit insurers (CIs) to issue ratings.

Barroso said that ECAs and CIs have an “established credibility” in measuring risk. Christian Noyer, the governor of France’s national bank, today came out in support of letting CIs issue ratings.

The Commission said it would present detailed ideas in September, to be followed by proposals, including possibly draft legislation, by the end of the year.

National governments and the Commission have criticised the main rating agencies for downgrading the credit ratings of Portugal, Spain and Greece during the eurozone debt crisis. They believe that the downgrades were an unjustified response to the eurozone situation and out of step with economic fundamentals.

“We want to achieve a stronger break-up of the oligopoly of the big three rating agencies,” Wolfgang Schäuble, Germany’s finance minister, said today.

Nicolas Sarkozy, France’s president, and Angela Merkel, Germany’s chancellor, sent a letter to the Commission last month calling on it to take action. They said there was a need to reinforce competition on the ratings market, and to prevent CRAs from causing financial instability.

Sarkozy said last month that the EU would “moralise” CRAs through tougher regulation.

Barroso today denied that the Commission was pursuing a vendetta against the CRAs. The Commission’s decision to act “is not connected specifically with the problem of the debt crisis,” he said. He added that CRAs were under scrutiny because they had “underestimated the risks” faced by the banking sector prior to the collapse of Lehman Brothers in September 2008. 

Barroso said it was legitimate to ask whether it was “normal” that the market was so reliant on three dominant operators, all of which are based in one country (the US), and all of which are outside the scope of supervisory oversight.

Barroso urged member states and the European Parliament to rapidly agree a package of draft legislation to strengthen EU financial supervision. He said the legislation, which was presented by the Commission in September 2009, was essential to toughen up regulation of rating agencies.

The supervisory reforms would, if enacted, include the creation a European Securities and Markets Authority (ESMA), with directly supervisory powers over CRAs.

The draft legislation presented by the Commission today clarifies the powers which the ESMA would have over CRAs. These powers will only become effective once the ESMA is up and running.

The draft legislation would allow ESMA to suspend a rating agency’s right to issue ratings if it believed the CRA to have broken EU regulatory standards (eg, by placing itself in a conflict of interest). It would also initiate the process for fining CRAs that break regulatory standards, although the fine would be formally levied by the Commission.

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The Commission wants the supervisory reforms to be agreed in time for the ESMA to start work on 1 January 2011. The European Parliament and governments, however, are currently at loggerheads over the reforms, because MEPs want to place far more supervisory power at European level than is acceptable to member states.

Restrictions

The Commission will next week launch a consultation on possible measures to restrict short-selling of securities in the EU, ahead of proposals that it will present in September.

The German government today proposed to its national parliament to extend a ban it has in place on naked short selling of eurozone sovereign debt, credit default swaps on eurozone sovereign debt, and shares in ten leading German financial firms. Germany believes naked short selling exacerbated the debt crisis by allowing speculators to bet that eurozone countries will default.

The Commission has responded to German calls to accelerate its timetable for addressing the issue. The Commission had originally planned to present its proposals on short selling in October.     

The Commission may also launch a consultation as soon as next week on broader reforms to the derivatives market, with a view to presenting draft legislation by the start of September.