Cicero Policy Briefer

Issue 25, June 2008

EU looks to improve transparency in Credit Rating

By Michael Cooper

When something as disruptive as the credit crunch gives the global economy a nasty shock the blame game naturally ensues. Whether it be journalists looking for latest scoop or political leaders looking to hide a multitude of sins behind uncontrollable international market forces, everyone is on the lookout for a scapegoat to take the fall.

In the continuing economic downturn the EU is increasingly turning its attention to the issue of transparency. As other articles this month describe, some EU officials are looking to shine a light into the worlds of private equity and hedge funds in hope that it will shore up the stability of global financial markets. While these efforts are still very much in their infancy, greater political consensus and willpower is behind calls for greater disclosure among credit ratings agencies. In the aftermath of the market turmoil last summer a greater interrogation into the credit rating practice stood out as a united demand from Brussels, including free market champions such as Charlie McCreevy—the message was clear that it could not remain business as usual for CRAs.

The role of credit ratings agencies has become increasingly significant to borrowers of all shapes and sizes, as well as to instruments such as derivatives. Moreover, the reliance of regulators on the quality of these assessments when deliberating over capital requirement levels for banks or security firms is becoming increasingly evident under the implementation of Basel II. Given this integral role in the functioning of money markets, the Committee of European Securities Regulators (CESR), which is responsible for securities supervision, has been keeping a close eye on CRAs’ self-imposed codes of conduct at the request of the European Commission. In a report last month, the chair of the CESR task force on CRA, Ingrid Bonde, stated that as a result of the recent turbulence there is a need for “a thorough re-evaluation of the current self-regulatory regime”.

That report concluded that the CESR was not left fully satisfied with these self-regulated codes of conducts, and has recommended improvements in terms of greater information and communication from agencies of their modelling assumptions as well as the process methods and performance of their ratings. Furthermore, there is a call for ensuring adequate resourcing so that agencies can guarantee that they can maintain up-to-date, high quality ratings. The CESR also raised concerns regarding potential conflicts of interest given the advisory roles that CRAs provide to issuers. As a result, it has requested clearer definitions from agencies of their advisory roles, as well as greater disclosure of fees from issuers.

While these practical recommendations for individual rating agencies’ codes of conduct offer some real opportunities to answer questions around disclosure and conflicts of interests, industry-wide consensus on an international scale will be key in order to silence calls for regulation.

To this end, the CESR has made a request for an international body made up of investment firms, investors, issuers and CRAs themselves to set common standards and monitor them effectively. While this is certainly ambitious, the Committee has also been realistic in its short-term expectations, and accepts that a similar body on an EU scale would represent significant progress in the foreseeable future. It is now up to the Commission to put a timescale in place to realise these recommendations. The report is emblematic of a real effort from the EU to find non-regulatory solutions, and the industry must take the suggestions seriously. If it does not, there are more than enough politicians queuing up to make it wish it had.

Michael Cooper can be contacted on +44 (0)20 7665 9530 or click here to email.