Brussels calls for European ratings supervisor

Brussels on Wednesday proposed the creation of a new continent-wide supervisor to oversee the activities of credit rating agencies, which have been blamed for exacerbating the sovereign debt crisis in the single currency zone.

José Manuel Barroso, the president of the European Commission, said Brussels wished to go further, and assess the idea of an independent European credit rating agency, in the full set of proposals to be released in September. He refuted a reporter's suggestion that this was a kneejerk reaction to the sovereign debt crisis, saying the proposals on ratings agencies were already under discussion before the eurozone's sovereign troubles started late last year. "Is it normal to have only three relevant actors in such a sensitive area, where there is such great probability of conflict of interest? Is it normal that they all come from the same country? Is it normal that they escape fundamental supervision and regulation when they are acting in such important fields?," he asked.

Michel Barnier, the European Commissioner for internal market regulation, echoed the need for a European agency, and added that a schedule had been agreed for implementing the proposals. "Between now and December, we will put in place the first set of rules on the registration of credit rating agencies, on reducing the risk of conflicts of interest, and on greater transparency," he said. The Commission hopes for an agreement on the amended laws by the end of the year, so that they can take effect on 1 January 2011.

Under the proposal, a European Security Markets Authority (ESMA) will be set up to carry out direct and centralised supervision of ratings agencies, in line with recommendations made by the De Larosière group's report in late February last year. The amendment reflects a change to the existing law on ratings agency regulation, which calls for agencies to be controlled by national authorities working together in colleges and under the supervision of the Committee of European Securities Regulators.

However, ESMA will be able to delegate responsibilities back to national authorities where appropriate, on occasions such as when on-site inspections are called for. In return, national authorities will be able to request ESMA to examine whether the conditions for the withdrawal of a credit rating agency's registration are met or whether the use of credit ratings issued by a credit rating agency should be suspended based on their assessment of a serious and persistent breach of the regulation.

ESMA will charge agencies fees, full details of which have yet to be agreed.

The Commission dismissed potential criticism that national regulators are better equipped to supervise ratings agencies, pointing to the international nature of the services rating agencies provide. "They are not a global business," the Commission said. "Ratings are used by financial institutions across Europe and are not linked to where the agency is established."

In addition, agencies would benefit from having a single point of contact throughout the continent, and more consistent application of the rules, regardless of where they were located. There were also potential efficiency gains, due to a "shorter and less complicated registration and supervisory process," the Commission said. Investors who rely on ratings agencies also stood to gain from coherent and centralised supervision, it said.

The amended law vests ESMA with the power to stop agencies from issuing ratings, and suspends the use of credit ratings, if an infringement is judged to have occurred. The regulator will also be able to fine agencies, according to criteria that have yet to be established. The amendment also gives the European supervisor the authority to require agencies to submit relevant information, examine and take copies of any records and data, and close off business premises, books and records if necessary.

The rules governing ratings agencies are themselves unchanged from those approved in April 2009. Under the legislation, credit rating agencies:

- must not provide advisory services;
- cannot rate instruments without information of sufficient quality;
- must provide the models, methodologies and assumptions on which ratings are based;
- must differentiate ratings of more complex products by showing specific symbols;
- must publish annual transparency reports;
- must set up internal audit functions to vet their ratings; and
- must have at least two independent directors on their board, whose pay does not depend on the agency's performance.

Greater competition
Brussels has also proposed a clause to increase competition and circumvent potential conflicts of interest that arise because issuers of securities pay for the services of rating agencies. Under the amendment, issuers must provide access to information about their instruments not only to the agency that they employ, but to any competing agency that is interested. Aside from the conflict of interest problem, "the issuance of unsolicited ratings will promote the use of more than one rating per instrument," the Commission said.

The Commission also unveiled proposals to improve corporate governance standards in financial institutions. Suggestions included a limit on the number of board memberships that directors can have, and an enhanced role for supervisors in monitoring corporate governance standards.