Page last updated at 13:49 GMT, Wednesday, 12 November 2008

EU gets tough on credit agencies

Euros and dollars
US housing debts triggered massive losses on both sides of the Atlantic

The European Commission has announced proposals for tougher regulation for credit rating agencies (CRAs).

The proposed new rules would make sure that CRAs act in a more transparent manner and that ratings are not affected by conflicts of interest.

The move comes after CRAs were blamed for playing a major role in causing the current global credit crunch.

The agencies carry out work to determine the worthiness or otherwise of financial investments.

They have been accused of failing to spot the size and risk of the bad US housing debt that was resold around the world, causing multi-billion pound losses.

It was the discovery of these losses that caused the global credit markets to freeze up, and ultimately led to governments around the world having to bail out their banking sectors.

New authorisation

The commission proposes the introduction of a registration procedure for CRAs in order that European supervisors can control more closely their activities.

EU Internal Market Commissioner Charlie McCreevy said: "Credit rating agencies will have to be authorised to operate in full conformity with EU rules."

"They will no longer be able to use the defence that credit ratings are just opinions," he added.

Ratings agency Standard & Poor's admitted that consistent regulation could help to restore confidence in global credit ratings.

It said: "We share the commission's goal of bringing greater transparency and confidence to the markets and are examining its latest proposals to see if they support ratings opinions that are independent and internationally consistent."

Proposed solutions

The proposals include:

  • CRAs may not provide advisory services
  • They will not be allowed to rate financial instruments if they do not have sufficient quality information to base their ratings on
  • They must disclose the models, methodologies and key assumptions on which they base their ratings
  • They will be obliged to publish an annual transparency report
  • They will have to create an internal function to review the quality of their ratings
  • They should have at least three independent directors on their boards whose pay cannot depend on the business performance of the agency. These will be appointed for a single term of office that can be no longer than five years. They can only be dismissed in case of professional misconduct. At least one of them should be an expert in securitisation and structured finance.

The commission argues that the way CRAs assessed some products in the lead up to the financial crisis underestimated the level of risk, and so played a significant part in creating the current turmoil.

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