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BackThis week, a public hearing on the planned new rules for credit rating agencies took place in the European Parliament. Whilst the agencies are free to put their thumbs up and down as they please and in the process plunge already ailing countries even deeper into the abyss, some MEPs were surprisingly lenient towards them.
Credit rating agencies so far without any public supervision
The Committee on Economic and Monetary Affairs of the European Parliament had invited experts to outline to MEPs their assessment of the Commission’s proposal, which had been presented in November. This is the third attempt of the Commission to rein in the so far unregulated activities of the credit rating agencies. The two previous proposals of the Commission had been limited to formalities such as the provision that credit rating agencies had to register in the EU. The credit rating agencies, 3 of whom are undertakings mainly controlled by Wall Street, controlling almost 90 % of the global rating business, were unimpressed.
Commission presents watered down proposal
In November of last year, the French Commissioner Michel Barnier upped the ante. He presented a comprehensive proposal, which was to get on top of many of the current problems with the agencies. However, not without a large drop of bitterness: the Frenchman was not even able to gain the support of his own colleagues in the Commission for two of the originally planned key projects, namely the ban on the - in any case - dominant giants to snap up smaller agencies, and the ban on rating countries that were in financial difficulties. They were deleted without substitution. Apart from that, the proposal of the Commission also does not mention the setting up of a European credit rating agency as a counter balance to the US-American agencies.
The ball is now in the corner of the European Parliament
The draft of the Commission must now be debated by the European Parliament and the Member States under the codecision procedure in accordance with the current EU regulations. Provided everybody agrees, it is possible to make changes to the draft of the Commission. The hearing in the European Parliament took place against this background. The MEPs wanted to fill some gaps in their knowledge before entering the crucial phase of the negotiations, which should be concluded by early summer.
European supervisory authority: we are lacking the required resources!
Verena Ross, Executive Director at the newly established European Securities and Markets Authority ESMA, which is also responsible for supervising credit rating agencies, commented positively on the proposal of the Commission. However, she voiced concerns whether her Authority would have the necessary muscle power and the resources to review and if necessary to query the assessment models of the credit rating agencies. The agencies assess undertakings and states with mathematical models, which so far they managed to keep close to their chest. It is therefore impossible for the outside world to understand to which extent the assessments of the agencies are based on objective criteria. The proposal of the Commission shall change all that; in future, agencies shall be obliged to disclose their models and ESMA shall review them.
The reference to ratings must be removed from all legislation
Another fundamental problem, which was criticised by many of the invited experts, including the French economist Norbert Gaillard, is the consistent reference to ratings in a large number of national and European Acts as well as in regulations of the European Central Bank. As a result of this, the assessments of the agencies, which actually claim only to publish expressions of opinion, were given a quasi-legal status by politics. Gaillard argued that banks, insurance companies and pensions funds had to assume responsibility to assess the risk of an investment themselves instead of blindly and automatically following the ratings of the agencies. Apart from that, Gaillard demanded the mandatory publication of the hit and error rates of the agencies.
Credit rating agencies should have an interest in the survival of undertakings and states
Makoto Utsumi, President of the Japanese credit rating agency JCRA provided a telling insight into cultural differences. In Japan, the US-dominated Big 3 would not have much to laugh about; 80 % of Japanese government bonds would be assessed by Japanese agencies. Europe too should have its own credit rating agency as it would be better equipped to take cultural and social conditions into account. His general opinion was that credit rating agencies, even though they were private and profit-oriented enterprises, had a public duty they should not forget. They should have an interest in the survival of undertakings and states and not wilfully destroy them.
Letter confusion
A new proposal was presented by Thierry Philipponnat, Secretary General of the newly established NGO Finance Watch, who wants to provide an expertise on regulating the financial market, which is independent from the financial lobby. He suggested abandoning the current rating in form of letter combinations (e.g. AAA) and replacing it by written reports and by specifying numeric values for the probability that a debtor might become insolvent.
On the way to a European credit rating agency?
The contribution of Markus Krall, a representative of the German Consultancy Roland Berger, was also eagerly awaited. It is a known fact Roland Berger is currently in the process of setting up a non-profit oriented European credit rating agency. Krall welcomed the rule, provided for in the Commission proposal that credit rating agencies should in future be liable for grossly negligent errors. He also proposed that those being rated should not pay for the verdict of the agencies. Roland Berger would instead work on a model where investors had to pay for the analysis of the credit rating agency. This would prevent conflicts of interest and interrelations between credit rating agencies and their clients.
Industry, Conservative and Liberal MEPs in favour of more watering down
A key issue of the Commission proposal was noticeably strongly attacked by representatives of the industry, but also by Conservatives and Liberal MEPs. This too concerns conflicts of interest between credit rating agencies and their clients. The Commission suggests that in future undertakings should change the credit rating agency after a certain time and also obtain the verdict of a second agency. On the one hand, this would have the advantage that corporations would not be able to rely on a trusted agency, which would turn a blind eye if it came to the crunch. On the other hand, new or smaller credit rating agencies would get a chance to penetrate the oligopolistic market of the Big Three. A representative of the Big Three, Susan Launi of Fitch Ratings rejected this rule. She felt that the rotation suggested by the Commission would disadvantage Fitch, as the ratings would then only be divided between the two largest providers Standard & Poor‘s and Moody’s. Similar critical and surprisingly clear were the reactions of the shadow rapporteur of the EPP Group, the French MEP Jean-Paul Gauzès and the shadow rapporteur of the Liberals (ALDE), the German MEP Wolf Klinz, both of whom were opposed to the rotation principle.
The Italian rapporteur, MEP Leonardo Domenici of the Socialists & Democrats will present his draft report in early February; then the crucial phase of the negotiations in the European Parliament will begin.
Link: Proposal of the Commission on credit rating agencies
The Committee on Economic and Monetary Affairs of the European Parliament had invited experts to outline to MEPs their assessment of the Commission’s proposal, which had been presented in November. This is the third attempt of the Commission to rein in the so far unregulated activities of the credit rating agencies. The two previous proposals of the Commission had been limited to formalities such as the provision that credit rating agencies had to register in the EU. The credit rating agencies, 3 of whom are undertakings mainly controlled by Wall Street, controlling almost 90 % of the global rating business, were unimpressed.
Commission presents watered down proposal
In November of last year, the French Commissioner Michel Barnier upped the ante. He presented a comprehensive proposal, which was to get on top of many of the current problems with the agencies. However, not without a large drop of bitterness: the Frenchman was not even able to gain the support of his own colleagues in the Commission for two of the originally planned key projects, namely the ban on the - in any case - dominant giants to snap up smaller agencies, and the ban on rating countries that were in financial difficulties. They were deleted without substitution. Apart from that, the proposal of the Commission also does not mention the setting up of a European credit rating agency as a counter balance to the US-American agencies.
The ball is now in the corner of the European Parliament
The draft of the Commission must now be debated by the European Parliament and the Member States under the codecision procedure in accordance with the current EU regulations. Provided everybody agrees, it is possible to make changes to the draft of the Commission. The hearing in the European Parliament took place against this background. The MEPs wanted to fill some gaps in their knowledge before entering the crucial phase of the negotiations, which should be concluded by early summer.
European supervisory authority: we are lacking the required resources!
Verena Ross, Executive Director at the newly established European Securities and Markets Authority ESMA, which is also responsible for supervising credit rating agencies, commented positively on the proposal of the Commission. However, she voiced concerns whether her Authority would have the necessary muscle power and the resources to review and if necessary to query the assessment models of the credit rating agencies. The agencies assess undertakings and states with mathematical models, which so far they managed to keep close to their chest. It is therefore impossible for the outside world to understand to which extent the assessments of the agencies are based on objective criteria. The proposal of the Commission shall change all that; in future, agencies shall be obliged to disclose their models and ESMA shall review them.
The reference to ratings must be removed from all legislation
Another fundamental problem, which was criticised by many of the invited experts, including the French economist Norbert Gaillard, is the consistent reference to ratings in a large number of national and European Acts as well as in regulations of the European Central Bank. As a result of this, the assessments of the agencies, which actually claim only to publish expressions of opinion, were given a quasi-legal status by politics. Gaillard argued that banks, insurance companies and pensions funds had to assume responsibility to assess the risk of an investment themselves instead of blindly and automatically following the ratings of the agencies. Apart from that, Gaillard demanded the mandatory publication of the hit and error rates of the agencies.
Credit rating agencies should have an interest in the survival of undertakings and states
Makoto Utsumi, President of the Japanese credit rating agency JCRA provided a telling insight into cultural differences. In Japan, the US-dominated Big 3 would not have much to laugh about; 80 % of Japanese government bonds would be assessed by Japanese agencies. Europe too should have its own credit rating agency as it would be better equipped to take cultural and social conditions into account. His general opinion was that credit rating agencies, even though they were private and profit-oriented enterprises, had a public duty they should not forget. They should have an interest in the survival of undertakings and states and not wilfully destroy them.
Letter confusion
A new proposal was presented by Thierry Philipponnat, Secretary General of the newly established NGO Finance Watch, who wants to provide an expertise on regulating the financial market, which is independent from the financial lobby. He suggested abandoning the current rating in form of letter combinations (e.g. AAA) and replacing it by written reports and by specifying numeric values for the probability that a debtor might become insolvent.
On the way to a European credit rating agency?
The contribution of Markus Krall, a representative of the German Consultancy Roland Berger, was also eagerly awaited. It is a known fact Roland Berger is currently in the process of setting up a non-profit oriented European credit rating agency. Krall welcomed the rule, provided for in the Commission proposal that credit rating agencies should in future be liable for grossly negligent errors. He also proposed that those being rated should not pay for the verdict of the agencies. Roland Berger would instead work on a model where investors had to pay for the analysis of the credit rating agency. This would prevent conflicts of interest and interrelations between credit rating agencies and their clients.
Industry, Conservative and Liberal MEPs in favour of more watering down
A key issue of the Commission proposal was noticeably strongly attacked by representatives of the industry, but also by Conservatives and Liberal MEPs. This too concerns conflicts of interest between credit rating agencies and their clients. The Commission suggests that in future undertakings should change the credit rating agency after a certain time and also obtain the verdict of a second agency. On the one hand, this would have the advantage that corporations would not be able to rely on a trusted agency, which would turn a blind eye if it came to the crunch. On the other hand, new or smaller credit rating agencies would get a chance to penetrate the oligopolistic market of the Big Three. A representative of the Big Three, Susan Launi of Fitch Ratings rejected this rule. She felt that the rotation suggested by the Commission would disadvantage Fitch, as the ratings would then only be divided between the two largest providers Standard & Poor‘s and Moody’s. Similar critical and surprisingly clear were the reactions of the shadow rapporteur of the EPP Group, the French MEP Jean-Paul Gauzès and the shadow rapporteur of the Liberals (ALDE), the German MEP Wolf Klinz, both of whom were opposed to the rotation principle.
The Italian rapporteur, MEP Leonardo Domenici of the Socialists & Democrats will present his draft report in early February; then the crucial phase of the negotiations in the European Parliament will begin.
Link: Proposal of the Commission on credit rating agencies