The European Commission has unveiled new proposals aimed at clipping the wings of credit rating agencies which are being seen as part of the problem of the current sovereign debt crisis.
During the past months, credit rating agencies have been playing important roles in the ongoing financial crisis particularly by issuing negative ratings even during ongoing negotiations with countries needing bailouts.
In order to decrease the reliance on credit ratings, which are dominated globally by three US based companies – Moody’s, Standard and Poor’s and Fitch – the EU wants to introduce stricter rules by obliging rating agencies to be more transparent and clients to do their own research.
At the same time, the Commission backed down from plans to create an EU credit rating agency and to suspend ratings of countries under EU and IMF surveillance. According to Internal Market Commissioner Michel Barnier, more work, and more convincing of his colleagues are needed to push further the latter reforms.
The new proposals reduce the number of references to external ratings and require financial institutions, including banks and fund managers, to carry out their own due diligence.
In addition, more and better information underlying the ratings would need to be disclosed by credit rating agencies and by the rated entities themselves, so that professional investors will be better informed in order to make their own judgments.
Another significant change will regard frequency. While member states are rated on an annual basis, the proposed rules state that this will now have to be done twice yearly – every six months – in order to have more precise ratings and avoid unnecessary shocks. Investors and member states would have to be informed of the underlying facts and assumptions on each rating.
To avoid market disruption sovereign ratings should only be published after the close of business and at least one hour before the opening of trading venues in the EU.
Issuers, like banks and other users of ratings, would now have to rotate every three years between the agencies that rate them and in addition, two ratings from two different rating agencies would be required for complex structured finance instruments.
A large shareholder of a credit rating agency should not simultaneously be a large shareholder in another credit rating agency.
Credit rating agencies have become almost an institution in the current financial atmosphere with countries rushing to take austerity measures in order to avoid downgrades by rating agencies.
Malta also had its fair share of credit rating worries recently as Moody’s, one of the three global credit rating agencies, decided to downgrade Malta’s economy and issue a negative outlook.
Although this created a certain level of uncertainty, the situation was soon diffused as the other two credit rating agencies, Standards and Poor’s (S&P) and Fitch confirmed Malta’s rating and their stable outlook.
Recent events have backed the Commission’s initiative on agencies.
Mr Barnier said yesterday that the serious incident at Standard and Poor’s last week, when the agency circulated a message to some clients warning of a potential downgrading of France’s sovereign debt, had increased the yield on French bonds because investors feared that the country would not be able to meet its budget targets due to fallout from the Italian political crisis.
The warning later resulted to be a mistake. Mr Barnier said he was working on additional proposals to curtail practices whereby some people get rating information way ahead of the country or body in question. He said this type of practice was likely to fall foul of EU insider dealing rules.