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Session 2008 - 09
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The Committee consisted of the following Members:

Chairman: Hywel Williams
Ainger, Nick (Carmarthen, West and South Pembrokeshire) (Lab)
Battle, John (Leeds, West) (Lab)
Brady, Mr. Graham (Altrincham and Sale, West) (Con)
Cable, Dr. Vincent (Twickenham) (LD)
Duddridge, James (Rochford and Southend, East) (Con)
Eagle, Angela (Exchequer Secretary to the Treasury)
Gauke, Mr. David (South-West Hertfordshire) (Con)
George, Mr. Bruce (Walsall, South) (Lab)
Goodman, Helen (Bishop Auckland) (Lab)
Hall, Mr. Mike (Weaver Vale) (Lab)
Hands, Mr. Greg (Hammersmith and Fulham) (Con)
Hemming, John (Birmingham, Yardley) (LD)
Jenkins, Mr. Brian (Tamworth) (Lab)
Mick Hillyard, Chris Stanton, Committee Clerks
† attended the Committee
The following also attended (Standing Order No. 119(6)):
Hopkins, Kelvin (Luton, North) (Lab)

European Committee B

Tuesday 27 January 2009

[Hywel Williams in the Chair]

Credit Rating Agencies
4.30 pm
The Chairman: Does a member of the European Scrutiny Committee wish to make a brief explanatory statement on the decision to refer the draft regulation to this Committee?
Kelvin Hopkins (Luton, North) (Lab): It is a pleasure to attend this meeting under your chairmanship, Mr. Williams. I am not a member of this Committee, but as you and everybody else will surely know, Members of the House of Commons can attend and speak at meetings even though they are not allowed to vote. I am here to represent the European Scrutiny Committee and I thank you for allowing me this opportunity to explain why the European Scrutiny Committee has recommended the document for debate.
Credit rating agencies, which provide independent opinions on the creditworthiness of a particular issuer or financial instrument, play an important role in financial markets. Investors, borrowers, issuers and Governments may all use opinions from credit rating agencies. The unusually short time scale in which it is intended that the proposal be adopted has not allowed preparation of a UK impact assessment, although we understand that one is being prepared. Equally, a formal domestic consultation has not been possible, although we understand that key industry groups and large credit rating agencies have been contacted and informed of the proposal.
In the light of concerns expressed to us by the Government about the proposal, and despite the lack of an impact assessment and absence of formal public consultation, we decided to recommend that the proposal be debated now. We thought that that would give Members the opportunity to explore, in particular, developments on Government concerns about the scope of the legislation, especially the requirement for credit rating agencies to establish subsidiaries in the Community; the administrative burden of the proposal and the efficiency and effectiveness of the proposed procedures, including the role of the Committee of European Securities Regulators; developments on the Government’s concerns relating to European convention on human rights; and progress on the impact assessment.
The Chairman: I call the Minister to make an opening statement.
4.32 pm
The Exchequer Secretary to the Treasury (Angela Eagle): Thank you, Mr. Williams. I think that this is the first time this Session that I have served under your chairmanship. It is welcome.
Credit ratings are an important tool in the operation of the financial markets. They are used by investors, borrowers, issuers and Governments as one indication of the creditworthiness of a particular issue or financial instrument. Recent events have highlighted the extent to which such ratings are an integral part of many global financial systems. Credit rating agencies have been criticised for the levels of their ratings and for delays before ratings are downgraded. They have also been criticised for the potential conflicts of interest inherent in their business models, in which the issuer of a financial instrument pays for its rating.
In the aftermath of the events in global finance in the past year or so, referred to as the credit crunch, and particularly the intensification last October, there has been a great deal of comment on the role and practice of credit rating agencies, not only from national Parliaments but from regulators, academics and those who study how the global financial system works. A great deal of concern has been expressed.
The issue is being examined with great closeness and urgency in the Financial Stability Forum, which is looking at what lessons might be learned to ensure that, in future, the structure of our globalised financial system is much more stable. The European Commission has also been involved, in part because of its own worries about the role that credit rating agencies may have played in some of the events in global financial systems in the past year or so.
We have supported the work of the International Organisation of Securities Commissions to produce a global standard for a code of conduct for credit rating agencies. In July 2008, ECOFIN welcomed the revision of the code of conduct, which it considered to provide the minimum benchmark for actions that credit rating agencies should take to address concerns. ECOFIN agreed that current initiatives did not fully address the challenges posed, that further steps were needed and that regulatory changes might be necessary, particularly in the European Union. Because it did not believe that concerns were fully addressed by processes that were in place or planned, it supported the objective of introducing a strengthened oversight system for rating agencies subject to an EU registration system.
In November, the European Commission proposed a regulation to establish a registration and oversight regime for credit rating agencies; that is what we are discussing today. We do not, however, agree that that should be the final pronouncement on the matter. As hon. Members know, the evolution of Commission suggestions, especially when they are subject to the dual agreement process between the Parliament and the Council, can be rapid and swiftly changing. We are engaged in that process now, but I shall endeavour to share with the Committee as much information as I can on the development of the proposed regulation. We are in a very fast-moving situation, and negotiations are going on as we speak.
The intention of the Czech presidency is have agreement, at least in principle, by the February ECOFIN meeting, and final agreement by the end of the presidency in May—so we are looking at quite a rapid process, which I suspect is why concerns were expressed by the European Scrutiny Committee. I shall endeavour today to provide as much background information as I can on the shifting situation, and to set out the Government’s explanatory memorandum and their responses to the consultation that the European Commission held as it developed the process, so as to make clear our position on this important matter.
My final observation is that we are dealing with global companies. The best approach to getting a final resolution of the frameworks in which we all wish credit rating agencies to operate is, therefore, a global one.
The Chairman: We have until 5.30 pm for questions to the Minister. Questions should be brief, and Members may, subject to my discretion, ask related supplementary questions.
Mr. David Gauke (South-West Hertfordshire) (Con): It is a pleasure to serve under your chairmanship, Mr. Williams. I am grateful to the Minister for her introduction. Will she outline recent developments on the proposal in article 4 of the draft regulations to require credit rating agencies to be established in the European Union or to be subsidiaries of parent companies established elsewhere? What is the impact of those developments?
Angela Eagle: A feature of the Commission’s proposals is that such agencies ought to have an EU establishment in order for them to be subject to regulation in the territories of the EU. If the hon. Gentleman looks at the list, he will see that the vast majority of the agencies most affected are already so established, but obviously we are considering whether we can put in place any flexibilities. It is an unusual requirement, but I do not think that, in practice, it will give credit rating agencies much of a problem. As he knows, we are talking about an essentially oligopolistic structure, as it has been called, with three very dominant rating agencies taking most of the market. There is also a list of much smaller agencies, the vast majority of which have offices in Europe; only one or two do not. In practical terms, there is not much of a problem, although he might wish, as would we, to express worries about the principle of requiring global businesses to base themselves in the EU.
Mr. Gauke: In the debate, I will make just that point, but I am sure that you want me to stick to questions at this stage, Mr. Williams.
Further to my previous question, article 4 contains the statement:
“Investment firms and credit institutions ... should not execute orders on behalf of their clients with respect to financial instruments which have been rated, unless the credit rating has been issued by a credit rating agency registered in accordance with this Regulation.”
Under that provision, if a credit rating agency that does not have a subsidiary in the EU rates a US or Japanese bond, that bond cannot be traded in the City of London. That would be of some significance. Is my interpretation correct? Does the Minister agree that such a proposal could be damaging to the City?
Angela Eagle: I agree completely. We flagged up that issue immediately on seeing the draft text from the Commission. I reassure the hon. Gentleman that, after firm negotiation, that requirement has gone from the text. It would have caused us enormous practical difficulties. There would have been some perverse solutions had that provision remained in the text. However, I am glad to be able to tell the Committee that it is gone.
Mr. Bruce George (Walsall, South) (Lab): This does not count as a question, Mr. Williams, but I hope that complaints have been made to the House authorities about the truly appalling acoustics in this room, although they are wonderful for a Minister because it is impossible for anyone to know what is being said.
From this excellent document, we know exactly what the EU was doing before, during and after the economic disasters: it was naming and in some cases trying to shame the credit rating agencies. What were we doing at that time? Were we doing independent research? The Treasury Committee produced an excellent report early last year. Was our attitude toward these organisations subsumed within that of the EU or did we have independent views that fed into the EU view and influenced its proposals?
Angela Eagle: I will try to shout so that we can overcome the poor acoustics by sterling effort. I assure my right hon. Friend that I am listening intently and doing my best to answer the questions put to me.
The view of rating agencies and the possibility that they are the tail that wags the dog have come to the fore more and more as we examine the beginning of the credit crunch and as we have watched it intensify. It is fair to say that there has been a great deal of worry about that across all jurisdictions. That is why IOSCO has been beefing up its code of conduct, which is meant to apply globally.
Credit rating agencies are globally based organisations. There are only three major agencies, although others are seeking to come on to the scene, and perhaps their ratings have been used as a source of comfort rather than as they should be used, as an analysis to be taken into account as only part of due diligence by those making investment decisions. So there are many lessons to learn.
As I said in my opening remarks, we have been working to tighten up the international code of conduct. The Financial Stability Forum, which has been working under the aegis of the G20, is to look, among other matters, at rating agencies, the lessons to be learned and how to ensure we have a system in which we can have more confidence. How rating agencies did or did not foresee the problems—the way in which they rated certain innovative financial instruments, if I could put it that way—has been a cause of concern. Clearly, these matters need to be looked at in great detail if we are to come out of this process with a system that can command more confidence among those making investment decisions.
John Hemming (Birmingham, Yardley) (LD): I probably should declare interests at this stage rather than later in a speech. Those familiar with my entry in the register will know that I am a director, in fact chairman, of JHC LLP, a software house sometimes known as John Hemming & Co, which I founded many years ago. It provides software to stockbrokers for transaction business, so it handles the process of buying and selling securities, including those we are talking about today. I am also a shareholder in OMX Securities—a joint venture between JHC LLP and the Swedish stock exchange which is now owned by NASDAQ—and, in fact, for a period of three hours after my election was a director of that Financial Services Authority-regulated entity, so I have quite a bit to do with things there.
I am also, unsurprisingly, somebody who buys and sells securities and I currently own three securities that are relevant to this Committee. One is RBS where my interests are obviously aligned with those of the Government—I do think the Government have a chance of succeeding there. Another is NatWest 9 per cent. stock—the sort regulated here—and I also own shares in Barclays, another issuer of debt. One can argue whether I have made the right or wrong decisions but my interests are aligned with the country’s because if the country succeeds, I succeed. I am sorry about all of that but it has to be there. I will not have to declare some of these matters formally because one does not have to declare shares until the valuation—with valuation, one day one declares it and the next day one does not.
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Prepared 29 January 2009