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The Chairman: Will the hon. Gentleman ask the question?
John Hemming: Moving on to the key question for the Government, I am pleased to hear from the Minister that the directive is not as phrased here because that would cause a load of problems. Do the Government believe the directive should be modified to facilitate a global regulation of credit rating agencies? The danger is in creating a fortress Europe which will not necessarily help Europeans.
Angela Eagle: I understand the point the hon. Gentleman is making. Our financial system is global and interconnected. Given the list of experiences and interests he has rightly shared with the Committee, he knows how rapidly transactions can be made. Given how fast the IT and software for which he is responsible can communicate round the world, it is important to have global responses, but that does not mean that there is no role for European regulation. The US regulates credit rating agencies by law, so there is no reason why the European Union should not pursue regulation of this sort.
It is right for the Committee to be worried, which is perhaps why we are here this afternoon. It is important that national and EU regulations are not completely at odds with what is going to happen internationally. There has to be synergy between national or EU regulations and what the internationally agreed codes of conduct will be once the Financial Stability Forum has finished its work. It would be highly undesirable if the ranges of national regulations were at odds with each other, as that would make it difficult for credit rating agencies to register and be active in particular jurisdictions. In the process in which we are involved with the Commission on its proposed regulations, we are trying to make certain that what the EU suggests is consistent with what will happen internationally.
Mr. Gauke: I am grateful for the Minister’s answer to my previous question on article 4 and for her confirmation that the second element of it has been taken out. However, I seek further clarification on the first part of article 4, which says that “Credit institutions, investments firms” and various other regulated entities
“may only use for regulatory purposes credit ratings which are issued by credit rating agencies established in the Community and registered in accordance with this Regulation.”
We also know from page 4 of the draft regulations, paragraph 1.2 that:
“The Capital Requirements Directive...provides for the use of external credit assessments to determine risk weights and the resulting capital requirements applied to a bank or investment firm’s exposure.”
In the circumstances where a credit institution or investment firm that falls within the capital requirements directive has exposure to an investment that is rated, but rated by a credit rating agency not established in the European Community, is there not a potential difficulty? The interrelationship between the capital requirements directive and the draft regulation might create some difficulties. Will the Minister update the Committee on where we are on that part of article 4? The problem is not as acute as it is with the second paragraph, but there is still an issue. Does the Minister agree?
Angela Eagle: I hope that I made it clear in my answers to the hon. Gentleman’s reasonable spotting of the difficulty with the original drafting that the worst has gone. The process whereby we look at the rest is actively continuing as we speak.
The hon. Gentleman is asking is how the European Union legislation fits if a particular credit rating agency is not established in the EU. I emphasise that the vast majority of agencies are so established, so this is an almost hypothetical situation. The order is that the regulation would apply, as currently written; the requirements of particular directives would come after. As the regulation is currently written, a rating agency not being established in Europe would disadvantage the agency enormously in terms of its ability to have coverage in the jurisdiction of the EU. However, custom and practice as it has developed in the credit rating agency world is such that very small credit rating agencies and the ratings that they may give to certain instruments do not carry a lot of weight with investors at the moment. They look to ratings produced by the major players in the credit rating agencies’ oligopoly.
It is important to ensure that ratings that are used for capital purposes remain valid, and if in future we need a rating, because the existing rating is a non-EU rating, there will have to be time to adapt to that particular security. At the moment our view is that the regulation is not written clearly enough. We are still working with the Commission to try to get clarification on the implications of capital adequacy requirements and regulations in the EU in the small number of cases—almost certainly hypothetical—where a credit agency is not registered in Europe. The draft regulation is written in a way that seeks to have all credit rating agencies that wish to do business established within EU jurisdiction. That is absolutely the case.
Mr. Gauke: I am grateful for that answer. May I seek just a little more clarification? Am I correct in assuming that if an EU investment firm has exposure to a stock that has been rated, but only by a credit rating agency that is based outside the EU and does not have a subsidiary in the EU, its capital adequacy would need to be reassessed as a consequence of the regulation? Currently the exposure might take into account the credit rating of that stock, but because that rating is coming from a non-EU ratings agency it would no longer be possible under the capital requirements directive to take it into account.
Angela Eagle: It is precisely those types of very specific example on which we are seeking clarification as part of the ongoing work to hone and refine the text. As I said earlier, the draft is not ideal, but it is changing even as we speak. All I can say is that, as things stand, this is likely to happen in a small number of instances. We are seeking clarification on precisely how, for example, an agency in those circumstances might respond to its rating not being taken into account. I suspect that it would have to establish some kind of a presence in the EU, but I emphasise that this is a very minor issue in the context of the vast numbers of ratings that go on within the EU at the moment. We are in the middle of discussing, as part of the co-decision process, how the regulations might be refined before they are politically agreed and then carried. It is precisely that sort of detailed work that goes on in the EU working groups. That work is ongoing.
John Hemming: Much more will emerge later, but are there any proposals to have intermediate steps? One of the difficulties with article 4 as it stands is that if there are no transitional arrangements, institutions under article 2 that hold debt that is regulated only outside the EU would have to sell it straight away because it is not counted as part of their capital adequacy. Are the Government proposing any transitional arrangements?
Angela Eagle: Clearly, the idea of the regulation is not to cause disruption to the institutions—investment institutions or others—that exist and work in the European Union by the sudden introduction of a law that requires financial re-engineering of that sort. As I said earlier, the issue is in practice a minor one, and will be so for most entities that are currently registered and doing business in the EU. I cannot think of a law that does not include a transition period in which requirements can be met, and it would not be reasonable to pass legislation within the EU that required global businesses to have an office, for example, without understanding that one cannot wave a magic wand and get one. By definition there has to be transitional time.
It is clear from today’s debate that certain people in the market have recognised that the regulation exists and is being discussed, and I certainly hope that they are taking account of the requirements that might be put upon then in the next period. I said earlier that the Czech presidency is hoping to bring the regulation to a full conclusion and agreement at Council in May, after a preliminary political agreement that is being sought at the February ECOFIN meeting. That is a timetable of its own. Hon. Members have made an important point about financial stability and the sudden, perhaps unforeseen, consequences of having to sell securities that might not have been subject to that requirement to sell had it not been for the regulation. I assure the Committee that in our ongoing dialogue to refine the text, we are discussing these practical examples of behaviours that were perhaps not envisaged by the Commission when drafting the proposal. I am sure that the European Parliament will take up similar points.
Angela Eagle: I am afraid that I do not have any insight into the inner workings of the mind of the Commission when it drafts regulations. We could be here all day if we wanted to speculate about that. Looking down the list of credit rating agencies, I can spot only two that are not already established in the European Union. We must put into perspective the current landscape and the organisations, almost all of which are already established.
Is the article protectionist? It is more than possible to argue that such global international institutions, which are privately run, are not as transparent as perhaps they should be, and I think that many hon. Members would agree with that. I do not want to over-egg the pudding, because the situation that we have experienced in global markets in the past year is not all the fault of credit rating agencies, but when contemplating their role in destabilising the global financial system, there are legitimate questions that we should ask about how they do their business and their models for payment, which include the issuer of securities paying, and whether there are conflicts of interest.
I suspect, although I do not know, that the Commission wanted these organisations to have a presence in the European Union so that they could be regulated. Indeed, the USA has a regulatory regime whereby credit rating agencies—the big three are all based there—are subject to a registration process, so I suspect that the Commission was seeking to emulate that approach, which was legislated for by the US Congress in 2006. I do not see the article as protectionist in that way. I agree that in a globalised environment it is a bit surprising, but its practical effect, as I have said, will be minimal, given that the vast majority of credit rating agencies, including the big three that dominate the entire landscape, are already here. Many of them have offices in multiple member states, rather than in just London or Frankfurt.
Mr. Gauke: Of course the requirement is for subsidiaries, and it may well be that some credit rating agencies would prefer to structure themselves with branches, as opposed to subsidiaries. My final question on article 4 relates to the potential barrier to entry. The Minister referred to an oligopoly in this area, and perhaps, given its nature, we will never see a huge number of competitors. Is she concerned that by essentially requiring a credit rating agency always to have a subsidiary within the European Union in order to be effective, which is the essence of what article 4 establishes, the measure will make things difficult for new entrants?
Angela Eagle: There is certainly a theoretical problem of a barrier to entry, if one looks at the economic theory. However, as I have said, in practical terms we already have an industry that has very high barriers to entry, or else it would not be dominated, as it has been, by three entities that take the vast bulk of the market share of credit rating. Although I might not know what they are, I would say that there are already high barriers to entry to the industry, and I know that some commentators have discussed what might be done to open up this kind of business to much more competition. If one looks at the practical way in which the industry operates, with the dominant big three, it is possible to argue, using economic theory, that barriers to entry are already extremely high.
Mr. Gauke: I turn to the application process for credit rating agencies. Under article 13, applications for registration have to be made to CESR, yet the home state regulators—the FSA and its equivalents—will actually determine an application and have the role of supervising those credit rating agencies. Will the Minister outline why it is necessary for applications to be made to CESR, given that it will have 10 days from the receipt of the application to pass it on to the regular competent authority? Surely it would be easier and time would be saved if applications could be made directly to the competent authorities and they subsequently notified CESR.
Angela Eagle: The nature of the process forms part of the ongoing discussions on the text itself. I suspect that the article is written in that way simply because it allows there to be a central look at what is going on and then a farming of the basic work required to member state regulators, thereby maintaining a central pool of information about what is happening. The process could be done either way, but the Commission has suggested that it should be done that way, and I see no particular reason why not. The point of having such regulation in the first place is to build confidence in credit rating agencies, which has been quite badly shaken by recent events. All member states’ markets rely on ratings, as indeed do all markets in a local context, so it is important to maintain some confidence in them. The hon. Gentleman says that he would prefer the process to work the other way. That is possibly a matter of opinion, but we see no particular reason to worry about the process outlined in article 13.
Mr. Gauke rose—
Mr. George: On a point or order, Mr. Williams. I was very polite in asking one question, but had I known that this would be a duopoly, I would have come in with my own 10. May the rest of us join in by not only asking questions, but making comments?
The Chairman: As I said at the start of the debate, Members may ask supplementary questions under my discretion. Had you indicated that you wished to ask a question, I would certainly have called you, so I will bear in mind your point.
Mr. George: I thought that we were making presentations, not asking questions.
The Chairman: I call Mr. Gauke.
Mr. Gauke: My understanding is that we can ask questions until 5.30 pm.
I am grateful for the Minister’s answer on that last point, but speaking as someone who used to work as a lawyer in the regulatory area and who was involved in regulatory applications, I would have though that, from the point of view of an applicant, it is somewhat strange that the entity to which the applicant applies is not the entity that determines the application. Given that there is a delay of up to 10 days from the application being made to it being passed on to the home state regulator, does not the Minister think that that rather unnecessarily gives a role to CESR that need not really exist?
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