1 Financial services
| (30168)
15661/08
+ ADDs 1-2
COM(08) 704
| Draft Regulation on credit rating agencies
|
| Legal base | Article 95 EC; co-decision; QMV
|
| Document originated | 12 November 2008
|
| Deposited in Parliament | 18 November 2008
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| Department | HM Treasury |
| Basis of consideration | EM of 1 December 2008
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| Previous Committee Report | None
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| To be discussed in Council | Not known
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| Committee's assessment | Politically important
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| Committee's decision | For debate in European Committee B
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Background
1.1 Credit rating agencies (CRAs) are private sector organisations
that provide independent opinions on the creditworthiness of a
particular issuer or financial instrument — they assess
the likelihood that an issuer will default, either on its financial
obligations generally (issuer rating) or on a particular debt
or fixed income security (instrument rating). These opinions,
or ratings, may be based on information relating to the income,
expenditure and balance sheet (with particular focus on the debt)
of the rated entity. Ratings provide an indication as to the situation
at a given time and, therefore, need to be periodically confirmed
or updated. The ratings effectively categorise issuers into grades,
depending on the CRA's opinion of their risk of default. CRAs
employ creditworthiness scales, which vary between agencies, with
a generally key borderline running between investment grade (low-risk)
and speculative grade (high-risk) opinions of the likelihood of
default. Investors, borrowers, issuers and governments may all
use credit ratings, which thereby play an important role in financial
markets.
1.2 In April 2002 at an informal ECOFIN Council the
Commission made a commitment to analyse the issue of CRAs in the
aftermath of the Enron bankruptcy. In February 2004 the European
Parliament adopted a Resolution on CRAs calling on the Commission
to produce an assessment of the need, if any, for legislative
intervention in this field. In December 2004 the International
Organisation of Securities Commissions (IOSCO) published a voluntary
Code of Conduct, Fundamentals for CRAs. The Code, while
voluntary, was intended to be applied by CRAs of all sizes and
business models, and in all jurisdictions worldwide. In the Community,
CRAs are expected to give full effect to the provisions of the
IOSCO Code — by incorporating the standards in their own
procedures, as long as these provisions are consistent with the
relevant Directives.
1.3 In March 2006 the Commission published a Communication
on Credit Rating Agencies reviewing issues of concern and recent
relevant Community legislation, including the Market Abuse Directive
(MAD), the Capital Requirement Directive (CRD) and the Markets
in Financial Instruments Directive (MiFID).[1]
The Commission said:
- concern centred on the quality
of credit ratings provided by CRAs;
- ratings should be based on diligent analysis
of available information derived from sources whose integrity
is continuously controlled;
- ratings must be regularly updated as necessary
and CRAs must be more open about the way in which their ratings
are produced;
- CRAs must be independent and entirely objective
in their approach, avoiding compromise from the relationships
that they have with issuers;
- CRAs should be prevented from using inside information,
to which they had access as part of the rating process, for other
activities;
- the European Parliament expressed concern about
the degree of concentration in the ratings industry and its possible
anti-competitive effects;
- the MAD sought to tackle issues of insider dealing
and market manipulation, including conflicts of interest and fair
presentation of investment recommendations, while recognising
the difference between credit ratings and investment recommendations;
- the CRD provided for the use of external credit
assessments in the determination of risk weights (and consequential
capital requirements) applied to a bank or investment firm's exposures
and only the use of assessments provided by recognised External
Credit Assessment Institutions, mainly CRAs, were to be acceptable
to the competent authorities; and
- the MiFID required CRAs that also provide investment
services to become authorised. An authorised firm then needed
to comply with other aspects of the Directive, including provisions
on conflicts of interest.
The Commission concluded that, at that time, no new
legislative initiatives were needed. However, it also undertook
to continue to monitor developments and to consider introducing
legislative proposals in the light of new circumstances or serious
problems of market failure.
The document
1.4 In introducing this draft Regulation the Commission
recapitulates developments on CRAs since its Communication. It
recalls that:
- in October 2007 the ECOFIN
Council agreed conclusions, the "Ecofin Roadmap", which
included a proposal to assess the role played by CRAs and to address
any relevant deficiencies. Specifically, the Commission was asked
to examine possible conflicts of interest in the rating process,
transparency of rating methods, delays in rating reassessments
and regulatory approval processes;[2]
- to clarify the role of CRAs and assess the need
for regulatory measures, in autumn 2007 the Commission requested
the advice of the Committee of European Securities Regulators
(CESR)[3] and the European
Securities Markets Expert Group (ESME),[4]
who consulted with other stakeholders before providing their advice.
Meanwhile, IOSCO revised its Code in May 2008;
- on 8 July 2008 the ECOFIN Council welcomed the
IOSCO revisions and the CESR and ESME reports, but considered
it to be of high importance to address the concerns concerning
the transparency of rating processes, the risk of conflicts of
interest related to the remuneration models of the rating agencies,
accountability and the quality of ratings;
- the Council shared the Commission view that the
current initiatives did not fully address the challenges posed,
that further steps were needed and that regulatory changes might
be necessary. The Council supported without prejudice to consideration
of its practical application, the principle that the rating agencies
should be subject to a Community registration system;[5]
and
- the Commission then conducted an internet consultation
on CRAs before proposing the draft Regulation.[6]
The Commission also notes that in the USA, where
most of the CRAs with significant Community activities have their
parent companies, the Credit Rating Agency Reform Act of 2006
entered into force on 27 June 2007, establishing a legal
framework for the registration of Nationally Recognized Statistical
Rating Organizations.
1.5 The draft Regulation would:
- apply to credit ratings used
by credit institutions (as defined in other Directives);
- permit those institutions to trade in rated securities
only if those ratings have been issued by a CRA registered in
accordance with the Regulation;
- make registration of a CRA dependent on its compliance
with standards and procedures to avoid conflicts of interest,
including those created by the "issuer pays" business
model, ensure its employees are appropriately knowledgeable and
experienced, make transparent to the public its methodologies,
models and assumptions, provide an annual transparency report
and disclose, withdraw or update a rating in a timely manner;
- require a CRA to be a legal person established
in the Community in order for it to be able to apply for registration;
- place responsibility for the decision on the
registration of a CRA with the competent authority of a member
state — the relevant supervisory body of the member state
in which the CRA has its registered office;
- allow a group of CRAs, either a parent company
and its subsidiaries or a number of undertakings linked by control,
to apply for one registration;
- set out how competent authorities should act
as a college to consult over the registration and how, where there
is no unanimity of opinion, individual authorities should make
their own decisions for their jurisdiction;
- establish a role for the CESR to advise and coordinate
the actions of competent authorities; and
- require Member States to establish penalties
for infringement of the Regulation.
1.6 The Commission's impact assessment, attached
to the document:
- estimates that the proposed
legislation will create for a CRA a one-off administrative cost
of, on average, €313,744 (£246,887) and recurring costs
of €18,417 (£14,492) annually;
- assesses that there would be no additional cost
from the proposed Regulation for the Community; and
- has not assessed a cost to Member States of the
additional work required of their competent authorities.
The Government's view
1.7 The Financial Services Secretary to the Treasury
(Lord Myners) tells us that the Government, in discussions with
the Commission during the preparation of the draft Regulation,
has consistently supported:
- introduction of a strengthened
oversight regime for CRAs, as agreed at the July 2008 ECOFIN Council;
- the principle that CRAs should be subject to
a Community registration system, subject to resolving practical
considerations, and
- that such a system should be proportionate, principled
and risk based.
The Minister adds that:
- in response to the Commission's
consultation the Government said that it does not support the
formation of a centralised Community supervisory structure, because
it does not believe that such a structure is necessary or proportionate;
and
- at the first Council working group on this proposal
the Commission confirmed that the proposal does not include the
establishment of a new Community Agency, as the cost would not
be proportionate, nor does it give the CESR decision-making powers,
due to legal constraints.
1.8 The Minister says that the Government remains
concerned at:
- the scope of the proposals
for Community regulation for an industry that operates globally,
including the requirement for CRAs to establish one or more operationally
independent subsidiaries in the Community;
- the administrative burden of the current proposal;
and
- the efficiency and effectiveness of operation
of the proposed procedures, including the advisory and coordinating
role of the CESR.
The Government will continue to seek proportionate
solutions, currently through the Council Working Group negotiations.
1.9 The Minister also tells us of a Government concern,
which too will need to be addressed in the negotiations, that
the draft Regulation is not fully compliant with the European
Convention on Human Rights (ECHR). Particular issues that have
been identified are:
- the draft provisions (Articles
15, 17, 21 and 22) on competent authorities exercising powers
regarding registration, withdrawal of registration and permission
to issue credit ratings — exercise of these powers will
determine the civil rights of CRAs for the purpose of Article
6 of the ECHR and, as there is no right of appeal set out on the
face of the draft Regulation, compliance with Article 6 will depend
on the administrative law of the Member States themselves;
- the draft provision (Article 20(3)) on enforcement
powers for competent authorities — there are insufficient
safeguards to ensure full compliance with Articles 6 and 8 of
the ECHR; and
- the draft provisions (Articles 23, 24, 29 and
30) on cooperation between competent authorities — to the
extent that this involves the exchange and disclosure of information
relating to CRAs, this may raise issues under Article 8 of the
ECHR. Some strengthening of the safeguards may therefore bring
more certainty to the position.
1.10 The Minister says, in relation to the Commission's
impact assessment, that the Government:
- supports, in principle, the
conclusion of the Commission that a legislative solution would
be a proportionate measure to fulfil its objectives, subject to
practical considerations;
- supports the conclusion that registration, and
efficient and effective monitoring of compliance, should be carried
out using existing competent authorities of Member States, with
advice and guidance provided by the Lamfalussy Level 3 Committee,
comprising representatives of those authorities, the CESR;
- believes the assessment to be conservative in
the scale of impact on industry, and therefore of potential cost
implications to issuers; and
- estimates that the additional cost for the UK
competent authority, recoverable through fees charged to the registered
and supervised CRAs but not included in the Commission figures,
to lie between zero and £0.8 million annually, depending
on the form of the final Regulation and on operational decisions
that the CRAs may make as a result of its implementation.
1.11 The Minister adds that the short timescale has
not allowed preparation of a UK impact assessment to accompany
his Explanatory Memorandum and that such an assessment presently
under preparation will be provided to us, together with an updated
Explanatory Memorandum, as soon as possible. Equally, a formal
domestic consultation has not been possible. So, in the time available,
key industry groups and large CRAs have been contacted and informed
of the proposal. Those wishing to submit comments on it have been
invited to do so. Those comments have been considered in relation
to the working group negotiations and will continue to be so considered.
Conclusion
1.12 We note that this important measure is being
carried forward hurriedly. Nevertheless, we think time should
be found to debate the document in European Committee before the
Council reaches a decision on the draft Regulation. So we recommend
such a debate. And, amongst other matters, we suggest that Members
in that debate might wish to explore:
- developments on the Government's
concerns about the scope of the legislation, especially the requirement
for CRAs 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 CESR;
- developments on the Government's ECHR concerns;
and
- progress on the impact assessment.
1 See http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2006:059:0002:0006:EN:PDF. Back
2
See http://www.consilium.europa.eu/ueDocs/cms_Data/docs/pressData/en/ecofin/96375.pdf Back
3
A Level 3 Lamfalussy committee; see http://ec.europa.eu/internal_market/finances/committees/index_en.htm#review
Back
4
See http://ec.europa.eu/internal_market/securities/esme/index_en.htm
Back
5
See http://www.consilium.europa.eu/ueDocs/cms_Data/docs/pressData/en/ecofin/101742.pdf
. Back
6 This consultation
ran between 31 July 2008 and 5 September 2008. The Commission
received 98 responses from across the Community, categorised as
22 responses from authorities, 15 from registered organisations,
and the remainder from individuals (although this category appears
to comprise organisations that have not registered). Back
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