Wednesday, July 27, 2011

House Leaders Note EU Rating Reform Efforts as Comm. Barnier Launches Broad Reforms

Against the backdrop of recent remarks on credit rating agency reforms by EU Commissioner for the Internal Market Michel Barnier, hearings before a House panel emphasized the need for international coordination and harmonization of reform efforts. The House Oversight and Investigations subcommittee heard testimony from SEC, Fed and OCC officials around efforts to comply with Section 939A of the Dodd-Frank Act, which directs the SEC, along with all other federal agencies, to remove references to credit ratings from their rules and forms and to substitute such alternative standards of creditworthiness as the Commission and the others determine to be appropriate. John Ramsay, Deputy Director of the SEC’s Division of Trading and Markets said that in each case the SEC’s goal is to reduce undue reliance on credit ratings and to encourage independent assessments of creditworthiness.

Subcommittee Chair Randy Neugebauer (R-TX) said that the debt ceiling negotiations and the long-term fiscal health of the U.S. have brought a renewed focus on the credit rating agencies. On the one hand, the Dodd-Frank Act attempts to de-emphasize the role of credit rating agencies in federal regulations and, on the other hand, the Act further entrenches the government-sponsored oligopoly of the big three credit rating agencies. The former approach to reduce reliance on credit rating agencies enjoys widespread bipartisan support, the Chair noted.

Chairman Neugebauer asked if the agencies have published standards of creditworthiness. The regulators described the effort as tricky and complicated. One challenge is around bank capital rules, and there is complexity because bank capital rules are inter-agency, and are also negotiated internationally and international accords contain credit references. Chairman Neugebauer likes the interagency approach, the approach needs to be standardized. He emphasized that the US cannot talk about Basel accord harmonization and other international coordination efforts until it has its own coordinated plan.

Financial Services Committee Chair Spencer Bachus (R-ALA) noted that the European Union is making great efforts to end their reliance on rating agencies. He referred to recent remarks by EU Commissioner for the Internal Market Michel Barnier that the Commission has as a top priority addressing reliance on credit ratings. Commissioner Barnier said that credit ratings are too embedded in legislation and that he intends to reduce as much as possible the references made to those ratings in prudential rules. Chairman Bachus urged the SEC, OCC and Fed to coordinate with the European Commission’s efforts.

Commissioner Barnier is working on an initiative to address over reliance on credit ratings. He said that the Commission wants credit ratings to be considered simply as one view among other views. According to Commissioner Barnier, this is an issue of financial stability, as well as an issue of political responsibility and democracy. The Commission can neither justify nor accept that private companies have such power over populations.

The first measure to limit overreliance will be integrated into the upcoming modification of the Capital Requirements Directive, he noted, which is the effective translation of Basel III into EU law. To limit overreliance, the Commission will strengthen the requirement for banks to carry out their own analysis of risk and not rely on external ratings in an automatic and mechanical way. Before the year end, the Commission will also make other concrete proposals to limit overreliance to deal with the insurance, asset management and investment fund sectors.

The issue of rating agency civil liability to investors will also be addressed. Commissioner Barnier noted that European regulation could allow for investors to take agencies to court when there has been negligence or violation of applicable rules. While there are already rules relating to civil liability in some member states, he acknowledged, a European framework would allow for a more coherent application of rules and might help to make financial actors more responsible.

Globally, there is the issue of the rating of sovereign debt, which plays a crucial role not only for the rated countries but for all countries, since a downgrading has the immediate effect of making a country's borrowing more expensive, makes states weaker, and there are possible effects of contagion on neighboring economies. Commissioner Barnier believes that regulators should be more demanding around sovereign debt. He asks if it is appropriate to allow sovereign ratings on countries which are subject to an internationally agreed program. In any event, he said that rating agencies must follow a methodology which is both specific and very rigorous when they rate sovereign debt, and they must be held accountable by regulators.