European Commission Will Propose Regulation of Credit Rating Agencies in October

In October, the European Commission will propose a registration and external oversight regime for credit rating agencies under which regulators will supervise the policies and procedures followed by the rating agencies. In remarks in Dublin, Commissioner for the Internal Market Charlie McCreevy also announced that the Commission will soon propose revisions to the Capital Markets Directive designed to enhance risk management. Separately, the commissioner rejected calls to temporarily disregard fair value accounting because he feared that precipitate action now could add to the confusion and create even greater distrust in companies' accounts. What is needed in the short-term, he emphasized, is additional guidance on the valuation of complex and illiquid financial instruments.

Noting that the IOSCO voluntary code of conduct for credit rating agencies has not worked, and that steps taken by the rating agencies themselves are insufficient, the commissioner concluded that an EU-wide regulatory regime must be implemented. Reforms to the corporate and internal governance of rating agencies will form a part of the new regime. He also emphasized that the Commission will try to strengthen competition by encouraging entry into the ratings market by new players. The European Securities Markets Expert Group has stressed the importance not just of governance of rating agencies, but also the importance of having an appropriate corporate culture as well.

He also said that the proposed regime for credit rating agencies will ensure that regulators with responsibility for oversight will have at their disposal sufficient resources and expertise to keep up with financial innovation and to challenge the rating agencies in the right areas, on the right issues, at the right time.

At their July meeting EU Finance Ministers (ECOFIN) said that the central role ratings play in structured finance makes it imperative to address the concerns that have been raised in the context of the financial turmoil concerning the transparency of the
rating processes, risk of conflicts of interest related to the remuneration models of the rating agencies, accountability and the quality of ratings.

On a broader topic, the commissioner emphasized the cross-border nature of the current market crisis and the need to enhance the cross-border regulation of financial groups. In this regard, the proposed changes in the Capital Markets Directive will require colleges of regulators for all cross-border banking groups. The objectives of the changes are twofold. First, the Commission wants more exchange of information, cooperation, and agreement on reporting and capital requirements to significantly enhance regulatory efficiency. Second, any signs of stress will be detected more easily and earlier in a college environment, thereby permitting joint contingency plans and crisis assessments.

In addition, the commissioner said that a new Memorandum of Understanding between national central banks, regulators, and finance ministers has been agreed upon. The MOU reflects the commitment of all EU authorities to deepen cooperation in concrete ways and facilitate coordinated actions in cross-border crisis situations that may affect a financial group, infrastructure or market.

The revision to the Directive will also address elements of the prudential treatment of securitization and credit risk transfer, as well as the large exposures regime and hybrid capital instruments. It will also take into account the work under way by the Basel Committee on Banking Supervision on banks' liquidity risk management which is due to be issued in the autumn of 2008.

According to the commissioner, the first objective of the ECOFIN Roadmap to resolve the malfunctions of the financial markets revealed by the sub-prime crisis is the urgent need for qualitative improvements in transparency for investors, markets and regulators. After being strongly pushed to come up with a convincing proposal on exposures to structured products and off-balance sheet vehicles, the industry is now starting to publish its quarterly reports on primary markets. Data on price and spread changes will be updated by the industry on a monthly basis. New data reports on holdings of securitized products should enhance the insight of regulators and policy makers into the exposures of financial institutions.

The banking industry has started a consultation on its guidelines for best practices on disclosures of securitization activities and risk exposures. While the G7 has endorsed the Financial Stability Forum’s recommendation to apply full disclosure to the mid-2008 financial statements, these guidelines will not be effective until the year-end disclosures. For this reason, the Commission asked the industry to clearly spell-out how it will comply with the G7 request. In a letter to the Commission, the industry committed to encourage the implementation of the FSF recommendations and to monitor the process to ensure consistency in the longer term.