Credit rating agencies are about to face tougher regulation following ASIC's announcement that it will require agencies to hold an Australian Financial Services Licence (AFSL) from 1 January 2010. ASIC had previously taken a no-action approach to the licensing requirements for credit rating agencies, announcing in 2005 that it would grant ongoing licensing relief to credit rating agencies.
The changes announced last month were foreshadowed by an announcement in November 2008 that the Government would remove the licensing exemption applicable to credit rating agencies and require them to hold an AFSL. The licensing requirements apply from 1 July 2009.
In addition to the general licensing obligations, credit rating agencies will be subject to a number of specific licence conditions, consistent with internationally adopted standards and procedures. These conditions will require licensees to:
- comply with the International Organization of Securities Commission (IOSCO) Code of Conduct Fundamentals for Credit Rating Agencies (on an 'if not, why not' basis until 30 June 2010 and on a mandatory basis from 1 July 2010);
- lodge an annual compliance report with ASIC, outlining how it has complied with the IOSCO code;
- disclose its procedures, methodologies and assumptions for ratings;
- implement arrangements to monitor and regularly review its credit ratings;
- review ratings affected by material changes to rating methodologies within six months of the change;
- implement training programs for credit analysts that have been externally assessed as adequate and appropriate (from 1 July 2010);
- refrain from anti-competitive behaviour, such as threatening to issue a lower credit rating for a structured product because the underlying asset is not also rated by the agency; and
- consent to information sharing between ASIC and foreign regulators.
The two major Australian ratings agencies reacted very differently following the announcement. Standard & Poor's announced that it would cease rating securities that were available to retail investors, saying that it could not accept the onerous rules. It will, however, seek a wholesale licence authorisation.
The other major player, Moody's, said it would review the way it assesses hybrid securities which may result in it effectively downgrading all Australian and New Zealand banking hybrids that it had previously rated. Although it has stated this is not in response to the new ASIC requirements, Moody's' announcement suggests that bank hybrids are riskier due to general regulatory changes applying to financial institutions, in terms of liquidity and capital requirements, following the financial crisis.
There is no doubt that credit rating agencies are thought to have played a significant role in the recent global financial turmoil, with much of the criticism focused on the perceived conflicts of interest in their operational and remuneration structure. The adequacy of the regulation of agencies has also been questioned by governments and investors around the world. The removal of the licensing exemption for credit rating agencies by ASIC is in line with the shift in regulation of credit rating agencies around the world. The new rules will no doubt make rating agencies more vulnerable to legal action, particularly where ratings are used by companies, including banks, to raise funds from retail investors but it remains to be seen whether they will be effective.