The two consultation papers published by the European Commission (Commission) on 31 July 2008 result from the perception that CRAs contributed to current market turmoil by underestimating the credit risk of structured instruments in which sub prime mortgages were embedded. Many investors relied too heavily on the generally favourable ratings given by CRAs to these products instead of assessing the risk characteristics themselves and assessing performance of the underlying assets.
The first paper seeks views on a Directive/Regulation that the Commission intends to propose with respect to the authorisation, operation and supervision of CRAs. It sets out the legal obligations that CRAs must comply with and a proposal for independent external oversight. The paper proposes two alternatives for authorisation and supervision:
- National authorisation and supervision with strong co-ordination through the Committee of European Securities Regulators; or
- Community authorisation via an agency combined with supervision by national regulators.
The objectives of the Directive/Regulation are:
- Avoidance, and appropriate management, of conflicts of interest by CRAs.
- A high standard for the quality of rating methodology and ratings to ensure they are accurate and reliable.
- Increased transparency of CRAs' activities.
- Establishment of a supervisory and enforcement regime within the EU with strong co-ordination among national regulators.
The second paper, aimed at tackling the problem of excessive reliance by investors and others on credit ratings, looks at:
- Requiring regulated and sophisticated investors to look beyond ratings and to rely more on their own risk analysis.
- Requiring that published ratings include "health warnings" on specific risks associated with rated investments.
- Examining references to ratings in EU financial regulation with a view to making changes if they are trigger undue reliance by investors on ratings.
The Commission is seeking views of the papers from all interested parties by 5 September 2008.