Today, the European Commission announced that it has put forward a proposal for a regulation on credit rating agencies “designed to ensure high quality credit ratings which are not tainted by the conflicts of interest which are inherent to the ratings business.” The Commission took this action to implement one of the recommendations made by the ECOFIN Council in October.

The proposal would establish conditions for the issuance of credit ratings and a registration procedure for credit rating agencies to “enable European supervisors to control the activities of rating agencies whose ratings are used by credit institutions, investment firms, insurance, assurance and reinsurance undertakings, collective investment schemes and pension funds within the [EU] Community.” Under the proposal, credit rating agencies would have to comply with rigorous rules to make sure that:

  • Ratings are not affected by conflicts of interest, 
  • Credit rating agencies remain vigilant on the quality of the rating methodology and the ratings, and 
  • Credit rating agencies act in a transparent manner (reinforced by a surveillance regime whereby European regulators will supervise credit rating agencies).

Additional proposed rules include the following:

  • Credit rating agencies may not provide advisory services; 
  • They will not be allowed to rate financial instruments if they do not have sufficient quality information on which to base their ratings; 
  • They must disclose the models, methodologies and key assumptions on which they base their ratings; 
  • They will be obliged to publish an annual transparency report; 
  • They will have to create an internal function to review the quality of their ratings; 
  • They should have at least three independent directors on their boards whose remuneration cannot depend on the business performance of the rating agency. They will be appointed for a single term of office which can be no longer than five years. They can only be dismissed in case of professional misconduct. At least one of them should be an expert in securitization and structured finance.

Some of the proposed rules are based on the standards set in the International Organization of Securities Commissions (IOSCO) code. “The proposal gives those rules a legally binding character [and] in those cases where the IOSCO standards are not sufficient to restore market confidence and ensure investor protection the Commission has proposed stricter rules.”

The announcement was accompanied by a comprehensive impact assessment and associated executive summary describing various policy alternatives were analyzed, including enhanced industry self-regulation based on the IOSCO code of conduct, voluntary adherence to a European code of conduct, and European Commission promulgated standards, but concluding that a more comprehensive legislative approach was the preferred route. The proposal was also accompanied by a set of responses to “Frequently Asked Questions” about credit rating agencies and the new proposal.