As the credit crisis continues to affect confidence in the global financial market, the EU plans to adopt radical legislative measures for the oversight of Credit Rating Agencies (CRAs).

CRAs have been criticised for greatly underestimating credit risks associated with structured credit products. The principal criticism is that CRAs failed to warn investors of the risks of US subprime mortgage-related products. The US subprime mortgage debacle subsequently contributed to the global credit crunch, leading to an estimated $480 billion of losses and write-downs by major financial institutions worldwide.

Under the new scheme, a pan-European regulatory framework will be introduced to act as a watchdog for the authorisation and supervision of CRAs.

The reform will have a substantial impact on the dynamics of the global credit rating market, which historically operated in a self-regulated environment in the EU. The new legislation will be of particular interest, not only to investors and issuers in the structured finance market, but also to industry participants involved in other sectors affected by credit ratings, such as investment funds, banking, insurance, reinsurance and pensions.

CRAs Under the Current Self-Regulated Regime

The credit rating sector is dominated by three main agencies (Standard & Poor's, Moody's Investors Service and Fitch Ratings). CRAs are recognised as independent providers of opinions and ratings in respect of creditworthiness.

CRAs play a critical role in financial markets as their ratings are relied upon by investors, borrowers, issuers and governments for a variety of reasons.

Despite the significance of credit ratings, prior to the global credit crisis, the general consensus in the market was that self-regulation was sufficient for the credit rating industry.

The European Commission initially took the view that various existing financial services directives could provide an answer to the major issues of concern in relation to CRAs. These included directives such as the Market Abuse Directive (2003/6/EC), the Markets in Financial Instruments Directive (2004/39/EC) and the Capital Requirement Directive (2006/48/EC) combined with self-regulation by CRAs on basis of the Code of Conduct of the International Organisation of Securities Commissions (IOSCO Code).

Proposed Legislation for Regulating CRAs

The subprime crisis has highlighted flaws in the self-regulated regime (primarily based on the IOSCO Code). CRAs are considered to have failed to reflect the worsening market conditions in the ratings designated.

The Commission plans to remedy the failures of CRAs by putting in place a legal framework which will ensure the effective supervision of credit rating activities, as well as the independence, objectivity and highest possible quality of credit ratings. To achieve these objectives, the new European legislation governing credit ratings will focus on the following policies:

  • authorisation, supervision and enforcement provisions; and
  • substantive requirements to be observed by CRAs.

Authorisation, Supervision and Enforcement Provisions

Under the new scheme, CRAs will require prior authorisation in order to carry out credit rating activities within the EU. The structure of the supervisory body responsible for the oversight of CRAs within the EU is as yet undecided. In the US the Securities and Exchange Commission has broad regulatory powers to supervise CRAs.

The Commission has proposed two options for an effective pan-European supervision of CRAs. The first model is based on a reinforced coordination role for the Committee of European Securities Regulators (CESR) and strong regulatory cooperation between national regulators. The second option would combine the establishment of a European Agency (either CESR or a new agency) for the EU-wide registration of CRAs and reliance on national regulators for the supervision of CRAs activities within their jurisdiction.

Substantive requirements to be observed by CRAs

The main objective of the Commission's proposal on "substantive requirements", is to ensure that ratings are reliable and accurate sources of information.

The primary focus of issuers is how to achieve a targeted debt rating. As a result, the credit rating process tends to involve a level of interactive relationship between CRAs and issuers that is perceived as too close.

On this basis, the substantive requirements in the new legislation will cover issues related to the organisational structure and internal governance of CRAs, the avoidance and management of conflicts of interest, the quality of ratings and transparency obligations. The new provisions will also make it unlawful for employees involved in the credit rating process in a CRA to buy, sell or deal in any financial instruments issued by an entity rated by such CRA.

In addition to the above policies, the new legislation will introduce investor incentives to carry out independent due diligence for risk assessment and to reduce undue and excessive reliance on credit ratings. However, the new scheme does not intend to interfere with the content of ratings, for which the CRAs will retain full responsibility.


The new EU proposal comes as the Securities Industry and Financial Markets Association, Wall Street's largest lobbying group, makes alternative recommendations for an enhanced self-regulatory model for CRAs. The lessons of the subprime mortgage crisis clearly demonstrated that self-regulation does not work. For that reason, we welcome the Commission's move to regulate CRAs at EU level, as there is an urgent need to restore confidence in credit ratings and the global credit markets. The material in this article is for general information only. Professional legal advice should be sought in relation to any specific matter.