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What Reforms for the Credit Rating Industry? A European Perspective

Journal 32: Applied Finance

Karel Lannoo

Credit rating agencies were the first victim of the crisis, with a regulation adopted in a period of six months – a record by E.U. standards. The regulation subjects E.U.-based CRAs to a mandatory license and strict conduct of business rules, whereas, unlike in the U.S., no rules had been in place before. This article discusses the role of credit ratings agents today, the regulatory role of ratings, the scope of the E.U. regulation, and the regulatory approach of the business models of the large ratings agents. It concludes that the regulation should have impacted the business model of ratings agents more fundamentally.

Credit rating agencies (CRAs) continue to find themselves in the eye of the storm. Despite having singled out the industry early on in the financial crisis as needing more regulation, policymakers seem not to be reassured by the measures that have been adopted in the meantime, and want to go further. Faced with a rapid downgrading in ratings in the context of the sovereign debt crisis, European Commissioner Michel Barnier raised the possibility last May of creating a new E.U.-level agency that would specialize in sovereign debt and regulating CRAs.

The debate on the role of rating agents considerably pre-dates this crisis. As early as the 1997 South-East Asia crisis, the delayed reaction of rating agents to the public finance situation of these countries was strongly criticized. The same criticism of CRAs was leveled in the dot.com bubble in 2001. Many reports were written on their role in that episode, but it was not until mid-2008 that a consensus emerged in the E.U. that the industry was in need of statutory legislation. In the meantime, the U.S. had adopted the Credit Rating Agency Reform Act in 2006. At the global level, in 2003, the International Organisation of Securities Commissions (IOSCO) adopted a Statement of Principles on the role of credit rating agencies, but apparently the initiative has not been successful.

Rating agents pose a multitude of regulatory problems, none of which can be solved easily. Some of these are specific to the profession and the current market structure, whereas others are of a more generic nature. Some are related to basic principles of conduct in the financial services sector, while others are part of horizontal market regulation. The financial crisis also demonstrated the important role of rating agents in financial stability, which involves macro-prudential authorities.

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