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The wait is over. The EU Regulation1 (the “Regulation”) on credit rating agencies (“CRAs”) was published in the Official Journal of the European Union on 17 November 2009 and will become effective, subject to certain exceptions, on 7 December 20092. The Regulation represents a fundamental change in the regulatory landscape for CRAs, banks and other market participants investing in rated products in Europe.
The main aspects of the Regulation include:
The Regulation takes a prescriptive, rules-based approach. Its complexity leaves many questions unanswered3.
The following are the main transitional provisions set out in the Regulation:
The Regulation applies to credit ratings issued by CRAs registered in the EU and which are disclosed publicly or distributed by subscription. The Regulation does not apply to, inter alia, (i) private credit ratings produced pursuant to an individual order and which are not intended for public disclosure, and (ii) certain ratings issued by central banks.
Credit ratings to which the Regulation applies cannot be used for regulatory capital purposes by banks and other financial institutions in the EU unless:
The endorsement regime contains stringent requirements including:
The equivalence regime also contains stringent requirements including:
CESR and the competent authorities of the Member States where CRAs are established will supervise the rating activities of CRAs in Europe. Although the EU regulators will not be involved with the substance of the rating process, extensive powers relating to registration requirements, withdrawal and suspension of registration, supervision and enforcement are given to CESR6 and the national authorities.
The Regulation imposes on CRAs duties of independence and avoidance of conflicts of interest including detailed organisational and operational requirements.
Organisational requirements. CRAs have to ensure that:
Operational requirements. CRAs are required to:
In addition, CRAs are prohibited from:
The Regulation introduces a comprehensive transparency and disclosure regime for CRAs. The relevant requirements include disclosure of:
More stringent (and controversial9) obligations are imposed on CRAs in respect of the rating of structured finance instruments, such as:
A statutory duty “not to rate” or to withdraw an existing rating has been expressly provided by the Regulation where “the lack of reliable data or the complexity of the structure of a new type of financial instrument or the quality of information available is not satisfactory or raises serious questions as to whether a credit rating agency can provide a credible credit rating”. The effect and enforceability of such a duty is questionable.
The registration process and supervision procedures are complicated, involving all Member States where a particular rating is used (deliberating through a college chaired by a facilitator) and, at a higher level, CESR. These requirements have been criticised as being likely to create unnecessary regulatory costs and inefficiencies, including:
The Regulation does not prescribe specific penalties for breach. This is instead left to be determined by the Member States, raising the potential for disparities between penalties levied by different Member States. These issues raise the risk of regulatory arbitrage. In determining their jurisdiction of operations, CRAs are likely to take into account criteria including the sophistication and responsiveness of the Member State’s regulator, their ability to cooperate with other regulators within the EU and overseas and the penalties imposed by the Member State’s regulator for breach of the Regulation.
The Regulation gives Member States and CESR far-reaching powers over CRAs and their activities in Europe. In particular, the authorities of the relevant home Member State and, in certain circumstances, the authorities of the other Member States where a rating is used, may, if it has been established that a breach of the Regulation by a CRA has occurred:
The authorities of the Member States will also have extensive powers to access documents from CRAs, demand information and carry out on-site inspections without announcement.
Many of these powers conferred on the authorities of the Member States and CESR may be exercised where the relevant Member State has “established that a registered credit rating agency is in breach of the obligations arising from this Regulation”10 following notification to the facilitator and consultation with the members of the college but without, at present, a right of CRAs to object or be heard.
The impact that the Regulation will have on the credit rating business in Europe is potentially significant. Many aspects of the Regulation such as the rules on disclosure of rating information and the conflicts of interest rules may help to increase market efficiency and restore investor confidence. Other aspects of the Regulation such as the lack of due process, the procedural complexities and the perceived lack of global approach may increase regulatory inefficiencies and costs. It is the explicit intention of the Regulation not to interfere with the substance of credit ratings. This raises the question whether regulating the conduct of the credit rating business without supervising the merits and contents of the rating activity itself, will prove to be adequate.
1 See Regulation (EC) No 1060/2009 of the European Parliament and of the Council of 16 September 2009 on credit rating agencies available at http://ec.europa.eu/internal_market/securities/agencies/index_en.htm.
2 The Regulation becomes effective twenty days after the date of its publication in the Official Journal of the European Union i.e. 17 November 2009 (see Article 41).
3 See Nick Shiren and Marco Crosignani, “Regulating Rating Agencies: Local Power, No Solution” IFLR, July/August 2009, 40.
4 See EU Commission, “Request for CESR technical advice on the equivalence between certain third country legal and supervisory frameworks and the EU Regulatory regime for credit rating agencies”, 12 June 2009 available at http://ec.europa.eu/internal_market/securities/agencies/index_en.htm.
6 See CESR, “Guidance on Registration Process, Functioning of Colleges, Mediation Protocol, Information set out in Annex II, Information set for the application for Certification and for the assessment of CRAs systemic importance”, 21 October 2009 available at http://www.cesr-eu.org/popup2.php?id=6142.
7 Ancillary services comprise “market forecasts, estimates of economic trends, pricing analysis and other general data analysis as well as related distribution services” (Annex I, Section B, Item 4).
8 A “structured finance instrument” is defined in Article 3(l) as “a financial instrument or other asset[s] resulting from a securitisation transaction or scheme referred to in Article 4(36) of Directive 2006/48/EC”; “securitisation” is defined as “a transaction or scheme, whereby the credit risk associated with an exposure or pool of exposures is tranched, having the following characteristics: (a) payments in the transaction or scheme are dependent upon the performance of the exposure or pool of exposures; and (b) the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme” (Article 4(36) of Directive 2006/48/EC).
9 See Nick Shiren and Marco Crosignani, “The New Rating Regime for Structured Finance Investments in Europe”, The Journal of Structured Finance, Fall 2009, 52.
10 See Articles 24 and 25.