European Union lawmakers today approved new rules for credit ratings agencies designed to promote transparency and to help ensure such firms are free from conflicts of interest.
The $5 billion-a-year ratings agency industry, led by Standard & Poor's and Moody's, has in recent months come under heightened scrutiny on both sides of the Atlantic for failing to adequately warn investors of risks underlying mortgage-backed securities tied to subprime loans.
Under the new rules, firms seeking to issue credit ratings in the EU would need to register with the Committee for European Securities Regulators (CESR), while a "college" of regulators would monitor an individual agency on a day-to-day basis.
Arguing credit ratings agencies contributed "significantly" to problems now affecting global capital markets, European Commission officials noted the rules would bar firms from providing advisory services and from rating financial instruments "if they do not have sufficient quality information to base their ratings on." The rules also force firms to disclose the models, methodologies and key assumptions upon which they base their ratings, officials noted in an April 23 press release.
With regard to transparency and accountability, credit ratings agencies will be required to publish an annual "transparency report" and to have at least two independent directors on their boards whose pay cannot be based on firm performance and who can be dismissed only in cases of professional misconduct. At least one of the directors must be an expert in securitization and structured finance, and terms would be capped at a maximum five years without the ability to re-nominate.
The new rules "will help give investors the information, integrity and impartiality they need from credit rating agencies if they are to make prudent investment decisions that create growth and jobs instead of bubbles of excessive risk," European Commission President José Manuel Barroso said. The rules "… are the latest example of the EU leading the world in responding to the economic and financial crisis, restoring confidence and preventing a repeat."
The rules received strong backing from EU parliamentarians who voted 569-47 in favor of the measures.
In the U.S., meanwhile, regulators and others also are focusing on potential credit ratings agency reform. At an April 15 roundtable, U.S. Securities and Exchange Commission chair Mary Schapiro acknowledged the need for ratings agency reform, telling attendees the firms' evaluation of securities backed by residential subprime loans, and the collateralized debt obligations linked to such securities, has "shaken investor confidence to its core."
U.S. investor organizations, including the Washington-based Council of Institutional Investors, also have actively backed credit ratings agency reform efforts calling for greater accountability and stronger oversight of such firms. In a CII-commissioned paper released earlier this month, the authors call for enhanced oversight by creating a new credit rating agency oversight board or supplementing the SEC's authority to substantively regulate rating agency practices. Notably, the paper also recommends removing rating agencies' exemption from liability under the Securities Act of 1933, and to make Nationally Recognized Statistical Rating Organizations, such as credit raters, subject to private rights of action under the anti-fraud provisions of the securities laws.