18 December 2014

European Voice: Rules put pressure on credit-rating agencies

European Union efforts to reduce the influence of credit-rating agencies (CRAs) continue unabated, with new rules coming into force on Sunday (21 December) requiring the managers of pension schemes and investment funds to reduce their reliance on credit agencies. The rules require fund and pension managers to ensure that their risk management processes do not “solely…rely on credit ratings issued by credit-rating agencies”.

The three big CRAs – Moody’s, Fitch, and Standard and Poor’s – dominate the global market for credit ratings. In 2011, the three US-based firms accounted for 95% of the EU market, according to the European Parliament. But the CRAs came under criticism for their role in the global financial crisis and in the eurozone’s sovereign-debt crisis.

The first charge against them was that they wildly underestimated the dangers associated with certain complex financial products. In the run-up to the financial crisis, the big three gave their highest ratings to subprime mortgage-backed securities and collateralised debt obligations. By 2010, the CRAs had downgraded such products to a ‘junk’ rating.

That failure led to a first round of EU regulation, which sought to introduce greater competition into the market, to impose liability on CRAs for negligent assessments, and to reduce the scope for conflict of interests, since CRAs would often be assessing financial products produced by their subscribers.

A second wave of EU legislation followed in the wake of the eurozone sovereign- debt crisis. EU officials accused the agencies of aggravating the crisis by downgrading Greek and Irish debt to ‘junk’ status in a surprise 2011 decision.

With the new rules, the EU aims to edge closer to its goal of creating greater competition between CRAs.

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