At the beginning of the crisis, CRAs were heavily criticised for being far too optimistic: this related to their role regarding structured products. Now they are criticised for being too pessimistic: this is related to their role in rating sovereign debt. Considering these opposing directions of criticism, both areas of criticism merit further discussion.

Major CRAs played a key role in the near financial meltdown at the start of the financial crisis. The so-called “CDO machine” would not have worked without the active role played by the leading CRAs. They have contributed in lowering the perception of credit risk by giving top credit ratings to the senior tranches of complex structured products. The inflation of credit ratings was accompanied by a major underestimation of the credit default risks of such instruments. These flaws were the result of inaccurate rating methodologies. The conflicts of interest in CRAs made matters worse. The issuer-pays model, and the drive for more profits, resulted in the accommodation of investments bankers bringing the business. Issuers shopped around CRAs to ensure they could get an AAA rating for their products. Considering that we are now able to look back at the ratings given to structured products, we have objective measures of the very poor performance of ratings in this area.

The issues related to sovereign debt ratings are of a different nature. The European sovereign downgrades highlight the risks from spillovers across countries and financial markets. Downgrading of one country might trigger downgrades of other countries. And as ratings affect borrowing costs, there is the risk of a self-fulfilling prophecy. These potential stability effects of ratings only reinforce the importance of strong CRA supervision.

CRAs have been criticised for downgrading sovereigns and thereby increasing their fiscal problems. However, it is clear that there are serious fiscal problems in downgraded countries, and we do not yet have the historical perspective which we have for the structured product ratings. This makes judging the performance of sovereign debt ratings more difficult. Indeed, given the difficulty in judging the performance without the benefit of time, Mr Maijoor suggests strongly the need to avoid overreliance on ratings.

Supervision of CRAs in the EU
Given the failures in the financial crisis it is only logical to establish a solid regulatory and supervisory framework for CRAs. Looking back, it is surprising that until recently we have relied on very light regulations, or no regulations at all, for financial institutions that have such an important role in financial markets.

There have been intensive debates as to how best to ensure effective and efficient regulation and supervision of CRAs. Several policy actions have been initiated and new regulatory frameworks have been introduced, both inside the EU and outside the EU, including the US. Having their lessons learned and confronted with increasing pressures from supervisors and the general public, CRAs have also taken actions. They have revised their models and methodologies, increased the disclosure and transparency, and they have adjusted their internal structures and processes. Of course, this is also related to the fact that CRAs are now involved in the registration process and need to meet new requirements.

The first main EU regulatory initiative is the CRA Regulation of September 2009, which Mr Maijoor discusses in more detail later in his speech. However, in December 2010 the European Parliament decided on a very important revision of this young regulation. As from the first of July, ESMA will be the sole supervisor of CRAs in the EU. National supervisors will remain responsible for the supervision of the use of credit ratings by financial institutions, and can request ESMA to withdraw the registration of a CRA. In addition, ESMA may also delegate specific tasks to national authorities, in particular in respect of the on-site inspections.

This new Regulation is a major change of the European framework of CRA supervision compared with the previous regulation adopted in September 2009. This change is only very logical considering that credit ratings are used throughout the EU. Also, a model with supervisory colleges is not an optimal solution when CRAs are active in a large number of Member States. Therefore, the establishment of ESMA combined with the decision for one EU CRA supervisor is very logical.

EU regulatory framework and supervision
The new Regulation on CRA, the so called CRA II, was passed on 11 May and will be issued within the coming days. The new framework will very substantially increase the regulatory and supervisory powers of  ESMA regarding CRAs established in the EU. Indeed, all competencies and duties related to supervisory and enforcement activities in the field of credit rating agencies, which were conferred on the competent authorities, will move to ESMA on the first of July 2011. From this date, ESMA will be exclusively responsible for the registration and supervision of credit rating agencies in the Union. The only exception to this is applications for registrations that were received by 7 September 2010 and which will be decided on by national competent authorities and colleges of supervisors established for the registration of EU cross border CRAs.

Three main elements of the European regulatory approach to CRAs can be identified, namely (1) the registration requirement; (2) rules of conduct for registered CRAs; and (3) the supervision of registered CRAs.

Possible further changes to the regulatory framework for CRAs
In the fall of 2010, the European Commission has consulted on possible new initiatives regarding CRAs. Mr Maijoor fully supports this continued debate on the proper framework for the sector. One issue that has come clearly out of this debate is the need to limit mechanistic reliance on ratings. There is broad support for this need, although we should realise that there is a limit to reducing reliance: as stated earlier, CRAs are simply an important and inevitable element of well-functioning financial markets.

Another remark Mr Maijoor would like to make is that he is a bit cautious to make at this stage further fundamental changes to the current newly created supervisory system. The new supervisory framework needs to be implemented and to have its full effect on the way in which CRAs work. Once the new system has its full impact on the day-to-day operations of CRAs, we can better assess where further improvements are needed. This word of caution is not at all a sign of complacency. It is clear to Mr Maijoor that if the industry and the new supervisory system do not deliver a proper functioning system this time, it will dramatically affect the reputations of all parties involved and further sweeping changes will then be unavoidable. Hence, we all have strong incentives to make the new system work.

Full speech