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Self-regulation based on voluntary compliance with the IOSCO code does not appear to offer an adequate, reliable solution to the structural deficiencies of the business, the proposal says.
Although some of the proposed rules are based on the standards set in the IOSCO code giving them a legally binding character, it recognizes that it has “some limitations that need to be overcome”. Most importantly, the code provides no enforcement mechanism but only invites credit rating agencies to give reasons if they do not comply with it.
“This proposal goes further than the rules existing in any other jurisdiction in the world”, Commissioner McCreevy said in his presentation. “While we are setting standards for the EU we want these to become global standards and we will discuss them with our main international partners with that objective in mind.”
The proposal has four overall objectives:
Ø to ensure that credit rating agencies avoid conflicts of interest in the rating process or at least manage them adequately;
Ø to improve the quality of the methodologies used by credit rating agencies and the quality of ratings;
Ø to increase transparency by setting disclosure obligations for credit rating agencies;
Ø to ensure an efficient registration and surveillance framework, avoiding ‘forum shopping’ and regulatory arbitrage between EU jurisdictions.
The proposal introduces a registration system for credit rating agencies wishing to operate within the European Union. It may also prevent CRAs from offering consulting services in addition to ratings when this may lead to conflicts of interest.
Furthermore, rating agencies will become subject to surveillance of the securities supervisors and will have to reform their internal governance structure.
They should have at least three independent directors on their boards whose remuneration cannot depend on the business performance of the rating agency. They will be appointed for a single term of office which can be no longer than five years. They can only be dismissed in case of professional misconduct. At least one of them should be an expert in securitization and structured finance.
CRAs will need to disclose the models, methodologies and key assumptions on which they base their ratings, will be obliged to publish an annual transparency report, and will have to create an internal function to review the quality of their ratings.
To avoid conflicts of interest:
Ø a CRA will have to disclose to the public the names of the rated entities from which it receives more than 5 % of its annual revenue,
Ø a CRA will not be able to issue a credit rating or will have to withdraw an existing credit rating when itself or its analyst involved in the credit rating have ownership of financial instruments in the rated entity or control links,
Ø a CRA will not be allowed to provide consultancy or advisory services to the rated entity or any related third party regarding the corporate or legal structure, assets, liabilities or activities,
Ø a CRA will only be entitled to provide ancillary services in case they do not present conflicts of interest with its rating activity,
Ø analysts will not be allowed to make proposals or recommendations, either formally or informally, regarding the design of structured finance instruments on which the CRA is expected to issue a rating.
Appointed European Parliaments ECON rapporteur Wulf Klinz (ALDE/DE) welcomed the proposal. “However, the proposal does not yet solve the problem of the lack of competition”, he said and already announced to improve it to “significantly lower market entry barriers” in
Discussion in ECON will take place on 1 and 2 December. A special workshop on CRAs is planned for the 4th of December. Mr Klinz intends to publish his draft report on 20/21 January 2009. Vote in Plenary is planned for 30 March followed by the vote in plenary in April