BRUSSELS: European Union regulators yesterday proposed strict new rules for credit rating agencies that would hold them liable for their opinions and stop them from advising banks on how to get top debt ratings.
The EU's financial services chief Charlie McCreevy said the "very exacting rules" were needed to restore confidence in ratings. Complex investments that turned out to be far riskier than originally rated have played a role in unleashing the global financial crisis.
"The reputation of credit rating agencies over the past year-and-a-half has gone down," he told reporters. "I was quite amazed in 2006 and 2007 about the tardiness of the credit rating agencies to respond then to the emerging turmoil" from rising defaults in US subprime housing loans given to people with poor credit, he said.
The requirements would mean big changes for New York-based Standard & Poor's, a business segment of publisher McGraw-Hill, and Moody's Corp. Most investments require two ratings, and these two companies mop up the bulk of the market.
The EU executive wants credit rating agencies to be supervised by European regulators for the first time, to require them to take steps to prevent conflicts of interest and to ask them to prove that they understand the risks of the debt they examine.
The commission said rating agencies "contributed significantly to the current problems in the financial markets" because they underestimated the risk that securitised - or repackaged - debt would not repay loans.
Investors, among them many European banks, were encouraged to buy these investments because they carried top ratings, it said. Losses on them have torn a huge hole in the balance sheets of European as well as American banks, leading to costly government bailouts.
The new rules will need the backing of EU governments and the European Parliament and could become law as soon as 2010.
Under the proposed rules, the agencies would no longer be able to claim that ratings are "just opinions", McCreevy said, and could face EU sanctions if found guilty of professional misconduct. That would see them lose their licence to rate debt in the 27-nation bloc.
They would not be allowed to provide lucrative advisory services that saw them help banks structure investments to win coveted top ratings. This business led to accusations that agencies were open to conflicts of interest because they are paid by the banks whose debt they rate.
Only highly-rated debt can be sold to pension funds and insurance companies under international banking guidelines.
The US is also considering banning rating agencies from doing consulting work for bond issuers.
Under the EU proposal, agencies would have to quit rating securitised investments if they can't prove that they have good quality information or staff with enough experience and training to make well-based decisions. They would also have to disclose the models and assumptions they use for rating debt.
They would have to review their own ratings and appoint at least three independent directors to their board, including one expert in securitization and structured finance. They could not receive bonuses based on the agency's business performance and could only be dismissed if they break business ethics.
S&P spokesman Martin Winn said many of the EU's proposals were already standard practice at its ratings unit. Analysts are not involved in the consultancy business and their pay is not linked to fees paid by the issuers they rate, he said.
S&P, Moody's and smaller rival Fitch Ratings Inc all said they wanted any new requirements to be in line with regulation in other parts of the world.
That may not be the case. McCreevy was clear that the EU rules would go further than the US - but said he wanted to export them to other regions and make them global standards
McCreevy said many investors had also caused their own woes because instead of "having their own due diligence and appropriate credit risk management, they all started to rely on credit ratings as doing the job for them." - AP
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