The Securities Industry and Financial Markets Association (SIFMA) Credit Rating Agency Task Force, in a comment letter to the European Commission (EC), has expressed its concerns over the nature and the scope of two proposals advanced by the EC to regulate credit rating agencies (CRAs) and to address credit ratings embedded in European Union regulation. The first, the Proposal for a Regulatory Framework for CRAs, outlines a comprehensive regime which seeks to restore confidence in credit ratings by governing the authorisation, operation and supervision of CRAs. The second offers Policy Options to Tackle the Problem of Excessive Reliance on Ratings.
“We fully support the EC’s commitment to ensure that credit rating agencies consistently provide ratings which are independent, objective, transparent and high quality,” said Deborah Cunningham, chief investment officer at Federated Investors and co-chair of SIFMA’s CRA Task Force. “At the same time, however, we believe that imposing a prescriptive regime of the kind proposed will not achieve the EC’s objectives and we encourage a less cumbersome approach that would allow the CRAs to operate their businesses independently, while still creating more transparency in ratings.”
Noting upfront that the two proposals appear to pursue mutually exclusive objectives (the first seeks to restore confidence in ratings through a comprehensive regime, while the second signals that investors should not rely on the presumably more trustworthy ratings that would result), SIFMA's Task Force response outlines a number of significant concerns about the overall proposed framework:
1. CRAs are global businesses and require a global regulatory approach. There is little evidence that the framework proposal has benefited from coordination with other branches of EU government, member states, or third countries.
2. The proposal has extraterritorial consequences. The EU cannot impose EU ratings or governance standards on third country CRAs and the requirement that a third country CRA establish a branch or subsidiary in the EU does not sit well with the global trend towards global regulatory convergence and cooperation aimed at facilitating cross-border business.
3. The proposal gives authorities the power to interfere in ratings decisions and CRAs’ independence. This would undermine market confidence. Analytical independence is the core of the rating business and should be explicitly protected.
4. The proposal establishes unduly prescriptive substantial requirements. Many of the draft rules relating to CRA conduct of business matters and conflict management are either too specific (leaving insufficient room for business judgment) or so vague that they sow confusion about what is required and how they can be enforced. The measures will increase CRA response time, increase cost, create undue risk aversion, and halt innovation in an industry that requires a fresh start and a new outlook if market confidence is to be restored.
5. The proposal does not offer workable options for supervision. The proposal goes beyond the suggested ECOFIN registration system and against the recommendations of the EC's own advisory bodies (CESR and ESME), and also fails to take account of the likely less disruptive approach of building from existing EU regimes (e.g. the ECAI regime under the CRD).
6. Certain provisions create a real risk of market disruption. The rules on ratings withdrawals and different rating symbols could result in a sell-off of securities into already illiquid markets, prolonging the market instability, loss of confidence, and economic damage to individual investors that the draft framework seeks to remedy.
7. The proposal raises barriers to entry and negatively impacts EU competitiveness. Certain provisions will, combined with the prescriptive proposed rules, contribute to raising barriers to entry in the ratings industry in Europe and damage the competitiveness of Europe’s capital markets.
8. Removing ratings from regulation could act against the EC objective of restoring investor confidence in ratings. The over-reliance on ratings, which the proposal seeks to address, should not be overstated. Credit ratings serve positive and legitimate ends and provide an important reference point that is a useful component of an investor’s risk analysis. Removing them from regulations is a drastic remedy for a limited problem, which risks destabilising the market further and harming investors. Providing additional ratings transparency that allows investors to thoroughly understand and independently check an individual rating is a better way of ensuring both that credit ratings regain the trust of investors and that the ratings are used appropriately.
Finally, the SIFMA Task Force recommends that many of the problems set out in its comment letter would be eliminated or substantially minimised via the implementation of a basic registration scheme, possibly building on the existing ECAI regime, and requiring compliance with the comprehensive disclosure-based approach of the IOSCO Code. More time is required to properly think through the most appropriate supervisory framework and rules calibration in an industry that is critical to the efficient functioning of global capital markets and the return of investor confidence.
“It is essential that any policy response to the credit crisis does not further disrupt the market and not be detrimental to the competitive posture of investors in the EU,” said Gareth Adams, executive director, regulatory strategy at FIL Investments International. “We urge the EC to reconsider the scope of this proposal and ensure that it is consistent with other global regulation, and is agile and responsive to the market.”
The European Securitisation Forum, an affiliate of SIFMA, also supports the comments and recommendations included in the letter.
About the SIFMA Credit Rating Agency Task Force:
The Task Force is a global, investor-led industry member task force formed to examine key issues related to credit rating agencies. It is comprised of 37 individuals from the US, Europe, and Asia, and includes asset managers, underwriters, and issuers who are experts in structured finance, corporate debt, municipal debt, and equity securities. More information on the Task Force, including a roster of Task Force members, can be found at www.sifma.org/capital_markets/cra-taskforce.shtml.
