Credit Rating Agencies under tethers?
Credit rating Agencies ("CRAs"), such as Moody's, Standard &
Poor's, and Fitch, make part of the core framework of the capital
markets. Their role has traditionally been that of opinion givers
concerning the creditworthiness of particular obligors and their
securities. In the 1930's bank regulators adopted the opinions or
credit ratings of CRAs into their regulatory framework by requiring
from banks to hold only securities that have been rated at the
least "investment grade" by at the least one nationally recognized
CRA. The role of CRAs was cemented into law by the American
securities regulator, the S.E.C., in 1975, by exempting broker
dealers from the net capital requirements rules in case of
securities rated at the least "investment grade" by a nationally
recognized CRA. The role of CRAs expanded into other areas of the
financial markets, such as governmental and municipal financial
regulations, and international banking regulation, most notably the
Standardized Approach of the Basel II framework.
The role of CRAs in the structured finance market, which grew
exponentially in the beginning of the twenty-first century, has
shifted more and more from pure opinion giving to the facilitation
of structured finance transactions. CRAs have been heavily
criticized during the current crisis, and radical measures have
been taken to regulate the credit rating industry. While new
measures are under way, such as the rule by the S.E.C. that
prohibits a nationally registered CRA to issue or maintain a credit
rating on an obligor or security where the credit rating agency, or
an affiliate, made "recommendations" to the obligor or the issuer,
underwriter or sponsor of the security about the corporate or legal
structure, assets, liabilities or activities of the obligor or
issuer.
In the European Union, the European Commission has proposed a
Regulation concerning CRAs, which is currently on the vote at the
European Parliament. According to the proposed Regulation, "Credit
rating agencies are considered to have failed, on the one hand, to
reflect early enough in their credit ratings the worsening market
conditions and, on the other, to adjust their rating in time
following the deepening market crisis." The intense collaboration
of CRAs in relation to structured finance transactions has also
raised the issue of the liability of CRAs.
According to the Regulation, CRAs are required to register with
CESR ("the Committee of European Securities Regulators") to issue
credit ratings in the E.U. The measures of the EU include
furthermore that a CRA is prohibited from granting consulting
services, for example with regard to the design of a structured
finance instrument, and that a CRA should exclusively limit itself
to issuing credit ratings. The EU proposes that credit rating
analysts may not work for more than four consecutive years on the
assessment of the same entities (Article 6(4) of the Regulation);
and that they may not be rewarded according to the extent of income
their credit ratings generate (Article 6(6) of the Regulation).
CRAs must also have a sufficient number of people employed with
appropriate knowledge and experience, for example to serve the
structured finance market. The EU proposes that the body or part of
the board of a CRA that supervises the board must at least have
three independent non-executive directors. Another important
measure that the EU proposes is to curb the so-called practice of
"rating shopping", in which issuers call round at the
various CRAs for a desired rating. The EU aims to achieve increased
transparency and integrity by, respectively: 1) keeping data and
making them public; and 2) adopting procedures to prevent abuse of
relevant non-public information, unpermitted conflicts of interest,
forms of abuse of market position, and practices deviating from
established methodologies within the CRA.
The supervisors are equipped with far-reaching investigative
powers for this purpose, in particular access (on site) to all
data, documents and communications. As the big stick, supervisors
can press for the repeal of the official registration of a CRA;
demand that certain practices that go against the Regulation are
ceased; halt the activities of a CRA temporarily with effect in the
whole E.U.; issue public warnings if the obligations in the
Regulation are not complied with; take appropriate measures to
further compliance with those obligations; and present cases for
criminal prosecution (Articles 20 and 21 of the Regulation).
Kennedy Van der Laan organizes a symposium concerning CRAs to
facilitate a debate around the central themes of the public and
private accountability of CRAs. The symposium will be held at the
Ketelhuis in Amsterdam on July 2, 2009, from 03:00pm - 07:00pm.
The symposium starts with a lecture by Professor Lawrence J.
White of the NYU Stern School of Business, who will address the
role of CRAs in the financial markets, in particular the structured
finance market. Next, Deniz Coskun of Kennedy Van der Laan will
give a lecture concerning the upcoming European regulatory
framework and the liability issues CRAs (may) face.
After the lectures, there will be a panel discussion moderated
by Professor Joseph A. McCahery, University of Amsterdam and
Director of the Amsterdam Center for Corporate Finance. The
panellists consist of Gerben Everts of APG/Eumedion, Jan Maarten
Slagter of the Vereniging van Effectenbezitters (VEB), Lawrence
White of NYU and Deniz Coskun of Kennedy Van der Laan. The panel
will discuss questions such as the responsibility of CRAs in the
financial markets, the public regulation of CRAs, and market
discipline, for example, in the form of civil law liability.