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Europe cracks down on credit rating agencies

The European Parliament is to implement stricter rules for credit rating agencies (CRAs) after their failings in the collapse of the global financial system.

Under legislation passed on April 23 and due to take effect in mid-summer, CRAs in the European Union will have to badge complex financial instruments with ratings different from their core rating system. CRAs will also be banned from carrying out consultancy or advisory work – a rule designed to avoid conflicts of interest.

A document from the European Parliament says: “Credit rating agencies are considered to have failed to reflect early enough in their credit ratings the worsening market conditions … and to adjust their credit ratings in time.”

Under the new rules CRAs must review ratings continuously, particularly when the quality of the information may have changed, and not just in annual reviews. They must also be prepared to prove they are up-to-date and “subject to a comprehensive review on a periodic basis”.

Methods and research should be as transparent as possible without revealing sensitive business information. Analysts should also include independent audits and publicly available information when making their decisions.

Other measures to boost confidence include providing rating users with historical ratings along with clarifications, setting up offices in all states in which a CRA operates, not just in its home nation, and registration with regulators.

The ruling to rate structured financial instruments seems to be aimed at sub-prime loans wrapped up by monoline insurers that begun to unravel at the start of the credit crisis in 2007.

CRAs should “clearly differentiate rating categories used for rating structured finance instruments from rating categories used for other financial instruments … by adding an appropriate symbol to the rating category.”
Deven Sharma, the president of Standard & Poor’s, says in a statement that it has already taken steps to reassure users of the integrity of its ­ratings and welcomes the rulings.

“Formal oversight by securities regulators in the EU of ratings firms’ policies and processes – combined with the ongoing intensive scrutiny of credit ratings by the market – will mean more transparency and accountability for ratings providers, and greater confidence in ratings” he says.

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