The FSA is planning to supervise credit rating agencies to deal with conflicts of interest.
The Turner review calls for agencies to be registered so financial regulators can play a supervisory role, coordinated at European level via colleges, to manage conflicts of interest. It supports EU legislation to address governance and conduct of agencies.
Jubilee Financial Products CEO Adam Habib says: “It is important the Government and the regulators speed up and enhance clarity for investors. You cannot have people making investment decisions based on so-called independent valuations when the independence of that methodology is questionable.”
Baronworth Investment Services director Colin Jackson says: “It is a question of whether you can place reliance on the ratings. If you are paying an organisation you expect something in return, but if the agencies are not paid by the people they are rating, then what is the fairest way for them to be funded?”
The FSA is calling for a fundamental review of the use of structured finance ratings in the Basel II framework, noting their role played in the financial crisis. It says the instability of ratings has had a procyclical effect, undermining confidence in future stability and sometimes prompting deposit withdrawals.
The review says ratings have not always been robust in their predictions of events and because they have been extended to cover instruments where there is limited historical experience of their performance. It points to a misplaced confidence in the ability of mathematical modelling to define risks.
The review says: “Rating agencies and regulators should ensure communication to investors about the appropriate use of ratings makes clear they are designed to carry inference for credit risk, not liquidity or market price.”