Regulatory Governance of Credit Rating Agencies in the EU: The Perils of Pursuing the Holy Grail of Rating Accuracy

This paper argues that the EU Regulation of credit rating agencies is concurrently pursuing two objectives that conflict with and would undermine each other. One is the objective of enhancing rating accuracy, and the other is the objective of restoring market discipline in the wholesale investment markets for credit ratings as information goods. The Regulation places more emphasis on regulating for rating accuracy which has the effect of instituting a form of product regulation for credit ratings, raising the public interest profile of credit ratings. This paper argues that this is undesirable and is contrary to policy-makers’ endeavours to enhance market discipline for rating quality and the private accountability of credit rating agencies. EU policy-makers would eventually need to confront the underlying conflicting objectives in the Regulation so that a normatively coherent and consistent regulatory regime can be designed and implemented.

Credit rating agencies play an important part in securities and bond markets as they provide information signals to investors, assisting and even replacing investor due diligence. Coffee has described the credit rating agencies’ role as a gatekeeper, providing an information service to facilitate market-based discipline in the securities markets. In the wake of the global financial crisis, credit rating agencies’ inflated ratings for sub-prime structured products were called into question and the EU quickly decided to regulate them. The EU Regulation on Credit Rating Agencies was one of the earlier pieces of reform legislation passed in September 2009 pursuant to the de Larosière report. When the European Securities and Markets Authority (ESMA) was formally established in end 2010, amendments were made to the Regulation in order to designate ESMA as the European Securities Markets Authority for credit rating agencies, undertaking the role of registration and approval, standard-setting and ongoing supervision and enforcement, replacing a fragmentary coordinated approach to registration, supervision and enforcement undertaken by a college of national supervisors. This young Regulation is now subject to another round of prospective reforms.

The global financial crisis has been partly attributed to the flawed quality of credit ratings concerning complex collaterised debt obligations rated by credit rating agencies. The overly exuberant market for structured products, which collapsed in the financial crisis, was supported by overly optimistic ratings issued for the products and investors’ unquestioning reliance on such ratings. Excessive reliance on credit ratings by investors exposed a problem of failure of market discipline for credit ratings. The problem of flawed credit ratings could be attributed to a number of factors including perverse incentives on the part of credit rating agencies.

The EU Regulation addresses both of the problems mentioned above. However, in doing so, the Regulation produces the following effects: The Regulation on the one hand desires to diminish the public interest profile of credit ratings so that excessive reliance on them would not be encouraged; but on the other hand provides a legal framework which would likely increase the public interest profile of credit ratings by enhancing rating accuracy. This paper discusses both aspects of the Regulation, the essential conflict between pursuing both objectives and the choice that policy-makers should make

Copyright: © Lexxion Verlagsgesellschaft mbH
Quelle: Issue 02/2013 (Juni 2013)
Seiten: 18
Preis inkl. MwSt.: € 41,65
Autor: Iris H-Y Chiu

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