Accurate credit ratings of states, companies and financial products are important to well-functioning markets and financial stability. The new rules are intended to improve credit ratings so that they reflect the true credit risk. The rules will also reduce dependency on credit ratings – both for investors and in financial regulation. The new rules will furthermore improve the possibility for investors and issuers to hold a credit rating agency liable if it fails to comply with the rules.
Minister for Economic Affairs and the Interior, Margrethe Vestager, says:
"I am very glad that all member states have agreed to a strengthening of the Regulation on credit rating agencies. The crisis has demon-strated that supervision and regulation of credit rating agencies is highly important – and with the compromise agreed today we can be more confident that credit ratings of both states and financial products are issued on a professional and qualified basis."
Minister of Business and Growth, Ole Sohn, says:
"Today the market for credit rating agencies is dominated by a few, large actors. The new agreement is therefore a positive step that strengthens the possibilities for more actors to enter the market and reduces overreliance on ratings in the financial system.
With the new rules we are also reducing the risk of conflicts of interest between a credit rating agency and its clients and improving transparency around credit ratings, pricing policies, and so on."
During the negotiations one of the central issues has been whether to introduce rules to make issuers switch credit rating agency after a certain period of time. Many Member States have been concerned that such rules would not function in practice. Therefore the Danish Presidency has prepared a compromise where these rules are limited to so-called re-securitisations, which are particularly complex structured financial products, where it may be particularly difficult for investors to evaluate the true credit risk.
The Danish Presidency will now begin negotiations with the European Parliament.
Press Secretary Søren Møller Nielsen, Ministry of Business and Growth
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Press Secretary Louise Brændstrup Bech, Ministry of Economic Affairs and Interior
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The proposal contains the following essential elements which should help reach the objectives of reduced over-reliance on ratings, reduced risk of conflicts of interest and improved competition.
In order to reduce over-reliance on external credit ratings the proposal in-troduces rules that require financial companies – e.g. credit institutions and insurance companies – not to rely solely on external credit ratings. Moreover, the proposal prohibits the European supervisory authorities from referring to external credit ratings in e.g. guidelines and technical standards, if this may result in automatic reliance on these credit ratings.
The proposal also introduces tougher disclosure requirements. For in-stance, credit rating agencies are required to arrange public hearings be-fore changes of methodologies are implemented. For structured finance (i.e. often very complex financial products), information is required to be disclosed about the risk of the products. The purpose is to improve inves-tors’ ability to make an independent assessment of the risk instead of re-lying on the credit rating.
The rules also introduce shareholder restrictions to reduce the risk that conflicts of interest will arise between a credit rating agency and its cli-ents. For instance there are limits for cross ownership of credit rating agencies. This means that agency person who owns more that 25 percent of the capital/votes in a credit rating agency is not allowed to own more than 25 percent in another credit rating agency.
Furthermore, credit rating agencies are required to disclose to the market owners who own 5 percent or more of the capital/votes in a credit rating agency. Finally, a credit rat-ing agency is prohibited from issuing credit ratings for an owner who owns at least 25 percent in the credit rating agency.
The proposal will mean that for re-securitised products, which are partic-ularly complex structured financial products, issuers who purchase credit ratings shall change (rotate) between different credit rating agencies at least every four years. This principle is supposed to promote competition in the market and reduce the risk that conflicts of interest will arise be-tween e.g. an issuer and its consumers. In the original proposal from the Commission this rule covered all issuances. However, several member states expressed concerns during the negotiations as to whether these rules would work in practice. In the compromise the rule is therefore lim-ited to re-securitised structured finance. This also means that Danish mortgage credit is not covered by the rules on rotation.
Also, a system of civil liability is introduced to improve the possibility for investors and issuers to hold a credit rating agency liable if it fails to comply with the rules. Civil liability can promote the enforcement of the rules. More harmonised rules will also reduce opportunities for credit rat-ing agencies to establish themselves in countries where the rules are more accommodating or unclear. The Commission initially proposed to intro-duce a principle of shared burden of proof, where the credit rating agency had to prove that it did not infringe the regulation, on the basis of facts put forward by the complainant which document a possible infringement. This principle however deviates from the normal point of departure where the complainant has to prove his case. Taking into account significant concerns from member states regarding legal certainty etc., the principle of shared burden of proof is not included in the final compromise text.
Finally, the new rules introduce a number of requirements regarding sov-ereign credit ratings. For instance, the entire analysis on which the credit rating is based has to be disclosed. This way the investors themselves can assess whether they want to use the credit rating. At the same time this improves the ability of the sovereign to deal with the credit rating. Sovereign credit ratings are now required to be updated every half year – and not only every year as at present.
Overall, the rules are intended to promote the issuance of credit ratings - of issuers, states and financial products - on a professional and qualified basis and reduce the reliance of the financial system on credit ratings.