EU Tweaks Rules for Rating Agencies

Yesterday the EU announced new rules of the conduct of rating agencies in terms of their sovereign assessments. The rules appear aimed at making the changes of ratings less disruptive for the both issuers and investors, but does not appear to impact the substance of decisions or curtail their use.

Starting at the end of this year, the rating agencies must publish a calendar of dates for the year ahead of its sovereign rating reviews. The rating agencies will be restricted to three assessments a year of sovereigns who have neither asked not paid for a review. Such countries include Germany, France, Italy and the UK (and the US). Of the 128 sovereign ratings S&P provides, for example, 15 qualify as unsolicited, according to their website.

Rating agencies must give all sovereign issuers one full day notice of any changes before the public announcement and must review each every six months.

In Europe, the rating agencies fall under the authority of a single regulator, the European Securities and Markets Authority since 2011. Here in Q2, the Economist Intelligence Unit and Dagong Europe Credit Rating Sri (China-based)were recognized by the ESMA. There is some flexibility built into the new rules, but require a case-by-case request to the ESMA.

Some observers warn that the new rules could inject new volatility around the announcement of the reviews, which investors will know about well in advance, given the requirement of a calendar a year in advance.  While there is some merit in such claims, the volatility needs to be evaluated against the current system where the timing of the announcement seems random or unpredictable.   Countries, like Spain, for example, where the current rating is just above a key threshold (investment grade status, in this case), may indeed see more volatility ahead of the pre-announced review date.  However, it seems that the new rules  will shift some of the volatility to before the fact rather than after the fact.

Claims that the EU rules are a form of financial protectionism seems wide of  the mark.  The establishment of clear rules of engagement serves investor interest as well as issuer.  Increased transparency is a proper objective.  There does not appear to be anything in the rules that impact the substance of decisions.  Nor should the new rules increase the cost of credit.

Earlier in the crisis, Nobel-prize winning economist Joseph Stiglitz quipped that the markets should be like a prize fight, but instead, without clear and transparent rules and a strong referee, we get a bar room brawl.   In this light, the EU’s decision should be welcomed.

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