Question

Discuss the way forward for CRA's, with reflection on the EU position.

Answer 1

Credit ratings help investors and lenders to understand the risks associated with a particular investment or financial instrument. However, over-reliance on credit ratings may reduce incentives for investors to develop their own capacity for credit risk assessment.

In the period leading up to the financial crisis in 2008, credit rating agencies (CRAs) failed to properly appreciate the risks in more complex financial instruments. For instance, structured finance products backed by risky sub-prime mortgages were issued with incorrect ratings that were far too high.

During the subsequent euro area debt crisis, certain countries were faced with abrupt bond sell-offs and higher borrowing costs following a downgrade of their credit rating.

n response, the Commission made proposals to strengthen the regulatory and supervisory framework for CRAs in the EU, to restore market confidence and increase investor protection. The new EU rules were introduced in three consecutive steps.

• The first set of rules, which entered into force at the end of 2009, established a regulatory framework for CRAs and introduced a regulatory oversight regime, whereby CRAs had to be registered and were supervised by national competent authorities. In addition, CRAs were required to avoid conflicts of interest, and to have sound rating methodologies and transparent rating activities.
• In 2011, these rules were amended to take into account the creation of the European Securities and Markets Authority (ESMA), which supervised CRAs registered in the EU
• A further amendment was made in 2013 to reinforce the rules and address weaknesses related to sovereign debt credit ratings. Way forward

• The latest legislative package on CRAs consists of a regulation (Regulation No 462/2013) and a directive (Directive 2013/14/EU). These laws seek to

• reduce over-reliance on credit ratings
• increase transparency regarding the issuing of sovereign debt ratings
• improve the quality of the rating process and make credit rating agencies more accountable for their actions
• reduce conflicts of interest and encourage a greater number of actors to operate in the credit rating market