The European Securities and Markets Authority (ESMA) has published two sets of Technical Advice and a Report on the regulation of credit rating agencies (CRAs) in the EU. These papers provide an overview of competition and give insight into the market dynamics of this industry. They also consider measures to provide stronger controls around credit ratings for structured finance instruments and to reduce reliance on credit ratings.

The Report finds that the EU CRA Regulation has improved the governance and operation of CRAs but that it is too soon to comprehensively assess the impact of measures regarding competition and conflicts of interest included in the CRA Regulation of 2013. ESMA’s key findings at this stage are:

  • The dynamics of the CRA industry are more complex than initially foreseen as most of the 24 CRAs now registered in the EU focus on a particular asset class or Member State. Only the largest CRAs offer credit ratings for all different asset classes throughout the EU and globally;
  • The high fees charged and regular fee increases imposed by some CRAs suggest there may be little effective competition for the provision of credit ratings in some specific market segments within the EU at present;
  • Following the financial crisis, the CRA Regulation aimed to improve investor confidence and stimulate competition for the provision of structured finance ratings, but ESMA finds that the measures adopted have had little impact to date. The provisions relating to the mandatory rotation of CRAs rating certain re-securitisations have not yet been used in practice as the re-securitisation market has not recovered since the financial crisis. Equally, measures requiring multiple credit ratings for structured finance instruments have had little impact as they represent existing market practice; and
  • Regarding reducing reliance on ratings, references to credit ratings still remain in national and EU legislation, as well as within the collateral frameworks of some central banks. As it may not be practical to remove all of these references, ESMA notes future action should focus on mitigating mechanistic reliance on credit ratings rather than removing them from legislation entirely.

Steven Maijoor, ESMA Chair, said:

“The financial crisis made it clear that reforming the CRA industry was imperative in order to have safer financial markets and I am pleased to report that the resulting legislation and our role as direct supervisor of CRAs are having a positive impact.

“While it is encouraging to see that changes are taking place, we are realistic and know there is still work to be done which is why we have made recommendations relating to further supervisory powers regarding the appointment of independent non-executive directors and enhanced enforcement powers.”

In particular, ESMA makes two recommendations:

  • It would benefit from further supervisory powers regarding the appointment of independent non-executive directors by CRAs; and
  • Its enforcement powers would be more effective if all requirements of the CRA Regulation had a corresponding infringement and if fines could better reflect a CRA’s turnover to ensure they have a proportionate and deterrent effect on CRAs of different sizes.
Next steps
The European Commission will consider ESMA’s Technical Advice and Report and then issue its own reports to the European Parliament and Council on whether all references to credit ratings should be removed from EU law for regulatory purposes and on the implementation of provisions of the CRA Regulation relating to competition, conflicts of interest and structured finance products. ESMA proposes to reassess the implementation of the CRA Regulation within the next 3 to 5 years.