EU Tightens Its Belt on Credit Rating Agencies

Last week, after the S&P released an erroneous report suggesting a downgrade of France’s highly-prized AAA credit rating, European Union Internal Market Commissioner Michel Barnier expressed his concerns on just how much power the big three credit rating agencies (S&P, Moody’s, and Fitch) have on the markets.

You see, France’s 10-year bond yields spiked by as much as 28 basis points following the release of the report and barely recovered even after S&P corrected the report a few minutes later. Barnier said that in a highly volatile and uncertain market environment, these credit rating agencies must exercise more discipline and be more accountable for their actions.

Is this why Barnier and his gang are now coming up with new rules that might shake up the ratings industry?

Word on the street is that the EU plans to encourage competition among the credit ratings agencies by requiring companies to rotate the firms that they use every three years. Companies using two ratings firms will be allowed to keep one firm for six years while rotating its other firm every three years.

EU on credit rating agencies

Another proposal making rounds in the rumor mill is that the EU will prevent credit rating agencies from giving out ratings to companies that own at least 5% of the rating firms’ shares. Not only that, some say that the European Securities and Markets Authority (ESMA) also gets to approve of these agencies’ methodologies!

On a macro level, Barnier is proposing that the ESMA be allowed to suspend ratings agencies from issuing adjusted sovereign debt ratings under special circumstances. Apparently, this includes periods when a country is negotiating for a bailout program.

Even though we’ll only get to separate the rumors from the facts once Barnier’s proposal is released later today, the issue has already inspired mixed reactions among the market players. Some say that the plan is a good step forward in clamping down on the oligopoly of the big three ratings agencies in the markets.

Others aren’t too convinced though. Those against the EU’s plan say that a mandatory rotation will just make credit rating agencies complacent as they simply just have to wait their turn instead of producing quality reports. Also, the potential decline in credibility and the difference in methodologies among the ratings agencies can lead to even more volatility in the markets.

As for the plans to suspend giving out sovereign debt rating adjustments, some say that the EU’s move is pretty expected. After all, haven’t we heard from a few European officials before on just how they disliked the ratings agencies shaking up the markets?

We’ll probably know more details when Barnier’s proposal is released today, but I think the bigger question that we need to consider is how the new set of rules will affect forex trading. Do you think that the powers of the S&P-Fitch-Moody’s trio needs regulating, or are the EU officials just looking for ways to control the ratings agencies industry?


  • Mike Dever

    This is another idiotic view by governments that they either
    1) can control or 2) are smarter than, the markets. Neither is true. I am no
    fan of the credit rating agencies. But the same reason they are essentially
    useless, is the same reason any government control of ratings would be useless.
    That is because the markets already set the credit worthiness of any borrower
    that has outstanding paper. The price is out there. The price of credit default
    swaps is out there. That is the ‘real’ credit rating of a sovereign or
    corporate borrower. Ratings are both redundant and dumber than the
    crowd-sourced price that already exists. I talk about the failure of the credit
    rating agencies and government regulations in my book “Jackass
    Investing.” I’m pleased to provide readers with a complimentary link to
    the two chapters dealing with this (Myth #13: It’s Best to Follow Expert Advice
    and Myth #14: Government Regulations Protect investors):
    http://jackassinvesting.com/lo

    http://jackassinvesting.com/lo

    Mike Dever

    Author, Jackass Investing: Don’t do it. Profit from it.

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