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EU Takes a Whack at Credit Rating Agencies

by Michael W. Stocker
Eyes On Wall Street |

Today the EU unveiled the most sweeping reforms to date of the troubled credit rating industry. The proposed rules, which will require the approval of the European Parliament and EU member states, represent some significant progress in ongoing efforts to improve ratings.

The reform proposal includes "mandatory rotation provisions" which would force issuers of financial products in Europe to rotate the credit rating agencies they use at least every three years. In addition, the proposal also contains a "cooling off" provision which would compel issuers to wait four years before hiring the same agency. The purpose of these provisions is to increase competition and reduce conflicts of interest.

While US regulators have been reluctant to intervene in rating methodologies, the reform proposals would give ESMA, the European market regulator, the power to develop technical standards and approve specific rating methods. New rating methodologies, or adjustments to existing models, would have to be open to consultation and submitted to ESMA for approval.

Crucially, the proposed rules include a method for private enforcement, in that they would allow investors to sue credit rating agencies for compensation if they break EU regulations "intentionally or with gross negligence."

Regulators apparently have dropped one of the most controversial proposed rules, which would have permitted ESMA to ban agencies from rating sovereign debt issued by countries in the process of being bailed out-an edict that would have further undermined the confidence of investors in sovereign debt.