Annexes to COM(2016)664 - Alternative tools to external credit ratings, the credit rating market and industry, and the feasibility of a European Credit Rating Agency - Main contents
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| dossier | COM(2016)664 - Alternative tools to external credit ratings, the credit rating market and industry, and the feasibility of a European ... |
|---|---|
| document | COM(2016)664  |
| date | October 19, 2016 |
Shareholders’ pressure on CRAs has the potential to undermine their independence where a CRA rates its own shareholders or financial instruments issued by the shareholders. This is mitigated through shareholding limitation provisions which ensure the CRAs independence and the quality of their ratings. The practical application of these provisions remains unclear, however, as there is currently no common definition on the term “shareholder” at a European level.
The CRA Regulation provides for a set of requirements related to knowledge, skills and behaviour of ratings analysts and other employees of a CRA who are involved in the rating process. By establishing a gradual rotation mechanism for those people, independence of ratings can be ensured. However, due to staff rotation, costs of transferring an analyst to another portfolio might arise.
ESMA’s current work on guidelines on the validation and review of Credit Rating Agencies’ methodologies 42 could give further clarity on the internal compliance and risk procedures of a CRA and thus a clearer definition of the notion “rating methodology” taking into account the 2015 IOSCO Code 43 definition.
The current level of sanctions does not seem to be proportionate to the turnover of CRAs, especially to the large ones. The possible fines that can be imposed by ESMA at present do not have a deterrent or dissuasive effect in practice 44 . The Commission will therefore further reflect on the sanctioning regime of the CRA Regulation that is different from the regimes under more recent European legislation.
2. Provisions related to SFIs and potential extension to other financial products
The CRA Regulation provision on mandatory rotation between a CRA and an issuer (Article 6b) is limited to the issuing of re-securitisations complemented by a cooling off-period of maximum four years during which a CRA is not allowed to issue ratings on re-securitisations with underlying assets from the same originator. Potentially burdensome effects for small CRAs are softened by an exemption.
Article 8b of the CRA Regulation requires the establishment by ESMA of a website for the purposes of disclosure of information on SFIs. ESMA recently announced that, due to a number of difficulties faced in the preparatory work for the setup of the website, it is unlikely that it will be available to reporting entities by the legal deadline of 1 January 2017.
Both Article 6b and Article 8b have yet to be implemented and applied in practice. In conjunction with the mandatory double credit rating provision for SFIs in Article 8c, it appears that there is currently not sufficient choice among CRAs rating different asset classes to allow competition to work effectively. Given the above, a potential extension of the mandatory rotation mechanism and the disclosure provisions of information on SFIs to other financial products appear to be premature at this stage as there is currently insufficient data available to analyse the impact of these provisions on the credit rating practice. The Commission will continue to monitor market developments as the relevant provisions of the CRA Regulation become applicable.
3. Alternative remuneration models
There has been little change observed in the rating industry since the implementation of the CRA Regulation concerning remuneration models, especially in the ratings for corporate bonds and SFIs. The dominant and most frequently used remuneration model in the CRA market is the issuer-pays model, where the CRAs are paid by issuers who wish to solicit credit ratings for their investment products.
Other examples of remuneration models are the Skin-in-the-game model - where investors produce ratings for projects they partially fund by holding the issued instruments, or where CRAs are remunerated in the instruments they rate which they would hold to maturity 45 and the Platform-pays model introducing an intermediary in the market in order to fund and produce the rating. The Pay-for-performance compensation-model requires each CRA to pay a fixed percentage of its revenue to a common fund, which is then paid out to the best performing CRA that provides an incentive for CRAs to improve the accuracy of their ratings, while potentially leading to uncertainty concerning the effectiveness of the incentive mechanism. Credit ratings could also be produced by non-profit organisations or be funded by governments. Government involvement in the allocation of CRAs to issuers could raise the risk of segmenting markets along national lines and could also potentially trigger conflict of interests within the industry, especially with regard to the issuance of sovereign and sub-sovereign ratings.
As identified in the Commission’s 2011 Impact Assessment, all potential remuneration models could entail possible conflict of interest. The CRA Regulation therefore does not mandate the use of one particular remuneration model as there is no essential need to favour one model over another.
Currently, alternative remuneration models are hardly used as stand-alone solutions in practice as CRAs tend to use hybrid models instead. Credit ratings are issued to some clients under the issuer pays model and others under the investor pays model or on a subscription basis. ESMA’s analysis concludes that this flexibility in the choice of the remuneration model should be maintained so that market players remain free to choose the most suitable model with regard to their market strategy.
4. Overall Assessment
Given the analysis above, the provisions of the CRA Regulation on governance appear to have a predominantly preventive nature while making an important contribution to ensure the independence of CRAs. Although, according to ESMA's Technical Advice, some provisions might create implementation costs for CRAs by imposing changes on IT systems, training, compliance and legal procedures, the recent framework on CRAs' governance is expected to bring benefits overall in the long-term.
Although changes might not be immediately visible in the credit rating practice, the provisions are effective in giving regulators the necessary tools to supervise CRAs that do not comply with the governance provisions of the CRA Regulation. However, the sanctioning regime in the CRA Regulation may need revision to ensure that it is credible and proportionate as a deterrent.
IV. Appropriateness and feasibility of supporting a European credit rating agency
Due to issues relating to procyclicality in the publication of ratings revealed by the recent EU sovereign debt crisis, the CRA Regulation was amended in 2013 by introducing additional measures to increase the transparency of sovereign debt ratings. Article 8a of the CRA Regulation requires now CRAs to publish annually a calendar where the dates for the publication of their respective sovereign credit ratings have to be set.
In addition to that, the Commission analysed in a report of 2015 46 the appropriateness of the development of a European creditworthiness assessment and whether there are sufficient and adequate sources of information for investors allowing them to carry out their own credit risk assessment of sovereigns. In its report the Commission came to the conclusion that the introduction of such a European creditworthiness assessment would add little additional value to the already existing information that is provided by various sources of the fiscal and macro-economic surveillance regime (e.g. the reports issued in the context of the European Semester). There would also be no improvement of information achieved for institutional investors since they already have sufficient data through public and private channels. Furthermore, investors operating in the global sovereign bond market tend to rely more on information provided by international institutions such as the International Monetary Fund (IMF) or the World Bank.
CONCLUSION
External credit ratings continue to play an important role in some parts of the EU's regulatory framework for the financial sector, especially for banks and insurance companies. However, the Commission is of the view that there are currently no feasible alternatives that could entirely replace external credit ratings. Against this background, supervisors should continue to promote the mitigation of mechanistic reliance on credit ratings by ensuring that market participants use alternative tools, such as those referred to in Section I.2, as a complement to external credit ratings. On its side, the Commission will continue to monitor the developments in the market.
As for competition, the Commission will also continue monitoring the development of the market in response to the implementation of the CRA Regulation before considering the adoption of further measures. This is particularly relevant as some of the provisions are still in the process of implementation and would require some time to assess the benefits.
Ensuring that the regulatory framework is proportionate and does not impose undue costs is a pre-requisite to promoting market entry and greater competition in the market for CRAs. As a follow-up to its Call for Evidence, the Commission will continue to monitor the application of the CRA Regulation on smaller CRAs, in particular the issue of proportionality.
More generally, the Commission will seek to avoid and further reduce regulatory barriers to market entry, as it recently did by amending the draft ITSs on the mapping of credit ratings proposed by the ESAs. It will also promote the broadest possible acceptance of smaller CRAs, including in the context of the ESCB's European Credit Assessment Framework (ECAF).
Notwithstanding these efforts to stimulate greater competition, recent developments suggest that the market for credit ratings may remain a highly concentrated oligopoly for the foreseeable future. In this context, it is essential to ensure that incumbent CRAs are subject to a robust regulatory framework backed-up by a credible sanctioning regime with proportionate levels of fines that act as an effective deterrent. Moreover, effective internal governance and compliance procedures play an especially important role to ensure the quality of external credit ratings in a market characterised by limited competitive market pressure and the CRA Regulation introduced important requirements to strengthen these arrangements.
With regard to SFIs, it is too early to assess the impact of the CRA Regulation, as certain relevant provisions have not yet been applied in practice. In this context, it does not seem appropriate at the moment to consider extending the respective CRA Regulation provisions to other financial products.
As regards the reporting obligation in Article 39b para 2 subpara 2 CRA Regulation, and considering the Commission’s 2015 report on the appropriateness of the development of a European creditworthiness assessment for sovereign debt, the Commission considers there to be no need at present for a European credit rating agency specialized in sovereign debt or a European credit rating foundation for other credit ratings. In addition, the establishment of such common agencies would be likely to add more costs than any additional value to the rating market in practice.
In general, the provisions of the CRA Regulation are considered to have a long-term positive impact on the credit rating market. There is currently no evidence related to potential negative consequences for CRAs or issuers. Since not all provisions of the CRA Regulation have yet been implemented, the credit rating market needs to be further monitored for an assessment of the full impact of this legislative framework.
(1)
Regulation No 1060/2009 of the European Parliament and of the Council of 16 September 2009 on credit rating agencies (OJ L 302, 17.11.2009) as amended by Regulation (EU) No 513/2011 of the European Parliament and of the Council of 11 May 2011 (OJ L 145, 31.5.2011), by Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 (OJ L 174, 1.7.2011), by Regulation (EU) No 462/2013 of the European Parliament and of the Council of 21 May 2013 (OJ L 146, 31.5.2013), and by Directive 2014/51/EU of the European Parliament and of the Council of 18 April 2014 (OJ L 153, 22.5.2014).
(2)
Article 39b(1) CRA Regulation.
(3)
Article 39(4)(5) CRA Regulation.
(4)
Article 39(4)(5) CRA Regulation.
(5)
Article 39b(2) CRA Regulation.
(6)
ESMA/2015/1471 – ESMA Technical Advice on reducing sole and mechanistic reliance on external credit ratings – publication available at https://www.esma.europa.eu/sites/default/files/library/2015/11/esma-2015-1471_technical_advice_on_reducing_sole_and_mechanistic_reliance_on_external_credit_ratings.pdf
(7)
MARKT/2014/257/F4/ST/OP-LOT1 available at http://ec.europa.eu/finance/rating-agencies/index_en.htm
(8)
ESMA/2015/1472 – ESMA Technical Advice on competition, choice and conflicts of interest in the credit rating industry – publication available at https://www.esma.europa.eu/sites/default/files/library/esma-2015-1472_technical_advice_on_competition_choice_and_conflicts_of_int.pdf
(9)
MARKT/2014/257/F/Lot 2 available at http://ec.europa.eu/finance/rating-agencies/index_en.htm .
(10)
For more information see p. 5 of ESMA’s Technical Advice on reducing sole and mechanistic reliance on external credit ratings, p. 5 et seq. of the ICF study, p. 10 of ESMA’s Technical Advice on competition, choice and conflict of interest in the credit rating industry, p. 7 of Europe Economics study.
(11)
See in particular p. 1 of the Financial Stability Board's (FSB) Principles for Reducing Reliance on CRA Ratings, available at http://www.fsb.org/2010/10/r_101027/ . See also the FSB's Roadmap for Reducing Reliance on CRA Ratings, available at http://www.fsb.org/2012/11/r_121105b/.
(12)
Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010.
(13)
Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (recast).
(14)
Directive 2003/41/EC of the European Parliament and of the Council of 3 June 2003 on the activities and supervision of institutions for occupational retirement provision.
(15)
Directive 2013/14/EU of the European Parliament and of the Council of 21 May 2013, amending Directive 2003/41/EC on the activities and supervision of institutions for occupational retirement provision, Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) and Directive 2011/61/EU on Alternative Investment Funds Managers in respect of over-reliance on credit ratings.
(16)
Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories.
(17)
Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012.
(18)
Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC.
(19)
The methodology is designated in the legislative text as the "standardised approach" and is currently the most commonly used methodology under CRR and CRD for banks.
(20)
For example, in the case of exposures to corporates, if the rating by a CRA is available and the exposure receives the highest rating (e.g. AAA) the risk weight applied is 20%. Therefore the bank will be required to hold regulatory capital equal to 20% of the values of the exposure. If, however, a rating is not available, the risk weight to be applied would be at least 100%.
(21)
Basel Committee on Banking Supervision, Second consultative document, Standards Revisions to the Standardised Approach for credit risk, Issued for comment by 11 March 2016, December 2015, available at http://www.bis.org/bcbs/publ/d347.htm
(22)
Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance.
(23)
Article 44(4a) of Solvency II, and Commission Implementing Regulation (EU) 2015/2015 of 11 November 2015 laying down implementing technical standards on the procedures for assessing external credit assessments in accordance with Directive 2009/138/EC of the European Parliament and of the Council, OJ L 295, 12.11.2015, p.16.
(24)
Article 3-6 of Commission Delegated Regulation (EU) 2015/35 of 10 October 2014 supplementing Directive 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II).
(25)
With reference to the location of the issuer or instrument rated.
(26)
See categories of assets classes in the CEREP database.
(27)
Market shares calculated on the basis of the 2014 financial statements.
(28)
See updated list of registered and certified CRAs available at https://www.esma.europa.eu/supervision/credit-rating-agencies/risk
(29)
Fitch France S.A.S; Fitch Deutschland GmbH; Fitch Italia S.p.A.; Fitch Polska S.A.; Fitch Ratings España S.A.U.; Fitch Ratings Limited and Fitch Ratings CIS Limited.
(30)
Registered with effect from 27 October 2015.
(31)
Registered with effect from 10 July 2015.
(32)
Moody’s Investors Service Cyprus Ltd; Moody’s France S.A.S.; Moody’s Deutschland GmbH; Moody’s Italia S.r.l.; Moody’s Investors Service España S.A.; Moody’s Investors Service Ltd; and Moody’s Investors Services EMEA Ltd.
(33)
Registered with effect from 1 December 2015.
(34)
Standard & Poor’s Credit Market Services France S.A.S.; Standard & Poor’s Credit Market Services Italy S.r.l.; and Standard & Poor’s Credit Market Services Europe Limited.
(35)
For instance, since the ECB decided to include DBRS in the list of ECAIs in the ECAF, DBRS has started to have better access to the market.
(36)
EACRA –, Position Paper, Reference: ECB criteria for acceptance of Credit Rating Agencies as ECAI sources for ECAF purposes, 26 February 2016.
(37)
The consultation document and the results of the Call for Evidence are available at http://ec.europa.eu/finance/consultations/2015/financial-regulatory-framework-review/index_en.htm
(38)
E.g. to have an independent review board made up of full-time employees, a full-time compliance officer, reporting and disclosure requirements, requirement to inform rated entities before the formal release of ratings.
(39)
Commission Implementing Regulation (EU) laying down implementing technical standards with regard to the mapping of credit assessments of external credit assessment institutions for credit risk in accordance with Articles 136(1) and 136(3) of Regulation (EU) No 575/2013 of the European Parliament and of the Council; Commission Implementing Regulation (EU) laying down implementing technical standards with regard to the allocation of credit assessments of external credit assessment institutions to an objective scale of credit quality steps in accordance with Directive 2009/138/EC of the European Parliament and of the Council and Commission Implementing Regulation (EU) on laying down implementing technical standards with regard to the mapping of credit assessments of external credit assessment institutions for securitisation in accordance with Regulation (EU) No 575/2013 of the European Parliament and of the Council.
(40)
The CEREP database collects data on credit ratings issued by registered and certified CRAs, and on credit ratings endorsed by registered CRAs, as well as on credit ratings issued in a third country by CRAs not certified or registered in the EU but belonging to the same group. Some of the information within the CEREP database is available to the public through the ESMA website.
(41)
See also Q&A, Guidance and other ESMA tool, as well as a common reporting template with related instructions.
(42)
See the consultation paper on ESMA’s website https://www.esma.europa.eu/press-news/esma-news/esma-consults-validation-and-review-cras%E2%80%99-methodologies-guidelines .
(43)
IOSCO Code of Conduct Fundamentals for Credit Rating Agencies Final Report 2015 available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD482.pdf
(44)
In comparison, the U.S. Securities and Exchange Commission (SEC) imposed in January 2015 aggregated penalties of US $77 million for a series of federal securities law violations by Standard & Poor’s, https://www.sec.gov/news/pressrelease/2015-10.html
(45)
The model is based on the assumption that the entity producing the rating – which is also an investor in the securities being rated – has a clear interest in the accuracy of the rating.
(46)
Report from the Commission to the European Parliament and the Council on the appropriateness of the development of a European creditworthiness assessment for sovereign debt, Brussels, 23.10.2015, COM(2015), available at http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX:52015DC0515