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by Zia Akhtar
The credit rating agency (CRA) are companies that assign credit ratings for issues of certain types of debt obligations as well as for the debt instruments themselves. These institutions comprise banks, building societies, utility companies and other organisations who keep details of all payments and transactions on credit/store cards, loans, mortgages, bank accounts, energy and mobile phone contracts. In order to streamline the recording of debts the EU has proposed a new Regulation because of the irregularities such as the credit ratings that include subscribing the AAA symbol on suspect American companies, which in a large number of cases have subsequently been downgraded or defaulted. (http://www.cbsnews.com/2100-201_162-20088944.html)
At present there are around 350 million debts a month that are logged which include ‘default data', that shows where there are default payments. This includes the ‘full data', which incorporates how to operate the account, from being the model customer to defaulting. This default data' has always been shared by financial companies, however, since the late 1990s, ‘full data' has been exchanged . This means every lender now has access to all information about the borrower taken by other creditors.
Prior to 2000, there was no data that was conveyed from that bank that was shared because of older data protection laws being in place which meant some of the client credit history was out of the loop. However, since 2008, the availability of complete data that credit card companies share about clients has increased. The major lenders such as Barclaycard, Capital One, GE Money, HBOS and MBNA now all view the amount you repay (ie, if it's the minimum, or if the client repays in full) and whether it is a promotional deal (plus, if there are any credit card cash advances, which you must not state.
In addition, payday loan data is now normally reported, and ‘doorstep lenders' are legally obliged to share the data that they hold on customers. While, overall, the aim is to stop irresponsible lending, the banking institutions have the object to eliminate those customers who are not genuine, and are not likely to reap an interest ratio that is rewarding. Their payment history is available and can be accessed by such organisations as Experian that can furnish documentary evidence of their debts. (http://www.experian.co.uk/consumer)
The credit ratings profile is used by investors, investment banks, brokers and dealers and governments. For the investing individuals the credit rating agencies increase the range of portfolios and provide independent, user friendly measurements of relative credit risk free alternatives. These generally increases the efficiency of the market, lowering costs for both borrowers and lenders. This increments the whole supply of risk capital in the economy, leading to stronger potential growth. It also leads to the opening of capital markets to the categories of borrower who might otherwise be precluded. These include governments of third world counties, new companies, hospitals, and universities.
Need for tighter regulations
The CRAs are major players in the contemporary financial markets, with rating actions being closely monitored and impacted on investors, borrowers, issuers and governments. The sovereign ratings are a major factor for the rated country, since a downgrading has the immediate effect of making a country's borrowing facility more expensive. The downgrading also has a direct impact, for example, on the capital levels of a financial institution.
The financial crisis and developments in the context of the euro debt crisis have revealed serious weaknesses in the existing EU rules on credit ratings. The causal link in the current financial markets mechanism exposed the CRAs failure to appreciate properly the risks inherent in more diverse instruments (especially structured financial products backed by risky subprime mortgages), issuing incorrect ratings that were far too high.
In December 2004, the International Organisation of Securities Commissions (IOSCO) published a Code of Conduct for CRAs that has the object of setting out a programme to redress the various types of conflicts of interest. The major CRAs have agreed to enroll on its Code of Conduct and it has been complemented by regulators ranging from the European Commission to the U.S. Securities and Exchange Commission.
The EU has moved towards the recognition that there must be no institution, product or market that was left unregulated at EU and international levels. As a consequence the EU Regulation on Credit Rating Agencies (Regulation (EU) No 513/2011 of the European Parliament and of the Council amending Regulation (EC) No 1060/2009 was promulgated. This was followed by Regulation (EU) No 513/2011 and often referred to as CRA II Regulation. (http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2011:145:0030:0056:EN:PDF), which was part of Europe's response to these commitments.
The CRA II Regulation adapts to the creation of the European Securities and Markets Authority (ESMA) The thrust of the CRA Regulation is based on registration which requires that in order to meet a number of obligations on the conduct of their business, intended to ensure the independence and integrity of the rating process and to enhance the quality of the ratings issued. The ESMA has the responsibility for registering and directly supervising CRAs in the EU; and furthermore in the conduct of business the Regulation requires CRAs are to avoid conflicts of interest (for example, a rating analyst employed by a CRA should not rate an entity in which he/she has an ownership interest); to ensure the continuous monitoring of credit ratings, and rating methodologies needed to ensure a high level of transparency by publishing an annual Transparency Report).
There also needs to be supervision that EMSA requires to comprehensively investigate powers including the possibility to demand any document or data, to summon and hear persons, to conduct on-site inspections and to impose administrative sanctions, fines and periodic penalty payments. This centralises and simplifies the supervision of CRAs at European level. Their centralised supervision ensures a single point of contact for registered CRAs, and significant efficiency gains that are owed to a reduced and less complicated registration process and a more consistent application of the rules for CRAs. The CRAs are at present the only financial institutions which are directly supervised by a European supervisory authority.
The new rules have a purpose that is to make the credit rating agencies more transparent in their dealings. The new powers are to circumvent their procedures so that they are able to issue unsolicited sovereign debt ratings only on set dates, and enable private investors to sue. The shareholdings in rated firms will be capped, to reduce conflicts of interest and these rules will aim to challenge the power of independent credit rating agencies such as Moody's and Standard & Poor's in the economic decision making process at EU level.
The costs of borrowing in many eurozone countries and the European commission, backed by MEPs, has led to banks and investment firms to assess risk and not rely on external agencies. The Italian Social Democrat MEP Leonardo Domenici, who was responsible for steering the proposals through European parliament stated that the reform was designed as a means for ‘taking some steps forward with this new regulation, fully in line with its basic spirit, which is to enable firms to do their own internal ratings. (http://www.theparliament.com/latest-news/article/newsarticle/eu-parliament-approves-new-rules-on-credit-agencies/) The object is to reduce the rating oligopoly and provide the market competition.'
Zia Akhtar is a member of Grays Inn and specialises in Business and Competition law.
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