EU PROPOSES TO REGULATE CREDIT RATING AGENCIES

UNCLAS SECTION 01 OF 02 BRUSSELS 001744
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E.O. 12958: N/A
TAGS: EFIN ECON ETRD EINV EUN
SUBJECT: EU PROPOSES TO REGULATE CREDIT RATING AGENCIES


1. (SBU) SUMMARY. On November 12, 2008, the European
Commission published its proposal to regulate Credit Rating
Agencies (CRAs). The proposed Regulation seeks to introduce
a new mandatory registration and surveillance regime, and to
harmonize rules on CRAs throughout the EU, ensuring that
ratings are not affected by conflicts of interest, that CRAs
pay special attention to the quality of their ratings and
rating methodology, and that they act in a transparent
manner.

MANDATORY REGISTRATION, IMPROVED CORPORATE GOVERNANCE AND
ENHANCED TRANSPARENCY
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2. (SBU) The proposed Regulation Q which, unlike a Directive,
is applicable directly in its entirety to all Member States
contains the following key provisions:

MANDATORY REGISTRATION AND SURVEILLANCE - Credit rating
agencies will be required to register in a central European
database, established by the Committee of European Securities
Regulators (CESR). The database will gather historical
rating information, allowing users to compare rating
performance. CESR will serve as facilitator, but the
responsibility for registration and surveillance of the
credit rating agency will remain with the competent authority
of the home Member State. Supervisors will not approve
ratings; only ensure compliance with the rules.

AVOIDANCE OF CONFLICT OF INTEREST - CRAs will be required to
disclose the names of rated companies that contribute more
than 5% of their revenue. They will also be forbidden to
rate companies in which their analysts own shares or
financial products. CRAs will be required to limit their
activity to credit rating and related operations, excluding
consultancy or advisory services.

INDEPENDENT CORPORATE GOVERNANCE - Each agency will be
required to have on its board at least three independent
directors, at least one of them an expert in securitization
and structured finance. Their remuneration will be based on
a fixed fee and their five year term is non-renewable.
Analysts will have a four year rotation requirement, and
their compensation must not be contingent on revenue from
issuer. They will not participate in fee negotiations and
will not hold financial interests in the rated entities.

ENHANCED TRANSPARENCY - CRAs will be required to regularly
disclose their methodologies, models and rating assumptions,
and the general nature of their compensation policy.

TRADITIONAL VERSUS STRUCTURED PRODUCTS - The proposal seeks
to enable investors to distinguish between ratings for
structured products and for traditional products. CRAs will
have the option of either using a different rating scale for
structured products, or to provide detailed information on
the different risk categories.

ALL CRAs WILL NEED TO REGISTER
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3. (SBU) No financial institutions in Europe will be allowed
to trade rated instruments without that instrument carrying a
rating from an-EU registered CRA. This will essentially
require all CRAs (the majority of which are from the U.S.) to
register in the EU and fulfill the criteria above.

COMMISSION PROPOSAL GOES BEYOND IOSCO
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4. (SBU) The European Commission believes that the self-
regulation regime currently applicable to Credit Rating
Agencies Qbroadly failedQ. Commissioner McCreevy noted to
the press that the proposed regulation will help CRAs regain
the market confidence they lost because of their role in the
financial crisis. The Commission acknowledges that the
reference point for its proposal is the QIOSCO Code of
Conduct Fundamentals for Credit Rating AgenciesQ, but it

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points out that it has "gone beyond these standards in those
areas where we felt that more exacting measures would be
appropriate". Commissioner McCreevy stated at a press
conference that the Financial Markets Regulatory Dialogue is
the vehicle for discussing such regulatory matters with U.S.
counterparts, but that the proposed regulation is not
conditional on U.S. approval.

OUTLOOK
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5. (SBU) The Economic and Monetary affairs Committee of the
European Parliament will begin its examination of the
Regulation proposal on December 1, under the leadership of
Austrian Christian Democrat Ottmar Karas, rapporteur. The
Commission aims for adoption before the summer of 2009.
However Commission officials admit privately that that may be
difficult to achieve.

SILVERBERG