EU parliament and Council approve rating agency regulation

BRUSSELS - The European Parliament and Council of Ministers has approved the European Commission's framework for the regulation of the credit rating agencies in the European Union (EU).

The regulation, approved on Thursday, means that for the first time the credit rating agency industry - dominated by the big three of Fitch, Moody's and Standard & Poor's - will have to register and be supervised to operate in the EU.

The credit rating agencies have come in for a barrage of regulatory and investor ire since the financial crisis broke, standing accused of holding conflicts of interest between analysts and those negotiating industry fees, their quasi-regulatory role as ratings providers, and for their issuer pays model for assigning ratings to structured products.

"Assumptions used by rating agencies in their analyses of structured securities have come in for heavy criticism," says Peter Green, a capital markets partner at regulatory law firm Morrison & Foerster in London. "Greater transparency in relation to their methodologies, and consistent standards in managing conflicts of interest, will help to ensure capital markets function more effectively."

The rating agencies have also come under regulatory scrutiny for their US operations, and international supervisory co-operation could prove crucial to regulatory efficacy. The Securities and Exchange Commission published a damning investigation of their conduct last summer, leading to fresh rules rolled out by Congress.

"There's a danger that if regulation isn't globally co-ordinated, regulatory arbitrage opportunities will be created," says Jeremy Jennings-Mares, capital markets partner at Morrison & Foerster. "The EU has opted for fairly prescriptive rules, which are more detailed and inflexible than the principles-based approach set out in the revised Iosco code of practice and recommended by the Committee of European Securities Regulators (Cesr). In particular, rating agencies will be required to comply with detailed corporate governance requirements. Ultimately, this may have a detrimental impact on the region's competitive position."