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Moody�??s, S&P�??s are to learn the lessons

Von Dr. Oliver Everling | 1.August 2008

Moody’s Investors Service and Standard & Poor’s may face regulation by a new European Union agency after being blamed for the turmoil in financial markets, say Bloomberg’s Neil Unmack and John Rega. The EU proposes a series of „substantive requirements“ firms will have to follow to improve the reliability of their ratings, Financial Services Commissioner Charlie McCreevy said in a statement. The EU recommends a new agency to revamp oversight of the ratings firms in cooperation with national regulators, or a „reinforced“ role for the Committee of European Securities Regulators.

Credit-ratings companies „will have to comply with exacting regulatory requirements to make sure ratings are not tainted by the conflicts of interest inherent to the ratings business,“ McCreevy said, who blames the rating firms for underestimating the risk of mortgage bonds that set off a global credit crunch leading to $480 billion of losses and writedowns at banks. The EU proposals come as the Securities Industry and Financial Markets Association, Wall Street’s biggest lobbying group, today made alternative recommendations to restore confidence in ratings.

The EU says ratings companies must „make a clear distinction between credit ratings of structured finance instruments and other credit ratings,“ while SIFMA said „modifiers“ differentiating between the two would lead to „significant unnecessary costs“ and likely cause „unintended negative consequences.“ The EU also recommends rating firms give investors „appropriate risk warnings,“ such as explaining how market developments could affect ratings.

Spokesmen for the three main rating companies said according to Bloomberg they support efforts to develop a worldwide solution to the issues. „We encourage and are hopeful that any approach adopted by authorities regarding the role and function of credit-rating agencies will promote global consistency,“ New York-based Moody’s spokesman Anthony Mirenda said in an e-mailed statement. „We will review the proposals carefully, including the expanded role envisaged for CESR, and respond,“ said S&P spokesman Martin Winn in London. The company will consider whether the EU is proposing a „globally coordinated approach to the oversight of credit rating agencies“ which „preserves the independence of ratings opinions.“ Fitch Ratings in New York said a coordinated European regulatory „framework — including CRA registration — is preferable to a proliferation of country-specific regimes.“

The European Commission hasn’t decided whether any proposals will be in the form of a regulation, and therefore automatically applicable across member states, or a directive, which national governments would have to make part of domestic law. The Commission will „decide in the autumn both on the form and the content“ of any proposals, the office of Brussels-based spokesman Ton van Lierop wrote in an e-mailed reply to questions.

The Commission is seeking to prevent investors from relying too heavily on ratings by proposing all published assessments carry „health warnings“ informing of the specific risks of investing in the security. It said it is already considering measures to make sure banks „look beyond“ ratings when calculating reserves for securitization exposure, and may prevent them from using the ratings if they don’t. Ratings firms must manage conflicts of interest by measures including rotating staff and keeping a record of „substantial elements“ of discussions between the rating staff and issuers for three years, according to the proposals. Market participants can comment on the proposals until September 5, the statement said. McCreevy plans to issue the final proposal later this year.

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