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Directing a Rating Agency

Von Dr. Oliver Everling | 11.September 2008

Feri EuroRating Services AG proposes some amendments to the European Commission’s proposal to regulate rating agencies. On 31 July 2008, the European Commission had published two consultation documents on CRAs seeking views from all interested parties by 5th September. The first document relates to the conditions for the authorisation, operation and supervision of credit rating agencies. The second proposes policy options in order to tackle what is felt to be an excessive reliance on ratings in EU legislation.

Feri EuroRating Services AG criticizes the Commisssion’s ideas on persons who effectively direct the business (Article 7). The article says that persons who effectively direct the business of a credit rating agency shall be of good repute and sufficiently experienced to ensure the sound and prudent management of the credit rating agency. The home Member State competent authority shall verify that the non-executive members of the administrative board or the members of the supervisory board shall in their majority have sufficient experience in understanding credit risk and relevant modelling sensitivity analysis techniques across the range of investments and credit structures that fall within the scope of activity of the credit rating agency. Their remuneration shall be linked to their experience and skill and to the contribution they make and are contractually expected to make to the supervision, quality, accuracy and integrity of the rating process and activity and not to the growth in earnings or share price of the credit rating agency. Their term of office, which shall be for a preagreed fixed period, shall not be renewable.

„We agree that the non-executive members of the administrative board or the members of the supervisory board shall in their majority have sufficient experience in understanding credit risk and relevant modeling sensitivity analysis techniques across the range of investments and credit structures that fall within the scope of activity of the credit rating agency.“ Their remuneration shall be linked to a large extent to their experience and skill and to the contribution they make. Nevertheless, says Feri, that the growth in earnings or share price of the rating agency would not relate to their remuneration goes too far and does not assure high quality services. „Their term of office cannot be for a preagreed fixed period which is not renewable, since we need to assure continuity and reliability in our top management.“

The existence of rating agencies is to some extent due to the fact that rating agencies are using economies of scale in their research, reducing costs for information, analysis and communication for investors and issuers alike and helping markets to become more efficient. Therefore it is paramount that rating agencies are run as profit-oriented businesses, incentivizing them by market forces to reduce costs and always strive for better services. If those incentives are taken away from the management of rating agencies, rating organizations would denaturalize and become bureaucracies and mere burdens for market participants.

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