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Halo Effects of CRAs�?? Authorizations

Von Dr. Oliver Everling | 9.September 2008

Providing rating services for two decades now, Feri EuroRating Services‘ corporate identity is the one of a truly independent, neutral rating agency focusing various niches in the rating market, with only a few overlaps with services of the US CRAs. „Our rating products never caused any market turmoil or crises, on the contrary: Since many years our ratings help investors to take better informed decisions and to make prudent investments. Nevertheless, the planned regulation of rating agency, which is focused on CRAs, will have effects on our business because it sets standards on how rating agencies in general should be organized and how they should operate.“ That is why they draw the European Union’s attention to their comments on the draft Directive / Regulation on „Authorisation, Operation and Supervision of Credit Rating Agencies (CRAs)“.

„As is proven by the history of our rating agency, it is possible to gain market acceptance by means of supreme quality of services alone. Better judgment and reliable investment advice are always welcomed by market participants. There is no need for a formal recognition process in the first place. Nevertheless, we fear that the authorization process designed by the Commission would have an effect on competition among rating agencies“, writes Feri.

The planned authorization, which shall be valid for the entire territory of the Community, will undoubtedly help authorized rating agencies. It helps mainly the US rating agencies to reestablish confidence in their services, since the need for change in their systems and processes is obvious. As obviously as an authorization helps authorized rating agencies it will hurt those who will get rejected, goes the argument of Feri. It will be understood by market participants that authorized rating agencies comply with the conditions for authorization, while others do not. „This would be no problem if rating agencies would compete only as credit rating agencies“, says Feri.

The reality is different, warns Feri: Some CRAs provide rating services also on mutual funds, insurance policies or similar rating niches. „We assume that the current proposal would not allow other rating agencies to get an authorization if they are not operating as credit rating agencies.“ Therefore they could meet all requirements for being recognized with the exception of not being a credit rating agency, but a real estate rating agency, mutual fund rating agency, insurance rating agency or whatever their investment rating focus is.

„Especially for those rating agencies serving retail customers we foresee a detrimental effect on competition, because it would be very difficult to explain to retail investors why one e. g. US rating agency got an official authorization while another European rating agency got none, although both are offering the retail investor guidance on his mutual fund investments by means of mutual fund ratings“, say Feri EuroRating Services AG’s board members Dr. Helmut Knepel and Dr. Eberhard Weiß „It is unlikely that everybody will understand the nuances of the law and differentiate among rating agencies accordingly.“

They believe that there will be a „halo effect“ of the authorization for credit ratings on other areas of the rating business, such as mutual fund ratings. According to their analysis of the market situation, authorized rating agencies will have fewer problems to convince investors on their compliance with minimum requirements and quality standards than unauthorized rating agencies. Since the Directive aims mainly at a segment of the rating market which is largely dominated by a US duopoly, the contradictory outcome of the law could be in the long run that the US duopoly will be even better entrenched in the future, leaving even less room for competition in other areas of competence in the rating business.

„We therefore recommend taking the authorization of other rating agencies into consideration, which were not causing the market turmoil which gave the reason for the new legislation.“ Also rating agencies that served the markets without any complaints of their clients and are therefore not subject to any project for regulating them should have the chance to get authorized and get public approval if they meet all requirements. The scope of the Directive should be extended to all rating agencies serving issuers, investors and other market participants in making better informed financial decisions.

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