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Scope on CRAs�?? Authorizations

Von Dr. Oliver Everling | 5.September 2008

The German rating agency Scope Analysis GmbH (www.scope.de), Berlin, comments on the draft Regulation / Directive „Authorizations, Operation and Supervision of Credit Rating Agencies (CRAs)“ to DG Internal Market and Services. Founded in 2000, Scope Analysis soon became one of the leading rating agencies in the sectors of closed-end funds and open-end real estate funds, certificates and alternative investments. More than 800 mainly institutional investors subscribe to our services. „Our ratings affect investment decisions of thousands of private investors every day. Our team of 40 employees is trained to ensure that our ratings are reliable and accurate pieces of information. High standards of quality in the ratings and transparency of our rating agency are cornerstones of our success story“, writes Scope Analysis.

„Scope Analysis meets substantive requirements which cover issues related to the organizational structure and internal governance of our rating agency, the avoidance and management of conflicts of interest, the quality of ratings and transparency to our subscribers“, writes Scope Analysis‘ CEO Florian Schoeller to Brussels, and goes on: „The draft Directive / Regulation in its present form does not provide for an authorization and supervision process which is adapted to the specificities of the rating activities of the various rating agencies active in the EU, since it does not take into account the different nature of the relationship to issuers of investor-driven rating agencies like ours“, and provides various examples.

Her claims that his rating agency is not mandated for investment ratings by any issuer and therefore making proposals or recommendations, either formal or informal, regarding the design of a finance instrument is none of Scope Analysis‘ business. „In our case,“ he writes, „rotation arrangements to be put in place for analysts and persons approving ratings to avoid that they develop long lasting relationships with the same rated entities, would not add to the quality, accuracy, thoroughness and integrity of their work. We believe that long-lasting experience and in-depth knowledge of issuers rated does not compromise the independence of our analysts, but allow us to as-sure that methodologies and models used by our rating agency are regularly re-viewed in order to be able to properly reflect the changing conditions in the underlying asset markets.“

The rating activity that is used for regulatory purposes e.g. risk assessment by financial institutions is concentrated among a very small number of players in the EU. „The draft Directive / Regulation is dangerously limited in its scope to this handful of players providing credit rating services internationally, with strongholds in the USA.“

Scope Analysis comments on the likely compliance costs, the likely effect on competition and other impacts, costs and benefits. „Given the extremely short timeframe to provide you with your comments, we have to limit our remarks to the following, notwithstanding further objection if we are allowed to go into detail: We believe that compliance costs would be limited, since our organization al-ready meets very high standards and requirements, which are really at the heart of our credibility and standing among investors and the public. Our biggest concerns are about the effect on competition, since in its current form the draft Directive / Regulation would not allow other rating agencies but credit rating agencies to get authorized. This would clearly provide a competitive advantage to the US rating agencies, since they serve like superstores different markets with a wide range of products. Their authorization in one product group, credit ratings, would transmit to other product groups like mutual fund ratings. Once provided with a special, authorized status, they could build on this recognition by making investors and the public believe that they are not only closely monitored, but that they merit an official status and therefore deserve their special attention.“

According to Scope Analysis, if CRAs which contributed to the recent market turmoil by underestimating the credit risk of structured credit products get authorization and recognition while others not involved in the crisis do not, the Directive / Regulation would ironically reward their failures with a pole position in the market.

„The scope of the Directive / Regulation must be broadened to all rating services on financial instruments and products, so that any rating agency can, but does not need to register as an authorized rating agency. Authorization should be provided to any rating agency which submits itself to supervision by the authorities and complies with all rules and standards. In addition, a proportionality rule should be included in the Directive / Regulation to assure that smaller rating agencies are recognized on a comparable basis.“

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