In the run-up to the financial crisis credit rating agencies often acted as cheerleaders, giving stellar ratings to complex financial instruments that later proved to be almost worthless, meaning immense losses for financial institutions, many of which had to be bailed out by the taxpayer. On Tuesday economic committee MEPs will vote on rules to make agencies liable for damage caused by their ratings and introduce more competition into the ratings market.
Ahead of the vote we spoke to Italian Socialist Leonardo Domenici who is steering the legislation through Parliament.
No free lunch
In the prelude to the crisis, although credit rating agencies (CRAs) rated many complex financial instruments that later turned out to be almost worthless as safe investments, investors have generally not been able to sue for damages. Domenici is adamant that this must change. "The CRAs must be subject to civil liability for their ratings," under the law of the country where the investor was residing when the damage occurred, he said.
Conflicts of interest
CRAs have a conflict of interest as they are paid by issuers whose financial products they are rating. Domenici said the proposed legislation would introduce a clause forbidding CRAs to issue "a credit rating on persons who hold more than 2% of the capital or voting rights of a CRA, or are otherwise in a position to exercise significant influence on the business activities of the CRA."
Sovereign debt ratings in focus
CRAs have been downgrading euro zone countries even as they implement harsh austerity measures, forcing them to pay higher interest rates on their debt. "Initially I proposed the ban of unsolicited rating on sovereign debt, although, at the moment, there is no majority supporting this proposal," he said.
Tougher rules on sovereign debt ratings are in the offing: ratings will have to reflect the specific situation of the country, with no prescriptions or guidelines on policy changes. In addition a calendar of ratings publication will have to be provided to the European Securities and Markets Authority (ESMA).
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