Standard & Poors – The Role and Regulation of Ratings Agencies in Europe


Ratings have been used for more than 100 years to help companies and governments around the world access bond markets – and to help investors make decisions about the riskiness of  lending to these organisations.

A credit rating has an important but very specific purpose. It is an independent view of a
borrower’s relative creditworthiness – that is, the risk that a borrower may not pay back its debts on time and in full.
Why investors value ratings
Ratings are valued by investors because they are independent and because they provide a consistent and comparable measure for assessing a very wide range of borrowers. Standard &  Poor’s, for example, publishes more than a million ratings on debt securities issued by over 20,000 organisations worldwide.

Analysing such a broad universe of borrowers is beyond the means of any individual investor, so many choose to use independent ratings, alongside other tools, to help in their decision process.

Investors do not, and should not, base investment decisions solely on ratings, as ratings are not investment advice and only cover one aspect of investment risk – the risk of default. But many investors find ratings a useful benchmark and common language for comparing the credit risk of all types of borrowers across sectors and markets.

How ratings support EU markets
Without ratings, investors and lenders in Europe would be less inclined to provide capital to borrowers with whom they are not directly familiar. That in turn would disrupt the functioning of the European bond market, which serves as an efficient mechanism for allocating capital to a wide range of borrowers.

As the IMF and other authorities have recognised, publicly-available ratings improve the flow of information about credit risk and consequently the efficiency and liquidity of capital markets.
They play an important role in helping debt issuers – including governments, financial
institutions and companies – to access international pools of investment capital across the
This function is fundamental to the health of the European economy. Finance from EU and nonEU institutional investors is crucial to supporting future growth and job creation in Europe, particularly at a time when banks have less capacity to lend. Ratings help this vital stream of capital keep flowing.
Importance of international consistency
International investors use ratings because they want to compare the creditworthiness of
borrowers on a like-for-like basis worldwide. That is why S&P applies consistent methodologies for rating debt across different markets and sectors.
It is therefore crucial to investors and issuers of debt that regulation supports the availability and consistency of credit ratings globally.
This was recognised by the G20 leaders in 2009 when they asked the Financial Stability Board to ensure a coordinated approach globally to regulating ratings agencies. Its focus has been two-fold:
 ensuring that major markets have a system in place for regulating and overseeing the
quality, independence and transparency of ratings; and
 limiting the use of ratings in regulation, which can result in their inappropriate use.
Current supervision of ratings in EU
In September 2010, the European Union introduced detailed regulations for ratings firms that provide a far-reaching set of standards governing the integrity and transparency of the ratings process.
S&P and other major ratings agencies were registered under these regulations on 31 October 2011. They are now supervised by the European Securities & Markets Authority (ESMA), which has extensive powers to inspect registered agencies and to apply significant sanctions in the event of any rule breaches.
Areas covered by these existing regulations include:
 policies and processes that ratings agencies employ to manage potential conflicts of
interest (for example, separation of analytical and commercial functions, regular rotation
of analysts, prohibition on advising debt issuers);
 governance of registered agencies (including a requirement for independent members of supervisory boards); and
 transparency of ratings (including public disclosure of methodologies, ratings
assumptions and ratings performance).
Impact of proposed new regulations
In November 2011, the European Commission proposed a further set of regulations for credit ratings. Some of these are in line with international policy, including steps to reduce the mechanistic use of ratings by regulators and investors and to promote transparency of ratings.
Other proposals, however, are out of step with ratings regulation elsewhere in the world and risk damaging the process for assessing, pricing and allocating debt capital for European businesses. These include:
 Mandatory rotation of rating agencies – forcing corporate debt issuers to regularly
rotate their credit ratings among various agencies would undermine the stability and
continuity of ratings and disrupt European companies’ access to global capital markets.
 Special liability standard – establishing an EU-wide liability standard for registered
ratings firms risks encouraging investor reliance on ratings, artificially depressing ratings,
and inhibiting the entry of new competitors.
 Regulatory involvement in ratings – requiring regulatory approval of proposed
changes in ratings methodologies, and standardising ratings scales and definitions,
could damage the independence and international comparability of European ratings and
reduce diversity of opinion about credit risk.
 Shareholder restrictions – prohibiting or limiting ratings from agencies that have 10%-
plus shareholders or 5%-plus shareholders in common could lead to major disruptions in
ratings coverage and exacerbate market uncertainty.
Regulation and oversight are important ingredients in restoring confidence in ratings and capital markets. S&P is committed to a constructive dialogue with policymakers and market participants, with the aim of further strengthening the quality and transparency of its ratings.
However, the unintended consequences of some of the Commission’s proposals for Europe’s borrowers, investors and the wider economy are potentially severe. Before pursuing them, it is important to fully assess their likely impact – and to evaluate the current system of supervision in the EU, which directly addresses how registered ratings firms can enhance the independence, quality and transparency of their ratings.

As published on on 7th February 2012