Critics say bad regulation is not the answer, that is true, but it would be better to deregulate rating agencies

European policy makers have produced a draft proposal which would bar a rating agency from issuing (paid-for) ratings on an issuer or its debt instruments for more than three years, or for more than 10 consecutive debt instruments.  It is hoped that this would help new rating agencies start-ups preferably of European origin.  However new rating agencies are not going to emerge overnight.  The three lead players have huge knowledge bases which cannot be replicated by start-ups in a short period of time.

In addition the EU wants to give the European Securities and Markets Authority powers to ban new sovereign ratings or rating revisions when they think there could be an imminent threat to financial stability.  That smacks of censorship and history is replete with examples where censorship can lead to.  Many people on the European continent would like to remind Brussels that sovereign debt ratings were not the cause of the current sovereign debt crisis.  It was the spending habits of certain European countries living beyond their means which is the root of the problem.

Another worrying aspect is a proposed requirement for rating agencies to submit their methodology to European regulators.  It is market forces at work which determine which methodology works and which do not, surely not regulators.  Who in the end would supervise the regulators and judge their qualification? 

The EU Commission should rather pave the way of deregulating rating agencies and allow investors (the market) to decide who is best in this business.  Releasing issuers from the requirement of having a rating would make them less addicted to ratings.  It would put the onus on investors to perform their own due diligence or to hire a rating agency to do it for them.   This would be an investor-pays model compared to the issuer-pays model.  It would also reduce the cost of regulation for the tax payer.    Rather than bashing rating agencies, regulators should clamp down on issuers and their auditors in order to achieve a high degree of transparency and governance. 

Smaller niche players could emerge to make their mark by providing investors with relevant insight for particular investment decisions.   There are already many substitute risk assessment products in the market in the form of decisions systems, analytics, indices, special research which are already growing at a faster pace than rating services.  The next wave of risk management services are just around the corner, let investors put them to good use. 

Sources:  Financial Times  –  Die Welt  –  BIIA Editorial Comment

The content of this editorial comment does not necessarily reflect the opinion of BIIA and its members