The European Commission has announced an investigation into the regulation of rating agencies, calling for evidence that could lead to legislation on the issue.
The issue has come to the fore in recent years following the collapse of companies such as Enron, Worldcom and Parmalat, all of which were rated as investment grade by at least one of the three major agencies at the time of their downfall.
The EC mandated the Committee of European Securities Regulators (Cesr), which brings together national regulators from across the EU, to report back on the issue by April 2005. Cesr was told to cooperate with the Securities and Exchange Commission (SEC) in the US and the International Organization of Securities Commission (Iosco), both of which have been conducting studies since 2003.
At a recent meeting of the International Bar Association, however, Barbara Sullivan of Moody?s Investors Service argued that investors have unrealistic expectations. ?Credit rating agencies are not systematically designed to uncover fraud,? she said. ?They are not equipped to audit the work of auditors.?
The agencies are also under scrutiny over the apparent conflicts of interest that result from most of their income coming from the companies they rate, and from the advisory services offered by the agencies.
Moody?s points out, however, that no single client accounts for more than 0.5% of its income, that none of the agencies negotiate on fees and that analysts are never paid according to the amount of ancillary business they bring in.
The agencies also claim they are accountable ? to investors, whose impression of an agency?s independence is essential to its success.
Companies, for their part, argue that investors rely too heavily on ratings, to the point where maintaining a rating restricts a corporate?s financing plans. Having worked to achieve a certain rating, the company?s entire management becomes dictated by the agencies, particularly if a downgrade would push it into the sub-investment grade category.
As a result, several leading UK companies are working on plans to ring-fence part of their operations so they can either dispense with a credit rating or obtain a separate rating for that activity. This is a tactic already employed by many car companies, who often have separately rated financing arms.
The Commission says it will wait for the Cesr report before making any announcement on whether it will begin regulating rating agencies.
