EN    EN EN 
 
EN    EN  COMMISSION OF THE E UROPEAN COMMUNITIES 
Brussels, 12.11.2008 
SEC(2008) 2746 
  
COMMISSION STAFF WORKING DOCUMENT 
 
accompanying the 
Proposal for a 
 
REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL 
 
on Credit Rating Agencies 
  
SUMMARY OF THE IMPACT ASSESSMENT  
{COM(2008) 704 final} 
{SEC(2008) 2745} 
 
EN 2   EN 1. I NTRODUCTION  
Credit rating agencies (CRAs) issue credit worthiness opinions that help overcome the 
information asymmetry between those issuing de bt instruments and those investing in these 
instruments. CRAs have a major impact on the fi nancial markets, with their rating actions 
closely followed by investors, issu ers, borrowers and governments. It is essentia l, therefore, 
that they consistently provide top-qualit y, independent, and objective credit ratings. 
Since August 2007 financial markets worldwide have suffered a major crisis of confidence. 
This crisis is a complex phenomenon invol ving multiple actors. CRAs alone cannot be 
blamed for the current financial turmoil; other actors and special circumstances were 
implicated. The crisis originated in the US  residential subprime mortgage market and 
subsequently spread into other sectors of the fi nancial markets. CRAs were close to the origin 
of the problems with subprime ma rkets: they were issuing exce ssively favourable opinions on 
structured instruments that were  financially engineered to give  high confidence to investors. 
This Impact Assessment considers what would be  the most appropriate policy response to the 
problems identified.  
The Impact Assessment presents a number of opti ons for addressing the situation at EU level. 
The Commission is proposing a seri es of measures targeting conflicts of interest, the 
transparency of CRA activities and specific qu ality aspects of the rating process. These 
measures would need to be underpinned by a re gistration and surveillance system for CRAs 
operating in the EU, to be in troduced under EU legislation.  
2. P ROCEDURAL ISSUES AND PUBLIC CONSULTATION  
Against the background of the financ ial scandals in the US and the EU at the begi nning of this 
century and following the resolution on CRAs adopted by the European Parliament in 
February 20041, the Commission considered very carefu lly whether or not fresh legislation 
was required to regulate the activities of CRAs.  In line with the advice received from the 
Committee of European Securities Regulators (CESR) in March 20052, the Commission 
decided not to present new propos als on CRAs, taking the view that the existi ng financial 
services directives applicable to CRAs provided an answer to all the major issues of concern 
raised by the European Parliament.  
Credit rating agencies are subject to various financial services directives, notably the Market 
Abuse3 and Capital Requirements Directives; they are also subject, on a voluntary basis, to 
the International Organisation of Securiti es Commissions (IOSCO) Code of Conduct 
Fundamentals for credit rating agencies. In 2006 the European Commission issued a 
communication Credit Rating Agencies4, in which it concluded that this approach would 
require it to monitor developments in this area. The Commission also asked the Committee of 
                                                 
1 European Parliament resolution on the role and methods of rating agencies (2003/2081(INI)). 
2 CESR technical advice to the European Commission on possible measures concerning credit rating 
agencies, CESR/05/139b, March 2005. The CESR is an independent advisory group to the European 
Commission composed by the national supervisors of the EU securities markets, set up in June 2001. 
3 Directive 2003/6/EC of the European Parliament and of the Council of 28 January 2003 on insider 
dealing and market manipulation (OJ L 96, 12.4.2003, p. 16). 
4 OJ C 59, 11.3.2006, p. 2. 
 
EN 3   EN European Securities Regulators to monitor co mpliance with the IOSCO Code and report back 
on an annual basis.  
The Commission indicated that it might consider proposing legislation if it became clear that 
compliance with EU rules or IOSCO’s code was unsatisfactory or if new circumstances arose 
— including serious market failure problems or significant changes in the way CRAs are 
regulated in other parts of the world. 
In view of the recent events in the financia l markets, the Commission asked the CESR and the 
European Securities Markets Expert Group (ESME)5 in autumn 2007 to provide advice on 
various aspects of CRAs’ activity and role in the financial markets and especially in structured finance. The Comm ission followed the work of bot h groups throughout the entire 
process. Both groups widely consulted stakeholde rs notably on the role of structured finance 
in the subprime turmoil. The CESR reported on 13 May 2008 and ESME on 4 June 2008. 
As well as closely following the progress of work at CESR and ESME, the Commission held 
discussions with major rating agencies and othe r stakeholders (industry associations from the 
insurance, securities and banking se ctors, information providers, etc. ). It also received written 
inputs from a wide range of a ssociations, market practitione rs and stakeholders. On the 
international side, it closely fo llowed other international developm ents such as the revision of 
the code of conduct for CRAs approved by IOSC O on May 26, the report of the Financial 
Stability Forum (FSF)
6 published on 7 April 2008 and the proposals for changes in the US 
Act on CRAs presented on 11 June and 1 July 2008. The Commission also followed the consultations carried out by both IOSCO and the FSF. It took into cons ideration the various 
initiatives proposed and/or implemented by the CRAs either individually or on an industry-
wide basis and benefite d from intensive informal dialogue with rating agencies. It also 
encouraged comments from interested stakehol ders in a public consultation starting on 31 
July 2008, receiving 82 contributions: 13 from cred it rating agencies, 52 from stakeholder 
organisations (banks, associations, investme nt funds, savings banks, etc.) and 17 from 
securities regulators and national finance ministries. 
3. P
ROBLEM DEFINITION  
Evidence shows that CRAs have performed markedly worse in assigning ratings to 
innovative, structured products than in issuing traditional ratings. The Commission’s analysis 
therefore focuses on the issues that have ar isen from rating structured finance products. 
However, it has to be borne in mind that as financial innovation progresses, similar problems 
may occur in the future in other areas where credit rating agencies have little or no 
experience. Moreover, certain deficiencies apparent  in structured finance ratings relate to the 
structure, business model and internal processes of  the entities, i.e. may also affect the more 
traditional areas of CRA activity.  
                                                 
5 The European Securities Markets Experts Group (ESME) is an advisory body to the Commission 
composed of securities markets practitioners an d experts. It was set up in April 2006. 
6 The Financial Stability Forum was convened in April 1999 and brings together on a regular basis 
national authorities responsible for financial stability in significant financial centres, international 
financial institutions, sector-specific groupings of regulators and supervisors, and committees of central 
bank experts. 
 
EN 4   EN 3.1. Failures in the integrity of CRAs; confli cts of interest in the rating business  
All contributors, institutions a nd stakeholders consulted unanim ously expressed the view that 
potential conflicts of in terest when CRAs rate structured products have not been avoided or 
managed satisfactorily.  
3.2. Lack of quality in methodology and ratings  
The significant number of downgrades observed in the second half of 2007 and first quarter of 
this year as compared to the first half of 2007  clearly indicates that the ratings given before 
the start of the turmoil were overoptimistic an d failed to reflect market conditions in the 
underlying assets. One cause of this  poor performance is most prob ably the lack of quality in 
the methodologies used by the CRAs to issue a rating.  
3.3. Lack of transparency in CRAs’ activity 
CRAs do not communicate the characteristics and lim itations of ratings for structured finance 
products with sufficient precision, nor do they pr ovide sufficient information on critical model 
assumptions. This lack of information hinders  market participants ’ understanding of the 
ratings’ significance. CRAs deliver information on rating performance, but this information 
does not facilitate comparison of CRAs’ performance. 
4. O BJECTIVES  
To deal with the problems defined above, three sp ecific objectives need to  be translated into 
substantive requirements. 
(1) Ensure that CRAs manage any conf lict of interest appropriately.  
(2) Ensure that CRAs remain vigilant on the quality of the rating methodology and the 
ratings.  
(3) Increase the transparency of CRAs.  There is also a broader, overriding objective, which is to enhance the compliance of CRAs 
throughout the European Union with the measur es taken to remedy the problems identified.  
5. P
OLICY OPTIONS  
In view of the above objectives, a number  of alternative options were analysed. 
5.1. Policy options for substantive requirements 
5.1.1. ‘Ensure that CRAs manage any c onflict of interest appropriately’ 
A number of issues need to be tackled. 
1. General approach to dealing with conflicts of interest.  
2. Conflicts of interest trigge red by CRAs’ advisory activity.  
 
EN 5   EN 3. Dialogue between rating analysts and the rated entity.  
4. Independence of the people invo lved in the rating process.  
5. ‘Shopping for ratings’.  6. Analysts joining the issuers they have rated.  
5.1.2. ‘Ensure that CRAs remain vigilant on  the quality of the rating methodology and the 
ratings’ 
A number of issues need to be tackled. 
1. Quality of methodologies, models and key rating assumptions.  
2. Rating surveillance.  3. Impact of methodology changes.  4. Quality of information used in ratings.  5. Staffing issues.  6. Impact of market developments  and macro economic expectations.  
5.1.3. ‘Increase the transparency of credit rating agencies’ 
A number of issues need to be tackled. 
1. The transparency of internal  processes and procedures.  
2. Ratings content.  
3. Differentiating ratings fo r structured finance.  
4. CRA performance statistics.  
5.2. Instruments to put the policy options in place 
As regards the overarching objective of en hancing CRAs’ compliance throughout the 
European Union with the measures taken to  remedy the problems identified, the following 
options are examined. 
Option 1:  Self-regulatio n, including: 
(a) the IOSCO Code of Conduct; 
 
EN 6   EN (b) The ‘industry White Paper’ — it woul d be assumed that the agencies 
themselves would find appropriate soluti ons to the problems and concerns cited 
above7;  
(c) Additional initiati ves by individual CRAs  — several  CRAs presented 
regulators and the market with a se ries of proposed improvements and 
committed themselves individually to incorporating them in their internal practices and procedures. 
Option 2:  A European Code of conduct for CRAs by which  members of the industry would 
commit themselves to maintain a series of voluntary standards and to accept and follow the 
recommendations of a monitoring body that w ould check signatories’ compliance with the 
code.  
Option 3: Commission Recommendation setting out the standards that CRAs would have to 
comply with to operate in the EU — the same  standards as in option 4 (legislation). The 
standards would build on the revised IOSC O code and CESR and ESME recommendations 
and would include additional standards c onsidered essential by the Commission.  
Option 4:  EU legislation providing for a compre hensive regulatory framework covering all 
existing (and prospective) CRAs with business operations in Europe whose ratings are used 
for regulatory purposes such as the Capital Requirements Directive
8. The proposal would lay 
down conditions for the issuance of credit ratin gs, introducing a registration procedure and an 
external surveillance regi me by EU regulators.  
6. A NALYSIS OF IMPACTS  
Given the technical character and detail of th e policy options addressi ng objectives 1 to 3, 
their particular impacts are not summarised here , but are set out in the Report. Here, we only 
analyse the various means of enforcement. 
Self-regulation 
The IOSCO Code fails to meet the policy obj ectives: CRAs’ management of conflicts of 
interest would remain as it is now, thus ina ppropriate; CRAs would not be obliged to improve 
their rating methodology and ra ting quality; the transparen cy of CRAs would not be 
increased; and there would be  no supervision and enforcement mechanism for competent 
authorities. The Industry White Paper and other in itiatives are very flexible for CRAs as they 
would be free to adapt to new voluntary requirements. However,  they would not be effective 
since they do not envisage a strong mechanism to monitor compliance w ith the standards set. 
Moreover, no common framework would be guarant eed. Self-regulation has been tested since 
2006 and the outcome is far from acceptable. 
                                                 
7 In January 2008 the five main CRAs jointly addressed a White Paper to regulators with 12 proposals to 
improve the IOSCO code of conduct in relation to th e independence, quality and transparency of credit 
ratings. 
8 Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the 
taking up and pursuit of the busi ness of credit institutions (recast). 
 
EN 7   EN A European code of conduct  
This solution would be highly fl exible, because CRAs would be ab le to apply the ‘comply or 
explain’ principle. It has the advantage of  including a monitoring body, albeit without any 
enforcement power so its effectiveness would be  limited. It would ensu re a reliable common 
framework, although no significant legal certainty  could be achieved. The outcome would not 
be sufficient to satisf y the policy objectives. 
A Recommendation by the European Commission 
This solution would help establish, to some ex tent, a common framework, at least concerning 
the reference criteria that CRAs had to fulfil; however, it could not include an enforcement 
mechanism and thus would have limited effec tiveness in achieving the policy objectives. 
Legislation 
This solution would ensure a leve l playing field within the Community for all market players, 
instead of a fragmented legal regime for CRAs throughout 27 Member States, which could 
arise if the EU does not act bu t keeps the current self-regulat ory regime based on the IOSCO 
Code. A legislative proposal would include a ‘diligent supervision’ system and a robust 
enforcement mechanism and thus be effect ive in assuring compliance with the policy 
objectives. It would ensure that the framework proposed for the issuance of credit ratings 
would be duly implemented, diligently supervised and robustly enforced. 
7. C OMPARING THE OPTIONS — CONCLUSIONS  
After due consideration of the im pacts of all specific policy op tions and their advantages and 
disadvantages compared with the baseline scen ario, the following conclusions may be drawn.  
To meet Objective 1  (Ensure that CRAs manage appropri ately any conflict of interest), 
CRAs will have to ensure that all existing and pote ntial conflicts of interests are identified and 
either eliminated or properly managed and disclosed. Specific internal governance 
arrangements will need to be put in place to as sist changes to corporate culture and internal 
policies. CRAs will be prohibited from providi ng consultancy or advisory services. Rating 
analysts will need to be insulated from the commercial aspects of the CRAs’ activities and to 
be subject to more demanding rules regarding di alogue with the client. Before analysts are 
employed in a position by a former client, speci fic safeguard rules should apply. Finally, 
CRAs’ clients should be discouraged from harmful ‘shopping for ratings’.  
To meet Objective 2  (Ensure that CRAs remain vigila nt on the quality of the rating 
methodology and the ratings), CRAs will have to use methodologies that are rigorous, 
systematic, continuous, and can be validated ba sed on historical expe rience. Methodologies, 
models and key ratings assumptions will need to be kept up-to-date and subject to comprehensive, regular review. An internal re view function will be established to monitor 
compliance in this area. Changes to rating me thodologies will trigger pr ompt re-rating of all 
existing ratings concerned. CRAs will also have  to monitor and update individual ratings on 
an ongoing basis. Greater transparency will be required to he lp users of ratings understand the 
due diligence conducted on the asset-level data and factored into the ratings. CRAs will need 
to disclose staff levels to trigger closer market scrutiny.  
 
EN 8   EN To meet Objective 3  (Increase the transparency of CRAs)  a general transparency obligation 
needs to be imposed on CRAs regarding the f unctioning of their internal processes and 
procedures, coupled with a duty to publish a yearly transparency re port. Information on 
analyses performed, any limitations and specific risks involved will need to be provided to 
users of ratings. CRAs should also use different rating categories for structured and traditional 
debt or provide investors with additional information when ra ting structured finance products. 
Historical performance statistics will need to be prepared using metrics that ensure 
comparability between market players.  
The legislation will set up a re gistration procedure for CRAs to en sure that their credit ratings 
can be used by credit institutions, investment firms, insurance and assurance undertakings, collective investment schemes and pension funds within the Community. Efficient and 
effective monitoring of compliance with the re quirements will be en sured throughout the EU 
(overarching objective ). The registration will be carried out by the competent authority of a 
Member State, but all Member States’ regulat ors should be able to express their opinion 
through the CESR. Day-to-day supervision will be  carried out by the competent authorities of 
the Member States. Close cooperation between national regulators a nd coordination by the 
CESR is a prerequisite to cr eating a common supervisory culture and an efficient network 
approach. National regulators s hould be empowered to  act and apply efficient sanctions where 
CRAs do not comply with the rules. Again, th e CESR should play an important role in 
creating a common enforcement culture.