COMMISSION STAFF WORKING PAPER IMPACT ASSESSMENT
Date: 2011-11-15
Institutions: European Commission
Subjects: administrative transparency, conflict of interest, economic analysis, financial institution, financial solvency, investment company, market supervision, public debt, securities, venture capital

EUROPEAN COMMISSION 

Brussels, 15.11.2011 
SEC(2011) 1354 final 

COMMISSION STAFF WORKING PAPER 

IMPACT ASSESSMENT 

Accompanying the document 

Proposal for a Regulation 

amending Regulation (EC) No 1060/2009 on credit rating agencies  

and a  

Proposal for a Directive 

amending Directive 2009/65/EC on coordination on laws, regulations and administrative 
provisions relating to undertakings for collective investment in transferable securities 
(UCITS) and Directive 2011/61/EU on Alternative Investment Fund Managers 

{COM(2011) 747 final} 
{SEC(2011) 1355 final} 

 
 
 
 
  
 
 
 
 
TABLE OF CONTENTS 

1. 

2. 

3. 

4. 

5. 

6. 

7. 

Introduction.................................................................................................................. 4 

Procedural issues and consultation of interested Parties.............................................. 5 
Legislative process and consultation....................................................................... 5 
Steering Group ........................................................................................................ 5 
Impact Assessment Board ....................................................................................... 5 

Policy context............................................................................................................... 6 
Role of CRAs and importance of ratings ................................................................ 6 
Overview of the credit rating market ...................................................................... 7 
International-level initiatives on CRAs................................................................... 7 

Problem Definition....................................................................................................... 8 
Overreliance on external credit ratings leading to "cliff" effects in capital markets
............................................................................................................................... 11 
Contagion effects of sovereign debt rating changes.............................................. 14 
Limited choice of rating agencies and ratings for issuers and investors ............... 17 
Insufficient right of redress for investors .............................................................. 18 
Potential conflicts of interest and other issues linked to credit rating 
methodologies and processes ................................................................................ 19 
The baseline scenario: how would the problem evolve without EU action? ........ 21 
Subsidiarity............................................................................................................ 22 

Objectives................................................................................................................... 23 

Identification and analysis of policy options ............................................................. 23 
Policy options to reduce reliance on external credit ratings.................................. 24 
Policy options to mitigate the risks of contagion effects linked to sovereign debt 
ratings .................................................................................................................... 30 
Policy options to improve credit rating market conditions ................................... 39 
Policy options to ensure right of redress for investors .......................................... 46 
Policy options to reinforce independence of credit rating agencies and improve 
credit rating methodologies and processes............................................................ 48 

2.1. 
2.2. 
2.3. 

3.1. 
3.2. 
3.3. 

4.1. 

4.2. 
4.3. 
4.4. 
4.5. 

4.6. 
4.7. 

6.1. 
6.2. 

6.3. 
6.4. 
6.5. 

Overall impact of the package.................................................................................... 54 
Cumulative impacts and synergies ........................................................................ 54 
7.1. 
Proportionality of the package .............................................................................. 55 
7.2. 
Impact on different stakeholders groups ............................................................... 56 
7.3. 
Assessment of administrative burden and compliance costs................................. 57 
7.4. 
Impact on EU budget............................................................................................. 59 
7.5. 
Impact on fundamental rights................................................................................ 59 
7.6. 
Social impact ......................................................................................................... 60 
7.7. 
Environmental impact ........................................................................................... 60 
7.8. 
7.9. 
Impact on SMEs .................................................................................................... 60 
7.10.  Coherence with other proposals ............................................................................ 60 
7.11.  Choice of legal instrument .................................................................................... 61 
Impact on third countries....................................................................................... 64 
7.12. 

8. 

Monitoring and evaluation ......................................................................................... 65 

Annex I. Overview of existing CRA Regulation and Possible new initiatives on CRAs 

(preferred options)...................................................................................................... 67 

Annex II. Stakeholder Consultation ......................................................................................... 77 

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1 – Summary of Responses to the Public Consultation Paper on new initiatives of CRAs 77 
2 – Roundtable on Credit Rating Agencies ......................................................................... 82 

Annex III. International context ............................................................................................... 86 
1 – Overview ....................................................................................................................... 86 
2 – Summary of FSB Report on overreliance to external credit ratings ............................. 87 
3 – Basel Committee on Banking Supervision.................................................................... 88 
4 – IOSCO disclosure principles for public offerings and listings of asset-backed securities

............................................................................................................................... 90 
5 – Comparison of the existing regulatory frameworks for CRAs in EU and US .............. 91 
6 – Regulatory Changes in the US vs. EU new initiatives on credit rating agencies ........ 100 

Annex IV. Overview of CRA market..................................................................................... 105 

Annex V. Overview of recent voluntary initiatives undertaken by major CRAs to enhance 

ratings quality........................................................................................................... 117 

Annex VI. Problem definition – background and technical details ....................................... 125 

Annex VII. Description of options......................................................................................... 147 

Annex VIII. Analysis of the impact of policy options on stakeholders ................................. 154 

Annex IX. Encouraging an existing, independent EU structure or promote a brand new 

European Credit Rating Agency to issue sovereign debt ratings............................. 159 

Annex X. European Network of Small and Medium-sized Credit Rating Agencies ............. 161 

Annex XI. European Credit Rating Agency........................................................................... 164 

Annex XII. Assessment of administrative burden and compliance costs .............................. 168 

Annex XIII. Coherence with main legislative initiatives ....................................................... 182 

ANNEX XIV – Additional Technical Changes ..................................................................... 187 

Annex XV. Measures against Over-reliance on External Credit Ratings in CRDIV ............ 188 

Annex XVI. Glossary............................................................................................................. 189 

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1. 

INTRODUCTION 

Regulation (EC) No 1060/2009 on credit rating agencies1 (CRA Regulation, CRA I) entered 
into full application on 7 December 2010. It requires credit rating agencies (CRAs) to comply 
with rigorous rules of conduct in order to mitigate possible conflicts of interest, ensure high 
quality  and  sufficient  transparency  of  ratings  and  the  rating  process.  Existing  CRAs  had  to 
apply for registration by 7 September 2010 and had to comply with the requirements of the 
Regulation  by  that  date.  Competent  authorities  coordinated  by  the  European  Securities  and 
Market  Authority  (ESMA) 2  are  currently  assessing  the  remaining  applications  for 
registration.3 
Furthermore, on 11 May 2011 an amendment to the CRA Regulation (CRA II)4 was adopted, 
entrusting  the  European  Securities  and  Markets  Authority  (ESMA) 5  with  exclusive 
supervisory powers over credit rating agencies registered in the EU in order to centralise and 
simplify  their  supervision  at  European  level.  From  1  July  ESMA  is  empowered  with 
comprehensive  investigatory  powers  including  the  possibility  to  demand  any  document  or 
data,  to  summon  and  hear  persons,  to  conduct  on-site  inspections  and  to  impose 
administrative sanctions, fines and periodic penalty payments. From that date ESMA is also in 
charge of any new application for registration. 

However, a number of issues related to credit rating activities and the use of ratings are not 
addressed in the existing CRA Regulation. These relate notably to the risk of over-reliance on 
credit ratings by financial market participants, the high degree of concentration in the rating 
market  and,  to  a  certain  extent,  remuneration  models  used  by  the  credit  rating  agencies.  
Although there are a number of smaller CRAs, the rating market is dominated by three major 
CRAs6 (Fitch, Moody's and Standard & Poors)7, with a combined market share above 95 % 
globally.8 Strong economies of scale in the sector as well as reputation of CRAs, which is a 
crucial  asset,  limit  market  entry.  The  specificities  of  certain  categories  of  ratings,  notably 

1  

2  

3  

4  

5  

6  
7  

8  

Regulation  of  the  European  Parliament  and  of  the  Council  on  credit  rating  agencies  of  16  September 
2009, OJ L 302, 17.11.2009. 
The European Securities and Market Authority (ESMA) has been established by Regulation (EU) No 
1095/2010 of 24 November 2010. It is an independent EU Authority that has been entrusted with the 
authorisation  and  supervision  of  CRAs,  contributes  to  safeguarding  the  stability  of  the  European 
Union's financial system by ensuring the integrity, transparency, efficiency and orderly functioning of 
securities markets, as well as enhancing investor protection. 
As  of  17.8.2011  eight  out  of  35  applicant  CRAs  have  been  registered  or  certified  and  the  remaining 
decisions on registration are expected in September 2011 (see ESMA list of registered CRAs in Annex 
IV. 1.1. 
Regulation  (EU)  No  513/2011  of  the  European  Parliament  and  of  the  Council  of  11  May  2011 
amending Regulation (EC) No 1060/2009 on credit rating agencies, OJ L 145, 31.5.2011. 
Regulation  (EU)  No  1095/2010  of  the  European  Parliament  and  of  the  Council  established  the 
European  Supervisory  Authority  (European  Securities  and  Markets  Authority)  (ESMA),  OJ  L  331, 
15.12.2010, page 84. 
A list of all registered CRAs can be found in Annex IV. 
Standard & Poor's and Moody's Investors Service have their head office and main management, 
administrative and supervisory bodies in the US. They operate in the EU through subsidiaries 
established in several Member States. Moody's Investor Services is owned by Moody's Corporation 
(listed in New York Stock Exchange - NYSE). Standard & Poor's is owned by the American publisher 
Mc Graw-Hill (which is a listed entity at NYSE). Fitch is dual-headquartered in New York and London 
and is a subsidiary of the French financial company Fimalac (listed in Euronext Paris). 
Finance – FAZ.NET, S & P, Moody’s and Fitch: Brussels’ battle against the rating oligopoly, June 
2011. Available from: http://financesjournal.com/finances/moodys-fitch-brussels-battle-rating-
oligopoly-5972.html.   

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related  to  sovereign  debt  instruments,  are  not  sufficiently  addressed  either.  In  particular, 
during the recent Euro debt crisis9, CRAs were criticised with regard to the transparency and 
quality of the sovereign debt ratings and the question was raised whether the EU regulatory 
framework  for  CRAs  needed  to  be  further  strengthened  to  address  this.  Finally,  conflicts  of 
interest linked to the shareholder structure of CRAs and civil liability of CRAs are also not 
sufficiently addressed in the CRA Regulation. 

2. 

PROCEDURAL ISSUES AND CONSULTATION OF INTERESTED PARTIES 

2.1. 

Legislative process and consultation 

Following the Communication of the European Commission ("Regulating Financial Services 
for Sustainable Growth") of 2nd of June 201010, in which the Commission announced the need 
to  examine  whether  further  regulation  is  needed  in  the  area  of  CRAs,  the  European 
Commission  conducted  a  public  consultation  from  5  November  2010  to  7  January  2011  to 
tackle  issues  not  yet  sufficiently  addressed  in  the  current  regulatory  framework. 11  The 
Commission  received  approximately  100  contributions  from  stakeholders  which  have  been 
taken  into  account  in  the  Impact  Assessment.  A  summary  of  responses  to  the  public 
consultation paper can be found in Annex II section 1.   
On 8 June 2011 the European Parliament issued a non-legislative report on CRAs.12 Among 
other proposals, the report supports measures and initiatives that would make market players 
(investors,  banks,  central  banks)  more  engaged  in  risk  analysis,  reducing  their  over-reliance 
on  ratings.  In  addition,  the  report  calls  for  support  for  the  creation  of  networks  of  smaller 
CRAs  and  for  the  establishment  of  a  European  Credit  Rating  Foundation  and  supports  the 
establishment of a civil liability regime.  

On 6 of July the Commission services held a roundtable in order to obtain further feedback 
from  relevant  stakeholders  on  these  issues.  A  summary  of  the  roundtable  can  be  found  in 
Annex II section 2.  

2.2. 

Steering Group 

A  Steering  Group  for  this  Impact  Assessment  was  formed  by  representatives  of  Directorate 
General Internal Market and Services, Directorate General Competition, Directorate General 
Economic and Financial Affairs, Directorate General Enterprise, Directorate General Justice, 
Directorate General Budget, the Legal Service and the Secretariat General and met three times, 
on  28  January,  4  May  and  14  July  2011.  The  contributions  of  the  members  of  the  Steering 
Group have been taken into account in the content and shape of this impact assessment. 

2.3. 

Impact Assessment Board 

DG  MARKT  services  met  the  Impact  Assessment  Board  on  5  of  October  2011.  The  Board 
analysed  this  Impact  Assessment  and  delivered  its  opinion  on  7  October  2011.  During  this 
meeting the members of the Board provided DG MARKT services with comments to improve 
the content of the Impact Assessment that led to some modifications of this final draft.  

9  
10  

11  

12  

A description and detailed analysis of the Euro debt crisis can be found in Annex VI.  
Communication  from  the  Commission  to  the  European  Parliament,  the  Council,  the  European 
Economic  and  Social  Committee  and  the  European  Central  Bank.  Regulating  financial  services  for 
sustainable growth, COM(2010) 301 final. 
Notably  related  to  overreliance  on  external  credit  ratings,  sovereign  debt  ratings,  competition  in  the 
rating industry, civil liability of credit rating agencies and conflicts of interest due to the "issuer-pays" 
model. 
European  Parliament  resolution  of  8  June  2011  on  credit  rating  agencies:  future  perspectives, 
2010/2302(INI). Dr. Wolf Klinz was the rapporteur of this resolution. 

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The main comments were the following:  

-  Strengthen  the  analysis  of  impacts  for  some  options  and,  specifically,  on  the  proposed 
additional powers of the ESMA; 

- Improve the analysis on implications of the limited territorial and jurisdictional applicability 
of EU law when evaluating the effectiveness of individual measures; 

- Individual policy options should be completed by a deeper assessment of the overall impact 
and proportionality of the preferred package of policy options; 

- Stakeholders' views should be discussed more extensively in the main text of the report.   

3. 

POLICY CONTEXT 

3.1. 

Role of CRAs and importance of ratings  

CRAs  are  companies  recognised  in  the  markets  as  independent  providers  of  credit  opinions 
(ratings13).  Their  main  business  is  to  perform  analyses  and  to  issue  opinions  regarding  the 
creditworthiness  of  companies  ("corporate")  and  governments  ("sovereign").  They  also 
provide  credit  opinions  on  a  wide  range  of  more  complex  financial  debt  instruments, 
including structured finance products.  

CRAs have a major impact on the financial markets, with ratings actions closely followed by 
investors, borrowers, issuers and governments. Investors rely on ratings as key information in 
determining investment decisions, depending on the degree of risk they are willing to accept. 
The rating given to an issuer or security will affect the cost of raising capital. Very often, a 
deterioration of a debtor's creditworthiness reflected in a rating change may trigger particular 
contractual obligations (e.g. immediate debt repayment). Finally, there are references to credit 
ratings  in  financial  regulation14,  most  prominently  in  the  Capital  Requirements  Directive15 
(CRD), under which credit institutions are  entitled  to use  ratings for the calculation of their 
capital  requirements.  However  –  and  with  the  intention  to  reduce  reliance  on  ratings  -  the 
proposal for a revised Capital Requirements Directive (CRD IV), adopted by the Commission 
on 20 July 201116, provides banks with an incentive to use internal rather than external credit 
ratings for the purposes of calculating regulatory capital. Also, financial institutions' internal 
risk management shall not rely solely or mechanically on external ratings. 

Moreover,  in  the  last  few  years  the  demand  for  sovereign  debt  ratings  has  increased 
dramatically as more and more governments and financial institutions borrow on international 
bond  markets.  Sovereign  credit  ratings  have  an  important  signalling  effect  to  investors  and 

13  
14   

15 

16  

See definition in Article 3 (1) a of the CRA Regulation 
An overview of all references in EU financial regulation can be found in Annex 1 of the Commission 
consultation paper on CRAs of 5.11.2010, available from: 
http://ec.europa.eu/internal_market/consultations/docs/2010/cra/cpaper_en.pdf.  
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 business of credit institutions (recast). OJ L 177, 30.6.2006, p. 1–200. An 
explanation on the Directive can be found in annex 9.1. 
COM(2011) 453 final and COM(2011) 452 final. 

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rating  downgrades  can  lead  to  "spillover  effects"17,  with  a  destabilizing  impact  on  financial 
markets.18 

The euro area sovereign debt crisis has highlighted the interdependence of different financial 
markets  and  the  contagion  effects  that  rating  changes  may  exert  on  the  broader  euro  area 
economy. Although government officials generally cooperate with credit rating agencies and 
should in principle anticipate sovereign credit rating changes, many euro area Member States 
have  recently  experienced  unexpected  sovereign  downgrades.  This  observation  prompts 
issuers,  investors  and  regulators  to  question  the  consistency,  rationale  and  transparency  of 
sovereign ratings, especially knowing that sovereign debt ratings have a significant impact not 
only  on  funding  costs  of  the  affected  country  but  also  on  its  financial  sector  and  on  the 
economies of other euro area Member States.19 

3.2. 

Overview of the credit rating market 

The credit rating market is oligopolistic and is effectively dominated by three large agencies 
operating  globally:  Standard  &  Poor's,  Moody’s  Investors  Service  and  Fitch  Ratings. 
Moody’s  and  Standard  &  Poor's  have  a  combined  market  share  of  circa  80%,  while  Fitch’s 
market  share  is  approximately  15%.20   In  the  United  States,  the  SEC  reported  in  2011  that 
these  same  three  firms  issued  97%  of  outstanding  ratings21 and  earned  over  98%  of  ratings 
revenues. Medium and smaller credit rating agencies often cater to very specific market needs. 
Among them, Dominion Bond Rating Service (DBRS), Japan Credit Rating Agency, Ltd. and 
Rating and Investment Information, Inc. are well established regional players (in Canada/US 
and Japan respectively) with ambitions to develop their international market presence. Finally, 
there  are  a  number  of  local  rating  agencies  active  in  different  countries,  issuing  rating 
opinions  both  for  general  purposes  and  for  specialised  uses;  their  impact  on  the  global 
financial markets is nonetheless marginal. For more details on the CRA market structure, see 
Annex IV. 

3.3. 

International-level initiatives on CRAs 

Discussions  on  regulating  CRAs  have  been  very  lively  not  only  in  Europe  but  also  on  the 
international scene. A full description of the various initiatives summarized in this section can 
be found in Annex III.  
In  October  2010  the  Financial  Stability  Board  (FSB)  endorsed  principles 22  to  reduce 
authorities’  and  financial  institutions’  reliance  on  ratings.  This  has  been  approved  by  the 

17  

18  

19  

20  

21  

22  

Spill-over effects are externalities of economic activity or processes affecting those who are not directly 
concerned.  In  this  particular  case,  an  externality  (or  transaction  spill-over)  is  a  cost,  not  transmitted 
trough prices, incurred by a party who did not agree to the action causing the cost. 
International Monetary Fund, World Economic and Financial Surveys Global Financial Stability Report, 
October 2010, page 5. Available from: http://www.imf.org/external/pubs/ft/gfsr/2010/02/pdf/text.pdf.  
The  downgrades  to  near  speculative  grade  ratings  of  some  European  countries  have  a  systematic 
"spillover  effects"  across  Euro  zone  countries.  There  is  strong  correlation  between  the  rating-based 
triggers used in banking regulation, CDS contracts, and investment mandates. The main finding is that 
rating downgrades have statistically significant spillover effects across countries and financial markets. 
IMF  Working  Paper,  Sovereign  Rating  News  and  Financial  Markets  Spillovers:  Evidence  from  the 
European Debt Crisis, Rabah Arezki, Bertrand Candelon and Amadou N. R. Sy, 2011. Available from 
http://www.imf.org/external/pubs/ft/wp/2011/wp1168.pdf.   
See  Handelsblatt  of  5  July  2011,  p.  6  ("Ratingagenturen-  die  unheimliche  Macht")  referring  to  CRA 
data and own research.  
US  Securities  and  Exchange  Commission  (SEC)  2011  Annual  Report  on  Nationally  Recognised 
Statistical Ratings Organisations, page 7. 
FSB, principles for reducing reliance on CRA ratings, adopted on 27 October 2010. Available from: 
http://www.financialstabilityboard.org/publications/r_101027.pdf.  

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G20. 23  The  FSB  principles  aim  to  reduce  the  "cliff"  effects  of  ratings  that  can  amplify 
procyclicality and cause systemic disruption. Market participants are expected to make their 
own credit assessments and not to rely solely or mechanistically on ratings.  

The FSB has asked standard setters and regulators to consider next steps that could be taken 
to  translate  the  principles  into  policy  approaches  tailored  to  specific  financial  sectors  and 
market  participants.  In  response  to  the  G20  statements 24 and  the  FSB  principles,  the  Basel 
Committee on Banking Supervision (BCBS) is currently working on specific policy actions to 
reduce  reliance  on  ratings  in  the  regulatory  framework  and  make  several  recommendations 
that will be included in the Basel III rules.25  

In  the  USA,  the  Dodd-Frank  Wall  Street  Reform  and  Consumer  Protection  Act,  (the  Dodd-
Frank Act)26 has strengthened rules on CRAs. Among other things section 939A of the Dodd-
Frank  Act  requires  federal  agencies  to  review  how  existing  regulations  rely  on  ratings  and 
remove such references from their rules as appropriate. As a consequence, the Securities and 
Exchange  Commission27 (SEC) is currently exploring ways to reduce regulatory reliance on 
external credit ratings and replace them with alternative criteria.28  

4. 

PROBLEM DEFINITION 

The problems described in the following section can be grouped into six broad areas:  

•  Overreliance on external credit ratings leading to "cliff" effects29 in capital markets; 

•  "Contagion effects of sovereign debt rating changes;  

•  Limited choice and competition in the credit rating market; 

• 

Insufficient  right  of  redress  for  users  of  ratings  suffering  losses  due  to  an  inaccurate 
rating issued by a CRA that infringes the CRA Regulation; 

•  Potentially undermined independence of CRAs due to conflicts of interest arising from 
the "issuer-pays" model, ownership structure and long tenure of the same CRA; and 

• 

Insufficiently sound credit rating methodologies and processes. 

These problems are largely interrelated and could reinforce each others' effects. 

23  

24  

25  

26  
27  
28  

29  

G20 Seoul Summit leaders' Declaration, 11-12 November 2010. Available from: 
http://www.g20.org/Documents2010/11/seoulsummit_declaration.pdf.  
G20, Toronto G20 summit declaration, 26-27 June 2010. Available from:  
http://www.g20.org/Documents/g20_declaration_en.pdf.  
These  included,  for  example,  proposals  to  remove  or  reduce  certain  "cliff  effects"  related  to  ratings 
from  the  internal-ratings  based  (IRB)  approach  and  standardised  approach  (SA).  In  particular,  the 
Ratings and Securitisation (RS) group is now working on addressing adverse incentives and cliff effects 
arising from the use of ratings through: (i) the recalibration of risk weights for securitisation exposures 
under the ratings-based approach, including to reduce "cliff effects"; (ii) the review of the hierarchy of 
approaches  in  the  securitisation  framework  with  the  aim  of  reducing  the  predominant  role  played  by 
external ratings; and, (iii) the enhancement of internal assessment and due diligence requirements. Final 
proposals on these topics are expected to be completed in time for the September 2011 meeting of the 
Basel Committee. 
Dodd-Frank Wall Street Reform and Consumer Protection Act, 29 June, 2010.  
SEC Initiatives under New Regulatory Reform Law.  
SEC Proposes First in Series of Rule Amendments to Remove References to Credit Ratings, 9 February 
2011. Available from: http://www.sec.gov/rules/proposed/2011/33-9186.pdf.  
"Cliff effects" are sudden actions that are triggered by a rating downgrade under a specific threshold, 
where downgrading a single security can have a disproportionate cascading effect. 

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While  some  of  these  issues,  notably  issue  of  overreliance  and  independence  were  already 
recognized when the CRA Regulation was first negotiated, the CRA Regulation did not fully 
address  these  issues  but  required  the  European  Commission  to  monitor  them  and  make  an 
assessment by the end of 2012.30 

30  

Article 39 (1) of the CRA Regulation. 

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Problem drivers 

Consequences 

Global problems 

Risks to  
market 
stability 

Low 
confidence 
in financial 
market 

Undermined 
investor 
confidence 

Undermined 
ratings 
quality 

Requirements to use external credit 
ratings in legislation

Excessive use of external ratings for 
internal risk management 

Investment strategies directly linked 
to ratings 

Insufficient information on structured 
finance products

Insufficient objectivity and 
completeness of the sovereign rating 
process 

Lack of transparency on the 
sovereign rating process 

Inappropriate timing of ratings 
publication 

High market concentration in the 
credit rating market

High barriers of entry into the market 
of credit ratings 

Lack of comparability of ratings 

Lack of civil liability regimes in some 
Member States

Risk of regulatory arbitrage 

Potential conflicts of interest due to 
ownership structure

Potential conflicts of interest due to 
the "issuer-pays" model 

Insufficient communication and 
transparency of ratings and their 
underlying methodologies  

Inappropriate timing of ratings 
publication 

Figure 1. Problem tree 

Overreliance on 
external ratings 
leading to 
procyclicality and 
"cliff" effects in 
capital markets 

Contagion effects 
of sovereign debt 
rating changes 

Limited choice and 
competition in the 
credit-rating market 

Insufficient 
right of 
redress for 
investors 

Undermined 
independence of 
credit rating 
agencies

Insufficiently sound 
credit rating 
methodologies and 
processes

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4.1. 

Overreliance  on  external  credit  ratings  leading  to  "cliff"  effects  in  capital 
markets 

Under certain economic conditions, market participants' mechanistic and parallel reliance on 
external  ratings  leads  to  herd  behaviour31and  "cliff"  effects.  This  can  entail  both  upward 
market  bubbles  and  downward  market  spirals  which  could  affect  market  stability.  This 
became  evident  during  the  current  financial  crisis  when  worsening  economic  forecasts  put 
pressure  on  public  finances. This,  in turn, led to  a downgrade of sovereign bonds32 below a 
threshold causing simultaneous selling off of debt instruments33 by many financial institutions 
and investors. Thus, overreliance on external ratings has exacerbated financial in-stability in 
individual countries, with negative effects on the European and global level. 

Use of credit rating in the regulatory regimes 

The current use of credit ratings in the regulatory regimes for banks, insurance undertakings 
and  other  financial  institutions  reinforces  this  overreliance  and  discourages  financial  firms 
from undertaking their own risk assessments and  due diligence.  

Reference  to  external  ratings  in  regulatory  capital  frameworks  of  financial  institutions  may 
lead  to  sudden  rises  in  capital  requirements  once  a  rating  action  occurs.34 In  reaction  to  a 
financial instrument's significant downgrade, many firms using a regulatory approach relying 
on external ratings may decide in parallel to sell off the downgraded instrument which may 
cause a downward price spiral with potential negative effects on financial stability.35  

In  the  banking  sector  the  use  of  external  ratings  is  explicitly  envisaged  by  the  Capital 
Requirements  Directive36,  which  requires  the  use  of  external  ratings  for  measuring  capital 
requirements under the standardised approach.37 38 In the insurance sector, neither the existing 
framework of insurance39 and reinsurance40 directives (commonly referred to as "Solvency I") 

31  

32  

33  
34  

35  

36  

37  

38  
39  

Herd behaviour implies systematic and erroneous decision-making by a group. Intuitively, investors can 
be said to herd if they would have made an investment without knowing other investors’ decisions, but 
refrain  from  making  that  investment  when  they  learn  that  others  have  decided  not  to  do  so.  See  The 
Financial Cycle, Factors of Amplification and possible Policy Implications for Financial and Monetary 
Authorities,  Banque  de  France,  Bulletin  No  95,  November  2001,  p.68.  Available  from: 
http://www.banque-france.fr/gb/publications/telechar/autres_telechar/fincyc95.pdf.  
Sovereign  Rating  News  and  Financial  Markets  Spillovers:  Evidence  from  the  European  Debt  Crisis, 
Rabah  Arezki,  Bertrand  Candelon,  Amadou  Sy,  CESIFO  Working  Paper  No.  3411,  Category  7: 
Monetary Policy and International Finance, April 2011.  
See section 4.2. Contagion effect of sovereign debt ratings. 
There  is  evidence  that  credit  ratings  affect  a  firm’s  cost  of  capital  specifically  due  to  the  regulations 
based on ratings. See Darren J. Kisgen Philip E. Strahan, Do regulations based on credit ratings affect a 
firm’s cost of capital?, March 2009. 
There  spillovers  from  the  Sovereign  to  the  Banks  and  Banks  to  Sovereigns,  International  Monetary 
Fund, Global Financial Stability Report, Sovereigns, Funding and Systemic Liquidity. October 2010, p. 
4. Available from: http://www.imf.org/external/pubs/ft/gfsr/2010/02/pdf/text.pdf.   
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 business of credit institutions (recast) (OJ L 177/1, 30.6.2006). 
The  standardised  approach  has  received  little  research  attention  even  though  some  estimates  indicate 
that  30%  of  European  banks  have  adopted  it.  Source:  Patrick  Van  Roy,  Credit  Ratings  and  the 
Standardise  Approach  to  Credit  Risk  in  Basel  II,  p.  5.  The  European  Central  Bank,  Working  paper 
series No. 517, August 2005. Available from: http://www.ecb.int/pub/pdf/scpwps/ecbwp517.pdf.  
Articles 94, 96 Directive 2006/48/EC. 
Directive 2002/83/EC of the European Parliament and of the Council of 5 November 2002 concerning 
life  assurance,  OJ  L  345/1,  19.12.2002.  First  Council  Directive  73/239/EEC  of  24  July  1973  on  the 
coordination of laws, regulations and administrative provisions relating to the taking-up and pursuit of 
the  business  of  direct  insurance  other  than  life  assurance  OJ  L  228,16.8.1973;  Council  Directive 
78/473/EEC  of  30  May  1978  on  the  coordination  of  laws,  regulations  and  administrative  provisions 
relating to Community co insurance OJ L151, 7.6.1978; Council Directive 87/344/EEC of 22 June 1987 
on  the  coordination  of  laws,  regulations  and  administrative  provisions  relating  to  legal  expenses 

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nor the "Solvency II" Framework Directive41, which has revised the existing solvency regime 
and introduced risk-oriented solvency requirements, contain any reference to external ratings. 
Such  references  may  however  be  considered  in  the  future  implementing  measures  of  the 
Solvency II framework directive in order to specify the standard formula. 

Reliance on external ratings for (credit/market) risk management and investment decisions 

Use of external ratings for (credit/market) risk management may lead to herd behaviour as a 
rating  actions  may  trigger  parallel  reactions  in  many  financial  firms 42 ,  all  relying 
mechanistically  and  solely  on  external  ratings,  issued  by  a  small  number  of  credit  rating 
agencies.43  

Financial firms basing their investment decisions solely on external ratings without carrying 
out  their  own  risk  assessment  may  not  have  the  necessary  understanding  of  the  financial 
instrument  in  which  they  invest.  Furthermore,  the  publicly  disclosed  information  about 
structured finance products is often insufficient for investors to adequately assess risks related 
to specific financial instruments and therefore forces them to rely on external ratings. 

In  a  similar  fashion  investment  policies  and  the  mandates  of  portfolio  and  asset  managers 
often  make  reference  to  external  ratings  when  defining  the  minimum  credit  quality  for  a 
portfolio or performance benchmarks. Investors often require investment managers to adhere 
to minimum credit quality standards defined by external ratings.44 This provides a relatively 
simple and transparent mechanism for investors to control and monitor the credit risk of the 
assets  in  which  the  manager  invests.  Even  if  the  widespread  use  of  ratings  in  investment 
policies,  mandates  and  other  commercial  contracts  is  not  a  direct  consequence  of  EU 
legislation,  it  may  exacerbate  the  "cliff"  effects  associated  with  rating  downgrades,  where 
investment  managers  are  obliged  to  sell  off  financial  instruments  no  longer  complying  with 
the credit quality standards specified in their mandate or policy. The simultaneous sale of debt 
instruments triggered by a downgrade may result in losses to investors45 and increase market 

insurance  OJ  L  185  4.7.1987,  p.77;  Second  Council  Directive  88/357/EEC  of  22  June  1988  on  the 
coordination  of  laws,  regulations  and  administrative  provisions  relating  to  direct  insurance  other  than 
life  assurance  and  laying  down  provisions  to  facilitate  the  effective  exercise  of  freedom  to  provide 
services OJ L 172, 4.7.1988 p.1; Council Directive 92/49/EEC of 18 June 1992 on the coordination of 
laws,  regulations  and  administrative  provisions  relating  to  direct  insurance  other  than  life  assurance 
(third non life insurance Directive) OJ L 228, 11.8.1992. 
Directive  2005/68EC  of  the  European  Parliament  and  of  the  Council  of  16  November  2005  on 
reinsurance, OJ L 323/1, 9.12.2005. 
Directive  2009/138/EC  of  the  European  Parliament  and  of  the  Council  of  25  November  2009  on  the 
taking-up  and  pursuit  of  the  business  of  Insurance  and  Reinsurance  (Solvency  II)  ,  OJ  L  335, 
17.12.2009. 
Credit institutions, investment firms, insurance and reinsurance undertakings, pension funds, investment 
managers. 
Moody’s (2001) describes three instances of rating-trigger-related "mutual assured destruction" during 
2000–01: (1) collapse of Enron: in that case, trading and other financial agreements gave counterparties 
the right to demand cash collateral, and lenders the right to demand repayment of outstanding loans 
once Enron’s credit rating declined below a certain level; (2) PG&E Corporation; (3) Southern 
California Edison Company. See IMF - Global Financial Stability Report - autumn 2010, p. 8. 
Available from: http://blogs.sciences-po.fr/recherche-predictions/files/2010/12/gfsr-201010-3-
sovereign_ratings-imf-global-stability1.pdf.    
Many investors have mandates limiting what they can invest in, and these are normally linked to ratings, 
so  they  will  have  a  bucket  allocated  to  triple-A  securities,  to  double-A  and  so  on.  If  they  cannot  fill 
those  buckets,  then  they  cannot  fulfil  their  mandate.  See  Banking  Supervision  and  Regulation  - 
Economic  Affairs  Committee,  Chapter  6:  Ratings  Agencies,  section  167,  Parliament  UK.  Available 
from: http://www.publications.parliament.uk/pa/ld200809/ldselect/ldeconaf/101/10109.htm.  
The thousands of mortgage-related securities rated by Moody's in 2006, 83 % of those rated AAA were 
ultimately  downgraded.  The  impact  of  these  inflated  ratings,  and  their  subsequent  mass  downgrades, 
was  far-reaching.  CalPERS,  on  which  one  and  a  half  million  Californians  rely  for  their  pension  and 

40  

41  

42  

43  

44  

45  

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volatility.46 Another  "cliff"  effect  may  occur  when  debt  instruments  downgraded  below  a 
certain threshold are removed from bond market indices used as a benchmark for portfolios. 

Other references to external ratings 

There are also references to external ratings in Member States' laws and regulations which are 
not required by EU legislation. In June 2009, the Joint Forum47 undertook a stock take of the 
use of ratings which showed the use of external credit ratings in the national legal orders of 
many EU Member States.48  

Furthermore, the ECB uses credit ratings for the purpose of defining securities acceptable as 
collateral in market operations. The definition of eligible securities includes the requirement 
for the issuer to have a satisfactory credit rating from two or more of the leading credit rating 
agencies. This practice may induce banks to sell off securities once they lose their eligibility 
as collateral, which further reinforces "cliff effects". One could claim that, to a certain extent, 
this ECB policy also sends a wrong signal to the whole banking industry what an acceptable 
level on external reliance should be. However, the ECB stated in its contribution to the public 
consultation  that  it  has  started  a  process  to  enhance  and  develop  further  its  internal 
capabilities  to  independently  assess  the  creditworthiness  of  issuers  for  its  own  purposes.  In 
this regard it should also be noted that the credit assessment framework of the Eurosystem is 
decided independently by the ECB Governing Council. 
Also  the  European  Financial  Stability  Facility  (EFSF)49 framework  agreement50 of  7  June 
2010 between the EFSF and the "euro-area Member States" or "EFSF Shareholders" sets out 
detailed  operating  conditions  of  the  EFSF  that  contain  references  to  external  ratings.51 The 
European Financial Stability Mechanism will be replaced by a new instrument as of 2013, the 
European  Stability  Mechanism  (ESM).  The  treaty  establishing  the  ESM52 does  not  contain 
any direct references to external ratings.  

For more detailed information on references to ratings in EU Financial Regulation, see Annex 
VI. section 2.1.  

4.2. 

Contagion effects of sovereign debt rating changes 

Spillover and contagion effects 

health  benefits,  estimated  it  lost  $1  billion.  It  is  estimated  that  pensioners  in  Ohio  lost  about  half  a 
billion dollars. The direct effect of these mass credit downgrades on retirement savings nationwide is 
almost  certainly  in  the  tens  of  billions  of  dollars.  As  a  result  of  the  financial  collapse  more  broadly, 
Americans' retirement savings saw losses of about $2 trillion. Information source: Official letter from 
US Senate (Al Franken and Roger F. Wicker, US Senators) to Chairman of SEC (Mary L. Schapiro) on 
the  implementation  of  the  Franken-Wicker  amendment  on  assigned  credit  ratings  and  also  other 
relevant policy measures, 14 September 2011.  
Ibid Moody’s (2001). 
The  Joint  Forum  was  established  in  1996  under  the  aegis  of  the  Basel  Committee  on  Banking 
Supervision  (BCBS),  the  International  Organization  of  Securities  Commissions  (IOSCO)  and  the 
International Association of Insurance Supervisors (IAIS) to deal with issues common to the banking, 
securities and insurance sectors.  
The Joint Forum, Stocktaking on the use of credit ratings, June 2009. Available from: 
http://www.bis.org/publ/joint22.pdf.    
The EFSF is a "société anonyme" incorporated in Luxembourg. 
http://www.efsf.europa.eu/attachments/efsf_framework_agreement_en.pdf.  
More particularly, point 2 (3) regarding issues of guarantees states that the EFSF may also request the 
Guarantors to issue Guarantees under this Agreement for other purposes which are closely-linked to an 
issue  of  Funding  Instruments  and  which  facilitates  the  obtaining  and  maintenance  of  a  high  quality 
rating for Funding Instruments issued by EFSF and efficient funding by EFSF. 
Treaty establishing the European Stability Mechanism (ESM) signed on 11 July 2011, currently under 
ratification by the Eurozone Member States. http://www.efsf.europa.eu/attachments/esm_treaty_en.pdf.  

46  
47  

48  

49  
50  
51  

52  

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The  recent  market  developments  have  highlighted  the  magnitude  of  the  potential  impact  of 
sovereign  ratings  which  goes  far  beyond  the  immediate  effects  on  the  bond  markets  of  the 
rated countries and can result in negative spillovers across markets and even across countries 
which  have  significant  economic  linkages.  The  multiple  effects  of  sovereign  ratings  on 
financial markets can be described as follows: 

•  Firstly,  sovereign  debt  ratings  play  a  crucial  role  in  determining  a  country's  borrowing 
costs.  Empirical  evidence53 shows  that  sovereign  rating  events  have  a  statistically  and 
economically  significant  effect  on  yield  spreads.54 It  is  worth  observing  that  available 
research shows that there is asymmetry in market reactions, i.e. while there is a significant 
reaction of sovereign yield spreads (and particularly CDS spreads) to negative events, the 
reaction to positive events is much more muted.55 

•  Secondly,  sovereign  rating  events  may  have  spillover  effects  within  the  country  across 
markets  (from  government  bond  markets  to  corporate  bond  markets  to  equity  markets) 
with  huge  impact  on  the  cost  and  access  to  external  funding  for  wide  range  of  entities 
(including  public  administrations,  local  governments  and  financial  institutions).  A 
sovereign rating is indeed one of the factors which heavily influences the assessment of 
the counterparty risk and serves often as a general benchmark for all other credit ratings 
for all the entities located in the country. Furthermore, the highest rating possible for most 
entities located in a country is often capped by the country's own rating.  

Multiple  examples  over  the  past  year  of  a  downgrade  of  a  Member  State  immediately 
followed by a downgrade of financial institutions of that country illustrate the importance 
of  a  sovereign  rating  for  ratings  of  financial  institutions  located  in  the  country 
experiencing a rating change. An example of this relation between sovereign ratings and 
ratings of financial institutions can be illustrated by the recent downgrade of Portugal by 
Moody's  on  the  6th  of  July  2011  followed  by  a  downgrade  of  four  Portuguese  financial 
institutions the following day. Another example is provided by the downgrade of Italy by 
Standard  and  Poor’s  on  20  September  2011  and  by  Moody’s  on  4  October  2011  which 
were followed a few days after by the downgrade of some of the major Italian financial 
and non-financial companies and local authorities. 

•  Finally,  sovereign  debt  ratings  may  trigger  contagion  effects  beyond  the  borders  of  the 
country directly affected by the rating event. Economic literature56 demonstrates that the 

53  

54  

55  

56  

Sovereign downgrades have a negative impact on sovereign bond yield spreads and can have spillover 
effects as demonstrated by: Alfonso, Furceri, Gomes, "Credit ratings and the Euro Area Sovereign Debt 
crisis" University of Freiburg, 2011, p3. As an example, yield spread of Portugal sovereign debt rose on 
2-year  and  10-year  sovereign  bonds  rose  to  respectively  8.971%  and  8.766%  after  the  downgrade  by 
Moody's on 5 April 2011 from A3 to Baa1, following an earlier Moody's downgrade of 2 notches on 
16 March 2011.  
The  yield  spread  is  the  difference  between  the  quoted  rates  of  return  on  two  different  investments, 
usually  of  different  credit  quality.  An  analysis  of  spread  developments  around  the  time  of  rating 
announcements  shows  that  sovereign downgrades  are followed by rising  sovereign  spread  changes  as 
demonstrated  in  "European  Economic  Forecast,  Spring  2011",  Staff  Working  document,  European 
Commission; Directorate General Economic and Financial Affairs, pag. 44-45.  
See Antonio Afonso, Davide Furceri, Pedro Gomes, Sovereign ratings and financial markets linkages. 
Application  to  European  data.  ECB  paper  n.  1347,  June  2011.  It  is  also  interesting  to  observe  that 
according  to  the  Authors  the  reaction  of  CDS  spreads  to  negative  rating  events  has  increased 
considerably after the beginning of the crisis (i.e. the 15.9.2008 – day of Lehman bankruptcy). 
Rabah Arzeki, Bertrand Candelon and Amandou N.R.Sy, IMF Working Paper, Sovereign Rating News 
and Financial  Markets  Spill-overs:  Evidence  from  the  European Debt  Crisis,  March 2011, WP/11/68. 
The paper demonstrates that sovereign downgrades have statistically and economically significant spill-
over  effects  both  across  countries  and  financial  markets.  Their  magnitude  depends  on  the  type  of 
announcement, the specific country affected by the rating decision and the specific CRA that issued the 

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excessive  prominence  given  to  sovereign  debt  ratings  by  market  actors,  including 
financial  institutions  and  institutional  investors,  generates  cliff  effects 57  within  the 
economy  of  the  downgraded  or  upgraded  countries  as  well  as  in  economically  linked 
regions.  Also  in  this  context  it  has  been  shown  that  negative  announcements  have  the 
most significant effects58, particularly from lower rated countries to higher rated countries, 
with potential contagion of neighbouring countries. 

Factors amplifying spill-over effects 

Recent market developments show that negative spill over effects attached to sovereign rating 
changes  are  amplified  by  a  series  of  factors  ('drivers')  which  can  exacerbate  a  situation  of 
crisis and result in spreading financial instability across markets and countries. In view of the 
implications of sovereign ratings on the wider economy the hereafter described problems and 
drivers suggest the application of the precautionary principle.  

The  first  problem  driver  behind  the  described  spill-over  effects  relates  to  overreliance  on 
external ratings, which was addressed in section 4.1. In the event of a sovereign downgrade, 
ratings-based  rules59, such as regulatory capital requirements and ECB collateral guidelines, 
can  prompt  automatic  sell-off  orders  of  sovereign  debt,  creating  spill-over  effects  to  the 
broader  economy.  The  recent  events  affecting  particularly  the  euro  area  sovereign  debt 
markets provide a good illustration of these mechanisms. 

Another  factor  which  is  relevant  in  amplifying  contagion  effects  of  sovereign  ratings  is  the 
important degree of subjectivity of the sovereign rating processes and to some extent the lack 
of  consistency  of  CRA’s  behaviour  over  time.  Indeed  recent  research  show  a  substantial 
increase  of  the  'arbitrary  component'  of  the  sovereign  ratings  over  the  recent  years, 
particularly  in  2009  and  201060,  and  point  at  the  existence  of  subjective  biases  in  favour  or 
against the rated nations to (partly) explain the differences in sovereign ratings given by two 
of the major Rating Agencies.61 This could be explained, inter alia, by the higher reputational 
risk attached to rating misspecification in a context of economic crisis and lack of investor's 
confidence which may lead CRAs to be 'keener' on lowering sovereign ratings (while CRAs 
could be keener to attribute higher ratings in boom times, when investor's trust tends to rise).62  
The lack of consistency of CRAs' behaviour can prompt market over (or under)reactions since 
the  markets  do  not  'understand'  sufficiently  the  message  the  Rating  Agency  is  trying  to 
communicate when it ventures an opinion on the future solvability of the country.  

rating. Furthermore, they find evidence that downgrades to near speculative grade ratings for relatively 
large economies such as Greece have a systematic spill-over effect. 
Cliff effects in this context are sudden actions that are triggered by a rating downgrade under a specific 
threshold.  They  may  for  instance  occur  if  a  specific  sovereign  debt  is  downgraded  to  non-investment 
grade and following this downgrade many investment managers have to sell off this instrument when it 
no longer corresponds to their investment policies or mandates.  
Ferreira and Gama demonstrate that sovereign rating downgrades are associated with an economically 
and  statistically  significant  negative  return  spread  in  stock  market  of  neighbourhood  countries  while 
upgrades  abroad  have  no  discernible  impact.  Furthermore  they  show  that  geographic  distance  is 
inversely related to the spillover impact. See Ferreira and Gama, Does sovereign debt ratings news spill 
over to international stock markets, Journal of Banking & Finance, 2007.   
Rabah Arzeki, Bertrand Candelon and Amandou N.R.Sy, IMF Working Paper, Sovereign Rating News 
and Financial Markets Spillovers: Evidence from the European Debt Crisis, March 2011, WP/11/68. 
See Gartner, Griesbach and Jung, PIGS or Lambs? The European Sovereign Debt Crisis and the Role of 
Rating Agencies, Univerity St. Gallen, 2011.  
See  S.  Iyengar,  Are  Sovereign  Credit  Ratings  objective  and  Transparent?  IUP  Journal  of  Financial 
Economics,  2010.  The  Author  argues,  comparing  Moody's  and  S&P's  sovereign  ratings  of  1995  with 
those  of  2007,  that:  1)  there  has  been  considerable  increase  in  the  average  difference  in  the  ratings 
provided by the two agencies; 2) the differences in their ratings are due to the subjective assessments of 
the countries by the two rating agencies.  
See Afonso and Gomes, Do fiscal imbalances deteriorate sovereign debt ratings?, ISEG, 2010 

57  

58  

59  

60  

61  

62  

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Moreover  recent  events  showed  that  some  rated  countries  have  questioned  the  accuracy  of 
sovereign  ratings  and  have  complained  that  possibly  not  all  the  available  and  up-to-date 
information  being  used  and  not  all  relevant  scenarios  being  taken  into  account.  This  could 
reinforce the feeling that rating events are based more on subjective perceptions rather than 
objective indicators and parameters. Examples are provided by the cases of the downgrading 
by Standard and Poor's of Greek sovereign credit on 29 March 2011 and of the change by the 
same Rating Agency of the outlook for Italy from stable to negative on 21 May 2011. In both 
cases the Ministries of Finances of both Countries complained about the lack of accuracy of 
the rating agency. In particular in the first case Greek authorities complained about the lack of 
an  adequate  assessment  of  the  latest  European  Council's  decisions  and,  in  the  second  case, 
Italian  authorities  criticized  the  worsening  of  the  outlook  without  any  justification  due  to 
changes  in  the  fundamentals  of  the  country  and  only  on  the  basis  of  the  subjective 
appreciation of a risk of "political gridlock63  

Another  problem  driver  specific  to  sovereign  ratings  is  the  lack  of  transparency  on  the 
sovereign  rating  process  both  in  terms  of  insufficient  disclosure  of  the  methodology  and  of 
underlying  assumptions 64  and  in  terms  of  inadequate  communication  with  the  issuers. 
Reasons  for  changing  sovereign  ratings  are  sometimes  inadequately  communicated  and, 
despite the level of disclosure required by Article 10 of Regulation 1060/2009, often remain 
unclear  to  the  public,  which  may  trigger  significant  investor  overreactions.  Investors  do  not 
always  have  all  the  necessary  information  (on  models,  on  underlying  assumptions,  on 
indicators, on the weight given to the different indicators) to fully decrypt the rationale behind 
the sovereign rating event. This in turn can strengthen the perception of the relevance of the 
subjective component of ratings and send out the wrong signals to the investors.  

This  is  also  applicable  to  the  rated  country's  public  authorities  which  do  not  always  have 
sufficient  understanding  of  the  variables  and  methodologies  used  by  the  rating  agency  and 
cannot always check in advance the accuracy of the information on which the rating is based 
nor challenge, where appropriate, the conclusions of the rating agency. The current enforced 
notification  period  of  12  hours,  appears  to  not  be  adequate  for  sovereigns  to  verify  if  the 
rating event is based on accurate and up-to-date data. This increases the risk of incorrect or 
outdated data not being timely removed before the rating process is finalised, which in turn 
can undermine the quality of the sovereign rating issued. An example of this problem is the 
downgrade of Greece and Spain by Moody's, three days and one day respectively before the 
Council meeting on the extension of the EFSF support package by 440€ billion on 11 March 
2011,  when  it  appeared  that  the  information  in  the  package  under  negotiation  was  not 
completely reflected in the rating process. Another example of the risks of incorrect data used 
for sovereign ratings by rating agencies was highlighted after the recent downgrade of the US 
in August 2011.65 

63  

64  

65  

See press releases of the Ministry of Finance of the Hellenic Republic on 29 March 2011 ("Press release 
on the downgrade of Greek sovereign credit by Standard and Poor's") and  of the Italian Ministry of the 
Economy – Treasury on 21 May 2011 ("Tesoro: l'Italia rispetterà gli impegni presi").Other examples in 
that sense are provided by the four-notch downgrade of Portugal on 5 July 2011 by Moody's which 
unleashed strong criticism by, inter alia, the German Minister of Finance W. Schauble for not being 
substantiated by adequate analytical elements and by the downgrade of the USA by Standard and Poor's 
on 5 August 2011 which was heavily criticized by the US administration after Treasury officials had 
discovered that the rating agency's estimates of the government's discretionary spending was $2 trillion 
too high. See for instance Reuters, Obama officials attack S&P’s credibility after downgrade, 6 August 
2011, available at http://www.reuters.com/article/2011/08/06/usa-rating-sp-error-
idUSN1E77500420110806. 
It  should  be  noted  that  Regulation  1060/2009  on  rating  agencies  has  introduced  transparency 
requirements for all types of ratings. However, there are no specific rules for sovereign ratings.  
The downgrade of the USA by Standard and Poor's on 5 August 2011; available at 
http://www.reuters.com/article/2011/08/06/usa-rating-sp-error-idUSN1E77500420110806.  

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Another problem driver is represented by the timing of ratings publication has proved to be 
not suitable for the specific relevance and potential impact of sovereign  ratings on markets. 
Actually current practices of publishing sovereign ratings when markets are open, particularly 
when this happens just before markets close, entails the risk of stimulating market volatility.66 
This was the case, for instance, of the downgrade of Greece by Standard & Poor's on 27 April 
2010, which occurred a few days before the adoption by the Council of the EU of the rescue 
package  on  6  May  2010,  which  at  the  time  of  the  decision  of  the  Agency  was  still  under 
negotiation.  

Finally,  CRAs  have  been  criticised  for  lagging  rather  than  leading  the  market  and  for  not 
revising sovereign ratings in a timely manner.67  

4.3. 

Limited choice of rating agencies and ratings for issuers and investors 

The analysis of the structure of the market for rating services unveils a level of concentration 
which  is  significantly  high  (see  Annex  IV).  This  entails  limited  choice  of  rating  services 
providers both for investors and issuers, the existence of economic rents for rating agencies 
and  most  likely  higher  prices.  Furthermore,  the  market  is  characterised  by  relevant 
"reputational" barriers which can prevent new potential competitors to enter the market (for 
more  information,  see  Annex  VI.  section  2.3).  Moreover  existing  legislation  on  capital 
requirements  further  aggravates  the  problem  creating  additional  obstacles  to  potential  new 
actors.  Indeed,  ratings  of  new  market  entrants  cannot  always  be  used  for  regulatory  capital 
purposes  unless  they  are  recognized  as  External  Credit  Assessment  Institution  (ECAI)  by 
banking supervisors (see below). 

For investors, beyond the issues mentioned above, the high market concentration emphasizes 
the problem of overreliance on the few international rating agencies. 
High  profit  margins68 of the existing CRAs and limited transparency of pricing suggest that 
there  are  risks  of  high  pricing  in  the  market  of  credit  ratings. 69  Moreover  the  limited 
availability of service providers reduces the elasticity of the demand, i.e. issuers have limited 
possibilities to change their CRA if they are not satisfied with its performance. Furthermore, 
some segments of issuers, particularly SMEs or small sovereigns, might experience difficulty 
to  obtain  a  rating  as  not  all  market  segments  are  adequately  covered  by  the  existing  rating 
agencies  or  ratings  might  be  too  expensive  for  these  issuers.  This  can  substantially  limit 
capabilities of small and medium sized issuers to access capital markets.  

Furthermore, as said above, competition is hampered by the existence of strong economies of 
scope  and  of  scale  and  by  the  relevance  of  reputation  in  the  market  for  credit  ratings. 

66  

67  

68  

69  

Opening remarks by the chairman of the IMF, International Monetary Fund at the IMF High–Level 
Roundtable Washington DC, March 18, 2011. Available from: 
http://www.imf.org/external/np/speeches/2011/031811.htm.  
Rabah Arzeki, Bertrand Candelon and Amandou N.R.Sy, IMF Working Paper, Sovereign Rating News 
and Financial  Markets  Spill-overs:  Evidence  from  the  European Debt  Crisis,  March 2011, WP/11/68. 
The  paper  explains  that  rating  agencies  have  been  slow  in  reacting  towards  a  potential  EU  sovereign 
crisis as very limited rating activities of European sovereigns were observed until October 2008. Since 
that  date  a  large  amount  (of  mainly  negative)  downgrades  have  occurred.  See  also  P.  Artus,  Are  the 
credit  rating  agencies'  country  ratings  partly  to  blame  for  the  public  debt  crisis?,  Natixis  Flash 
Economics,  May  2010  which  clearly  shows  through  a  comparison  between  CDS  markets  and  ratings 
movements  for  Portugal,  Spain,  Greece  and  Ireland  that  rating  changes  follow  financial  market 
movements instead of preceding them. 
For  example  S&P  reported  an  operational  margin  of  45  percent  in  2010,  McGraw  Hill  2010  Annual 
Report, p. 24. Accessible from: http://www.mcgraw-hill.com/about/annual_report/ar2010.pdf. 
Fabian Dittrich, The Credit Rating Industry: Competition and Regulation, 2007, p100. Available from:  
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=991821. 

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Moreover ratings from newly registered CRAs can face restricted uptake by the market also 
because they cannot be used for regulatory capital purposes if they have not been recognised 
as  External  Credit  Assessment  Institution  (ECAI)  by  banking  supervisory  authorities 
according  to  Article  81(2)  in  connection  with  Annex  VI,  part  2  of  Directive  2006/48.70 As 
shown in Annex V, only 3 CRAs have been recognised as eligible ECAI from the majority of 
national supervisors while all other CRAs have obtained ECAI status in only a very limited 
number of Member States,71 thus limiting the choice for issuers and investors of CRAs whose 
ratings  can  be  used  for  regulatory  purposes. 72 Measures  to  address  this  issue  have  been 
adopted in the proposal for CRD IV.73 

Another factor hindering competition is the absence of a standardized rating scale which can 
be  particularly  detrimental  for  small  CRAs'  ratings  lacking  a  well  established  international 
status.  

A further barrier to entry can be represented by the fact that some issuers and investors are 
sometimes  unaware  of  all  the  existing  providers  of  rating  services.  However,  it  should  be 
noted that the CRA Regulation partially addresses this problem by requiring registration74 of 
all rating agencies and subsequent publication on the ESMA website which should improve 
the visibility and credibility of new rating agencies establishing themselves on the EU market. 
A  list  of  authorized  CRAs  (see  Annex  IV  section  1)  has  been  published  in  the  'Europa' 
website  since  June  2011  and  is  now  available  on  the  ESMA  website75 since  the  latter  took 
over all the competences and duties related to the supervision of CRAs on 1 July 2011. 

4.4. 

Insufficient right of redress for investors 

Currently,  the  CRA  Regulation  does  not  establish  a  specific  civil  liability  regime  itself.76 
Investors' claims against CRAs are legally difficult to treat under the predominant issuer-pays 
model, where investors do not have a contractual relationship with the CRA (contrary to other 
financial  actors  such  as  banks,  insurance  companies  which  usually  have  a  contractual 
relationship with their clients, for instance, an insurance contract, investment advice contract 
etc). Consequently, an investor suffering a loss due to a flawed rating, in breach of the CRA 
Regulation,  can  not  base  claims  for  compensation  directly77 on  contract  law.  Whether  and 
under what conditions an investor can claim compensation based on the law of tort or delict 
varies largely according to the legal orders of Member States.78 Often, liability of CRAs vis-à-
vis  investors  outside  contractual  relationships  is  subject  to  restrictive  conditions  so  that  in 

70  

71  
72  

73  

74  
75  
76  

77  

78  

Article 2 (3) of the CRA Regulation states that registration is only a precondition to obtain ECAI status 
under  Directive  2006/48/EC.  According  to Article  81  (2) in  connection with Annex VI  Part  2, 2.1 of 
Directive 2006/48 banking supervisory authorities shall only recognize an ECAI as eligible for capital 
requirement purposes if its ratings are recognised in the market as credible and reliable which may be 
implied by a relevant market share of the ECAI.  
All other CRAs have obtained ECAI status in 6 or less Member States in July 2010. 
This is particularly relevant for issuers aiming to sell their debt instruments in an international context, 
requiring an ECAI status in all Member States. 
The legislative proposal on Capital Requirement Directive IV was adopted by the Commission on 20 
July  2011.  ECAI  statute  is  addressed  in  Article  130  (2)  and  article  262  (2)  of  COM  (456),  which 
outlines that all registered or certified CRAs under the CRA regulation are eligible ECAIs.  
Article 14 of the CRA Regulation. 
The list is available at http://www.esma.europa.eu/popup2.php?id=7692.  
Nerveless,  Recital  69  of  the  CRA  Regulation  states  that  any  claim  against  a  CRA  in  relation  to  any 
infringement  of  the  provisions  of  this  Regulation  should  be  made  in  accordance  with  the  applicable 
national law on civil liability. 
In Germany there is discussion regarding whether the contract between the CRA and the issuer could 
somehow  encompass  the  investors  ("Vertrag  mit  Schutzwirkung  für  Dritte").  However,  it  is  unclear 
whether a court would accept this reasoning.  
For more detailed information see Annex VI, section 2.4. 

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practice investors do not seem to have an effective right of redress. This is confirmed by the 
very limited case law in EU Member States on CRAs' civil liability towards investors. Also, 
the fact that the conditions under which investors can claim damage against CRAs are often 
either  not  very  clear  or  left  to  courts'  discretion  may  in  practice  prevent  investors  from 
claiming damage even in cases of clear infringements and gross negligence.  

It is not satisfactory that it is often difficult for investors to claim damage from CRAs. This is 
not consistent with the general principle of civil law that each person infringing its obligations 
towards another person acting negligently or with intent, thereby causing damage to the other 
person, should be held liable. Investors have an evident interest in good quality ratings as they 
use ratings as a basis for investment decisions. This implies that CRAs have an obligation of 
due care towards investors as specified in many requirements of the CRA Regulation.79 

Differences  between  Member  States'  civil  liabilities  regimes  applicable  to  CRAs  lead  to 
different  levels  of  protection  for  investors  and  could  even  incentivise  forum  shopping 
whereby  CRAs  try  to  achieve  the  application  of  the  law  of  a  Member  State  where  civil 
liability for infringements of the CRA Regulation is less likely. 

The results of ESMA Survey on Member States' civil legal orders in respect of provisions on 
which investors could base claims against CRAs having infringed the CRA Regulation can be 
found  in  Annex  VI.  section  2.4.  This  shows  that  in  some  Member  States,  including  Poland 
and Sweden, such civil claims would not be possible. 

4.5. 

Potential  conflicts  of  interest  and  other  issues  linked  to  credit  rating 
methodologies and processes 

Conflicts of interest due to remuneration models 

One of the sources of potential conflict of interest is the prevailing remuneration model under 
which  an  issuer  solicits  and  pays  a  CRA  to  rate  its  own  debt  instruments  ("issuer-pays 
model").  There  is  empirical  evidence  that  large  issuers  of  structured  finance  instruments 
received  more  favourable  ratings  than  smaller  issuers  during  the  booming  period  leading  to 
the  financial  crisis  which  can  be  explained  by  the  fact  that  especially  larger  issuers 
contributing  significantly  to  the  income  of  a  CRA,  used  their  bargaining  power  to  achieve 
higher ratings (which were not justified).80 In fact under the issuer-pays model CRAs have a 
financial incentive to generate business from rated issuers, risking the issuance of overinflated 
ratings in order to increase or keep business. 

79  

80  

E.g.  the  obligation  of  a  CRA  to  take  all  necessary  measures  to  ensure  that  the  information  it  uses  in 
assigning a credit rating is of sufficient quality (Art. 8 (2) CRA Regulation) or the obligation to monitor 
and  regularly  update  its  credit  ratings  (Art.  8  (5)  CRA  Regulation)  are  obviously  in  the  interest  of 
investors. Breaching these obligations may lead to faulty ratings and could cause damage to investors 
who have based investment decisions on these ratings. 
Jie (Jack) He, Jun ‘QJ’ Qian, Philip E. Strahan; Are all ratings created equal? The impact of issuer size 
on the pricing of mortgage-backed securities; July 2011. Available from: 
https://www2.bc.edu/~strahan/Ratings-July2011.pdf. The authors show that structured finance issues of 
large issuers were better rated than those of smaller issuers of comparable quality during the financial 
crisis. This shows the conflict of interests of the issuer pays model (large issuers can use their 
bargaining power to achieve higher ratings which are not justified). The paper concludes that " there is a 
robust relation between issuer size and the market prices of mortgage-backed securities conditional on 
ratings, and conflicts between the interests of issuers (who pay for ratings) versus those of investors 
(who consume ratings) may explain this relationship". 

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The CRA Regulation introduced some provisions81 to mitigate conflicts of interests related to 
the issuer-pays model. These provisions aim at mitigating conflicts of interests with regard to 
the  issuer-pays  model  by  requiring  transparency  and  disconnecting  the  interest  of  the  staff 
involved in the rating activity from the remuneration paid by the rated entity. In addition, the 
CRA Regulation requires staff to regularly rotate within the CRA so that analysts only deal 
with  a  specific  entity  for  a  limited  time.  However,  these  measures  do  not  fully  address  the 
conflicts of interest due to the issuer pays model.  An important issuer may decide to be rated 
on a continuous basis by his "preferred CRA" which in turn creates an incentive for this CRA 
to favour ratings of this issuer contributing significantly to its income. Even if the individual 
rating analyst does not profit directly from the continued business relationship to an issuer, the 
CRA as an organisation does. Increased transparency does not help as long as the issuer pays 
model applies on such a broad basis, so that it is difficult for investors to find a CRA whose 
remuneration  model  is  less  conflicted.  Also  the  CRA  Regulation  acknowledged  that  further 
action  may  be  needed  to  address  conflicts  of  interest  regarding  the  issuer-pays  model  by 
mandating the Commission to assess the appropriateness of this remuneration model by end 
of 2012.82 

Other  alternative  payment  models  are  the  "investor/subscriber-pays"  and  the  "public 
utility/government"  model.  Neither  of  these  remuneration  models  is  however  free  from 
conflicts of interest. 83 
The importance of reputation in rating business has also a "lock-in effect"84 whereby issuers 
remain with the same CRA for a long period. This is due to the fact that if an issuer considers 
switching  a  rating  agency,  it  would  create  a  suspicion  among  investors  and  can  lower 
investors' trust in issuers. This lock-in effect is at its strongest when issuers consider changing 
to new market entrants with a shorter track record. 

Conflicts of interest due to shareholder structure 

As  regards  conflicts  of  interests  due  to  the  shareholder  structure  it  could  bring  a  CRA's 
independence  into  question  when  a  CRA  rates  its  controlling  shareholders.  It  is  also 
problematic  if  shareholders  controlling  a  CRA  own  or  invest  in  products  rated  by  the  CRA 
they  control  or  the  same  group  of  investors  have  significant  stakes  in  more  than  one  large 
CRA, as they may have an incentive to influence the rating in their own interest. Finally, the 
fact that an undertaking linked to a credit rating agency provides consultancy services to an 
entity which is later rated by that credit rating agency raises concerns.  

Lack of transparency of rating methodologies 

The  lack  of  transparency  of  rating  methodologies  contributes  to  further  uncertainty  in  the 
market  and  thus  has  an  important  role  for  market  stability.  Current  rules  on  methodologies 
only  require  disclosure  of  underlying  assumptions  for  structured  finance  products,  creating 
varying  degrees  of  transparency  for  different  asset  classes.  In  addition,  investors  are  not 
always  well  aware  of  the  reasons  for  changes  of  methodologies  and  their  impact  on 
subsequently issued or revised ratings. This could cause a risk of disruption in the case that a 
revised methodology is misunderstood.  

81  

82  
83  
84  

CRAs have to disclose to the public the names of the rated entities from which they receive more than 5 
% of their annual income (Art 6 (2) in conjunction with Annex I Section B 2). Rating analysts may not 
be involved in any negotiation regarding fees with a rated entity and their remuneration shall not depend 
on the remuneration received from the rated entity (Art. 7 (2), (5) of the CRA Regulation). CRA staff 
has to rotate regularly, see Article 7 (4) in connection with Annex I, C, 8. 
See Article 39 (1) of the CRA Regulation. 
See Annex VI 2.5.2. and 2.5.3.  
Fabian Dittrich, The Credit Rating Industry: Competition and Regulation, 2007, p80-83. Available from:  
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=991821.  

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Pre-notification of ratings to issuers  

Recent  events  have  also  raised  an  issue  of  the  timing  of  publication  of  ratings.  There  is  a 
question  if  a  rated  issuer  is  properly  informed  in  advance  of  the  rating  publication.  The 
current  CRA  Regulation  requires  that  CRAs  communicate  12  hours 85  in  advance  of  the 
publication  of  a  rating  and  the  principle  grounds  on  which  a  rating  is  based.  In  practice, 
issuers find that if the time period includes out of office hours (for example, overnight, public 
holidays) there is little time to check potentially complex data and draw the attention of the 
CRA to factual errors. 

4.6. 

The baseline scenario: how would the problem evolve without EU action?  

Without coordinated EU action, the problems in the five main policy areas would be unlikely 
to be resolved in spite of the CRA Regulation and ESMA's role as supervisor for CRAs since 
1 July 2011.  

If  sectoral  financial  legislation  in  the  EU  remains  unchanged,  many  financial  institutions 
would  use  credit  ratings  to  calculate  regulatory  capital  in  a  mechanistic  fashion  and  would 
solely  base  their  internal  risk  management  on  credit  ratings.  Such  overreliance  means  that 
investors would continue to react simultaneously to downgrades, maintaining herd behaviour 
and  causing  the  "cliff"  effect  of  disorderly  markets  with  sudden  price  corrections  and 
contagion effects.  

Insufficient  transparency  would  continue  to  exist  especially  in  the  area  of  sovereign  debt 
ratings. Governments would have limited time to assess underlying data on which ratings are 
based and determine if all relevant information has been taken into account. In addition, rating 
agencies  could  continue  to  issue  sovereign  ratings  at  particularly  sensitive  times  during 
trading, i.e. immediately ahead of auctions, during the syndication process or just before the 
close of business of European trading venues. Furthermore, investors would continue to have 
a limited explanation on rating changes and might continue to act on the basis of insufficient 
understanding of sovereign rating. In combination with the problem of overreliance, the risks 
of  further  spill-over  effects  and  market  disorder  linked  to  sovereign  downgrades  would 
continue  to  exist.  Consequently,  risks  undermining  market  stability  in  EU  financial  markets 
would  remain.  Furthermore,  funding  costs  of  Sovereigns  could  continue  to  be  affected  by 
market reactions on insufficiently transparent sovereign rating changes.  

In the absence of EU-level action, the current structure of the CRA market would be unlikely 
to change quickly.  

Over  time  more  small  and  medium  rating  agencies  are  expected  to  register  under  the  CRA 
Regulation and will start operating with an EU license offering alternative credit opinions to 
investors. However, new market entrants will most likely continue to have difficulties to gain 
reputation  even  though  the  registration  requirement  of  the  CRA  Regulation  may  have 
improved the situation. Furthermore, these new entrants are expected to remain niche players, 
offering a service with is not comparable in terms of rated instruments, geographic reach and 
reputation, with the dominant market players. It is possible that over a period of 5 to 10 years 
one of the new market entrants could evolve towards a more sizable new market player.  

Differences between Member States' civil liability regimes applicable to CRAs could result in 
forum shopping, whereby CRAs chose jurisdictions where civil liability for infringements of 
the CRA Regulation is less likely. Despite a common EU regulatory framework for CRAs this 
situation may result in diverse levels of protection for investors. While it could be argued that 
the CRA Regulation, which has empowered ESMA to impose sanctions on CRAs for having 

85  

Annex I D I (3) of the CRA Regulation. 

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infringed the Regulation, already provides sufficient incentives to CRAs to comply with the 
rules, this does not improve the situation for investors. The possibility of sanctioning CRAs is 
not a substitute for an efficient right of redress for investors. Sanctions imposed in the public 
interest  do  not  compensate  investors  for  their  losses;  a  functioning  sanctioning  system  and 
efficient  right  of  redress  for  investors  allowing  for  private  enforcement  are  complementary 
instruments.   

Despite the current CRA Regulation's provisions aimed at reducing conflicts of interest some 
conflicts  of  interest  in  the  CRA  market  mainly  due  to  the  issuer-pays  model  would  remain. 
Since under the issuer-pays model CRAs have a financial interest in generating business from 
rated firms, there is still the risk that firms pay for higher ratings. The potential conflicts of 
interest  imply  threats  to  financial  stability,  as  well  as  for  investor  protection  and  market 
integrity.86 

4.7. 

Subsidiarity 

According to the principle of subsidiarity (Article 5.3 of the TEU), EU level-action should be 
taken only when the aims envisaged cannot be achieved sufficiently by Member States alone 
and can therefore, by reason of the scale or effects of the proposed action, be better achieved 
by the EU. The preceding analysis shows that although all the problems outlined above have 
important  implications  for  individual  Member  States,  their  overall  impact  can  only  be  fully 
perceived in a cross-border context. This is because ratings can be issued in one country for 
financial instruments issued in another, so that action taken on a national level might not have 
any effect, as ratings could continue to be issued and used if they were produced in a different 
EU or even third country jurisdictions. As a result, national responses to credit rating issuance 
risk being circumvented or ineffective without EU-level action. Therefore any further actions 
in  the  field  of  CRAs  can  best  be  achieved  by  a  common  effort.  Accordingly,  EU  action 
appears appropriate in light of the principle of subsidiarity. 

86  

Orderly markets usually do not have volatile price swings and prices are competitive, reflecting the true 
value of the good or service. 

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5. 

OBJECTIVES 

General objective
General objective

Contribute to reducing the risks to financial stability and restoring investor and other market participants confidence 
Contribute to reducing the risks to financial stability and restoring investor and other market participants confidence 
in financial markets and ratings quality
in financial markets and ratings quality

s
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e
v
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o

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i
c
c
e
e
p
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S
S

s
s
e
e
v
v
i
i
t
t
c
c
e
e
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j
b
b
o
o
l
l
a
a
n
n
o
o
i
i
t
t
a
a
r
r
e
e
p
p
O
O

1. Diminish the impact 
1. Diminish the impact 
of “cliff" effects on 
of “cliff" effects on 
financial institutions and 
financial institutions and 
markets by reducing 
markets by reducing 
reliance on external 
reliance on external 
credit ratings
credit ratings

2. Mitigate risks of 
2. Mitigate risks of 
contagion 
contagion 
effects linked to 
effects linked to 
sovereign debt ratings
sovereign debt ratings

3. Improve credit rating 
3. Improve credit rating 
market conditions with a 
market conditions with a 
view to improve ratings 
view to improve ratings 
quality
quality

4. Ensure right of redress 
4. Ensure right of redress 
for investors 
for investors 

Reduce references 
Reduce references 
to external credit ratings 
to external credit ratings 
in EU legislation
in EU legislation

Improve transparency 
Improve transparency 
of sovereign ratings and 
of sovereign ratings and 
their methodologies
their methodologies

Increase the choice of 
Increase the choice of 
credit rating providers
credit rating providers

Increase civil liability 
Increase civil liability 
of CRAs
of CRAs

5. Improve ratings 
5. Improve ratings 
quality by reinforcing 
quality by reinforcing 
independence of credit 
independence of credit 
rating agencies and 
rating agencies and 
promoting sound credit
promoting sound credit
rating processes and 
rating processes and 
methodologies
methodologies

Reduce the risk of 
Reduce the risk of 
conflict of interest 
conflict of interest 
due to a prevailing 
due to a prevailing 
“issuer-pays” model
“issuer-pays” model

Strengthen internal risk
Strengthen internal risk
management in financial 
management in financial 
firms
firms

Improve the timing and 
Improve the timing and 
frequency of sovereign 
frequency of sovereign 
ratings publication
ratings publication

Improve comparability 
Improve comparability 
and quality of information
and quality of information
on credit ratings and 
on credit ratings and 
on CRAs
on CRAs

Reduce a risk of 
Reduce a risk of 
regulatory arbitrage 
regulatory arbitrage 
between EU Member 
between EU Member 
States
States

Reduce the risk of 
Reduce the risk of 
conflict of interest due 
conflict of interest due 
to ownership structure
to ownership structure

Improve communication
Improve communication
between CRAs and 
between CRAs and 
sovereign issuers
sovereign issuers

Promote the use of 
Promote the use of 
internal rating models 
internal rating models 
for the calculation of 
for the calculation of 
regulatory capital 
regulatory capital 
requirements
requirements

Enhance transparency on 
Enhance transparency on 
structured finance 
structured finance 
products
products

Improve transparency 
Improve transparency 
of ratings and their 
of ratings and their 
methodologies
methodologies

Improve communication
Improve communication
between CRAs and 
between CRAs and 
issuers
issuers

Figure 2. Objectives 

The  identified  objectives  are  coherent  with  the  EU's  fundamental  goals  of  promoting 
harmonious development of economic activities, a high degree of competitiveness, and a high 
level of consumer protection, including the safety of citizens' economic interests (Article 169 
TFEU). 

6. 

IDENTIFICATION AND ANALYSIS OF POLICY OPTIONS 

This section presents the policy options for each objective, provides analysis of comparative 
advantages and disadvantages of different option in order to achieve these objectives (section 
5). Sections 6.1 to section 6.5 deal with specific objectives 1 to 5 respectively.  

An analysis in a table format in each section is made against the following criteria:  

(1) impact on stakeholders, which include investors, issuers, financial companies, credit ratings agencies, 
sovereigns and regulators. 

(2) effectiveness (the extent to which the option is likely to fulfil the objectives formulated in section 5).  

(3) cost-effectiveness (the extent to which the objectives are likely to be met having considered the costs of 
implementing the option).  

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We use the following scoring system when presenting impacts on stakeholders, efficiency and effectiveness: 
magnitude of impact compared to the baseline scenario (the baseline is indicated as 0): ++ strongly positive; + 
positive; – – strongly negative; – negative; +/– both positive and negative ≈ marginal/neutral; ? uncertain; n.a. 
not applicable. 

The presented policy options are not necessarily mutually exclusive, but also can be complementary. In the latter 
case, there are two or more preferred options to deal with a specific objective. 

In the tables presenting the policy options "financial firms" are understood as credit institutions, investment 
firms, insurance, assurance and reinsurance undertakings, undertakings for collective investment in transferable 
securities (UCITS) and institutions for occupational retirement provision.  

A more extensive description of policy options can be found in Annex VII. The analysis of 
the  impact  of  these  options  on  different  stakeholder  groups  is  given  in  Annex  VIII  an 
assessment of compliance costs and administrative burden is provided in Annex XII.  

6.1. 

Policy options to reduce reliance on external credit ratings 

1. No policy change 

 Policy options 

2. Reduce reliance on external ratings by enhancing internal risk management and promoting the use of internal rating models 
for regulatory purposes 

3. Require credit institutions, investment firms, insurance and reinsurance undertakings to use more than one rating   

4. Improve disclosure requirements for issuers of structured finance products on an ongoing basis 

These options are not mutually exclusive. Options 2 and 4 can be combined with each other. 

Option 1 – No policy change 

Taking  no  policy  action  raises  the  probability  that  market  players  would  continue  to  rely 
heavily on external credit ratings and fail to carry out sufficient due diligence, increasing the 
risk of market instability.  

At  the  international  level,  the  Basel  Committee  (BCBS)  is  undertaking  work  to  reduce 
reliance  on  ratings  in  its  rules.  The  Working  Group  on  Liquidity  will  seek  to  reduce  the 
importance  of  ratings  as  a  criterion  for  defining  liquid  assets.  This  would  increase  the 
importance of alternative criteria before the liquidity requirement becomes binding in 2015.87 
The  Ratings  and  Securitisation  Working  Group  has  already  developed  certain  language  to 
ensure better due diligence vis-à-vis credit risk. This forms part of the Basel III package. The 
work of the Ratings and Securitisation Working Group is planned to be finalised by the end of 
2011. These requirements would have to be implemented into the sectoral EU legislation. 

However,  this  option  has  shortcomings.  First,  Basel  essentially  deals  with  capital 
requirements for banks, meaning that other financial sectors would remain not addressed if no 
action were to be taken at the EU level. Second, also as far as banks are concerned the current 
situation  leaves  scope  for  the  continued  risk  of  procyclicality  and  cliff-effects  in  capital 
markets. It is unclear whether eventual requirements from other sources such as Basel will be 
sufficient  to  reduce  overreliance  on  external  credit  ratings,  and  when  they  would  be 
implemented  by  EU  Member  States.  Third,  making  no  policy  change  could  potentially 
aggravate  the  consequences  of  the  currently  on-going  euro  area  sovereign  debt  crisis  and 

87  

See Section 4.6. The baseline scenario: how would the problem evolve without EU action? 

24/193 

 
 
 
 
                                                 
result  in  a  heavy  burden  on  taxpayers  bearing  the  risk  of  rescuing  failing  systemically88 
important institutions.89  

Option 2 – Reduce reliance on external ratings by enhancing internal risk management 
and promoting the use of internal rating models for regulatory purposes 

Remaining  references  to  external  ratings  in  sectoral  EU  financial  regulation  (see  Annex  VI 
section  2.1),  including  the  guidelines  from  the  European  Supervisory  Authorities90,  shall  be 
addressed  in  the  forthcoming  reviews  of  these  acts.  Subject  to  separate  impact  assessments, 
these  references  would  be  removed,  substantially  reduced  or  replaced  by  other  criteria  to 
measure the creditworthiness of a rated instrument or an issuer. The criteria to be chosen may 
differ for each specific sector in order to take into consideration the specificities surrounding 
each  category  of  financial  actors.  This  approach  would  also  be  in  line  with  the  approach 
followed in the US (e.g., see Annex III. Section 6 which includes changes proposed by the US 
SEC, but also by other US regulatory bodies). 

It  should  also  be  made  sure  that  references  to  external  ratings  are  avoided  to  the  extent 
possible  in  any  future  EU  legislation  including  technical  standards  and  guidelines  of  the 
European  Supervisory  Authorities;  concerning  this  issue  a  clear  obligation  would  be 
introduced in EU regulation for European Supervisory Authorities to consider other solutions 
than pure reliance on ratings. 

Moreover,  it  should  be  acknowledged  that  there  will  be  a  degree  of  voluntary  reliance  on 
ratings by small and individual investors which cannot be addressed by regulatory measures. 
Nevertheless,  automatic  and  mechanical  reliance  on  external  credit  ratings  by  regulated 
financial firms could be reduced. 

Most  responses  to  the  public  consultation  from  respondents  in  several  categories,  including 
industry associations, governments and regulators and rating agencies favoured a requirement 
for firms to conduct their own due diligence without relying exclusively on ratings. 

Require all financial firms to strengthen their internal risk management  

Firstly,  the  financial  firms  (credit  institutions, investment  firms,  insurance  and  reinsurance) 
with  material  and  complex 91 credit  risk  exposures  would  be  required  to  strengthen  their 
internal risk assessment by developing and using internal rating models. 

The advantages  of  this sub-option compared to option 1 are as follows. As this option  is in 
line with FSB principle III.2.a,92 it would ensure coherence at international level. Furthermore, 

88  

89  

90  
91  

Banks, insurance companies and pension funds continue to be perceived as key “systemic” institutions 
in  many  financial  systems  post-crisis.  See  Guidance  to  Assess  the  Systemic  Importance  of  Financial 
Institutions,  Markets  and  Instruments:  Initial  Considerations—Background  Paper,  Report  to  the  G-20 
Finance  Ministers  and  Central  Bank  Governors,  prepared  by  FSB,  IMF,  Bank  for  International 
Settlements, October 2009. Available from: http://www.imf.org/external/np/g20/pdf/100109a.pdf.     

See  Annex  VI  Problem  definition  –  background  and  technical  details,  figure  9.  Cumulated  financial 
sector stabilisation operations and their impact on government debt and contingent liabilities (2008-10). 

See Annex VI, section 2.1, Money market funds.   

A good proxy for large or complex exposures is exposures of "large or sophisticated institutions" for a 
sectoral  legislation  where  entities  are  mainly  exposed  to  credit  risk  (e.g.  banking  sector).  This  would 
also  allow  applying  the  proportionality  principle  in  sectors  where  credit  risk  is  usually  not  the 
predominant  risk  of  large  or  sophisticated  entities  (e.g.  insurers).  Finally,  this  would  also  capture  the 
pending developments on complex exposures such as securitisation that are being discussed in Basel. 

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it would address the second shortcoming of option 1, as the development and use of internal 
rating models would enhance the capacity for internal credit assessment of firms with material 
and  complex  credit  risk  exposures.  It  would  meet  the  third  operational  objective  and  would 
overall  contribute  to  the  specific  objective  of  diminishing  the  impact  of  "cliff"  effects  on 
financial institutions and markets by reducing reliance on external credit ratings. The internal 
rating models would contribute to ensuring that credit risks are adequately managed. It would 
partially address the first and third shortcomings of option 1, as a requirement to develop and 
use  internal  rating  models  for  all  credit  institutions,  investment  firms,  insurance  and 
reinsurance  undertakings  (firms)  with  material  and  complex  credit  risk  exposures  at  the  EU 
level  should  give  a  greater  degree  of  confidence  in  financial  institutions  for  market 
participants.  

However, also this sub-option has disadvantages. First, although the ongoing costs associated 
with this sub-option would be proportional to each individual financial firm, the total ongoing 
costs  for  relevant  financial  sectors  could  be  substantial.  In  addition,  a  model  where  every 
financial institution performs its own rating analysis does not guarantee a better quality and 
transparency  of  ratings.  A  system  of  internal  ratings  can  prove  beneficial  for  the  macro-
financial stability only if internal rating methodologies are carefully and accurately reviewed 
and  approved  by  a  competent  authority.  The  need  to  validate  internal  rating  methodologies 
would  clearly  create  an  additional  burden  for  CRAs  supervisors.  Second,  since  the 
standardised approaches relying on external credit ratings would continue to be authorized for 
small institutions or institutions whose exposure to credit risk is less material or less complex 
(for which  the  development of internal models would be disproportionate), such institutions 
would  still  be  vulnerable  to  abrupt  ratings  changes  and  exposed  to  the  higher  market  risk 
compared  to  those  with  internal  credit  assessments.  Furthermore,  like  option  1,  no  policy 
change  for  small  institutions  could  result  in  the  need  to  rescue  failing  institutions  and, 
consequently increase risks to taxpayers.   

Nevertheless, most respondents to the public consultation favoured this option as they felt that 
financial  institutions  and  all  holders  of  securities  –  particularly  large  institutions  –  should 
understand  the  risks  associated  with  their  exposures.  They  should  therefore  be  subject  to 
rigorous due diligence standards and face financial and regulatory incentives to meet them. 

The  financial  firms  (credit  institutions,  investment  firms,  insurance  and  reinsurance 
undertakings,  asset  managers  and  investment  funds)  would  be  required  to  strengthen  their 
own internal risk management for investment decisions. 

This sub-option has a number of advantages. Firstly it would go towards reducing the risk of 
overreliance (FSB principle II)93 and III.3.a.94  Second, it would meet the second operational 

92  

93  

94  

Larger, more sophisticated banks within each jurisdiction should be expected to assess the credit risk of 
everything  they  hold  (either  outright  or  as  collateral),  whether  it  is  for  investment  or  for  trading 
purposes.  FSB  Report  on  Principles  for  Reducing  Reliance  on  CRA  Ratings,  27/10/2010.  Available 
from: http://www.financialstabilityboard.org/publications/r_101027.pdf.  

Reducing market reliance on CRA ratings: banks, market participants and institutional investors should 
be  expected  to  make  their  own  credit  assessments,  and  not  rely  solely  or  mechanistically  on  CRA 
ratings. FSB Report on Principles for Reducing Reliance on CRA Ratings, 27/10/2010. Available from: 
http://www.financialstabilityboard.org/publications/r_101027.pdf.  

Investment  managers  should  conduct  risk  analysis  commensurate  with  the  complexity  and  other 
characteristics of the investment and the materiality of their exposure, or refrain from such investments. 
They should publicly disclose information about their risk management approach, including their credit 

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objective  and  would  overall  contribute  to  the  specific  objective  of  reducing  reliance  on 
external  credit  ratings  and  mitigating  the  risk  of  cliff-effects.  The  downgrades  would  no 
longer necessarily lead to immediate sell-offs. In case of asset managers and investment funds, 
the  end-investors  would  justifiably  expect  their  appointed  investment  managers  to  exercise 
judgement in their investment decisions, rather than allowing rating changes dictate selling or 
buying decisions without due consideration. Investment managers would also be required to 
disclose  their  investment  policies,  including  their  approach  to  credit  assessment,  and  seek 
regular management review. Third, since this option would apply to all financial firms (credit 
institutions, investment firms, insurance and reinsurance undertakings and asset managers and 
investment  funds),  it  should  enhance  overall  investor  confidence  in  these  markets  and 
contribute effectively to financial stability.      

One  disadvantage  of  this  option  is  the  compliance  cost  for  firms  with  internal  risk 
management,  which  would  include,  for  example,  legal  advice,  access  to  capital  market 
information sources and a framework of technologies to manage internal risks. On the other 
hand, ongoing  costs  would  be moderate as  many  firms already have in place their own risk 
management  systems.  A  second  disadvantage  is  the  uncertainty  of  whether  it  is  possible  to 
impose such restrictions on an investment mandate that is a commercial agreement between 
two parties. Great care would have to be taken in considering any rules in this area, as there 
could be a significant impact on smaller investors that do not have the resources to perform all 
their  research  internally.  In  addition,  it  is  uncertain  whether  risk  assessment  performed  by 
asset managers would be unbiased and free of conflicts of interest.  Finally, this option has a 
strong cost element: requiring a multitude of market participants to duplicate the process of 
information  gathering  and  information  assessment  would  multiply  the  associated  costs  and 
thereby reduce the efficiency of financial intermediation at large.     

Promote  the  use  of  internal  rating  models  for  the  calculation  of  regulatory  capital 
requirements   

This  sub-option  has  the  advantage  over  option  1  that  it  would  help  to  reduce  reliance  on 
external  credit  ratings  in  the  calculation  of  the  regulatory  capital  requirements.  Credit 
institutions,  investment  firms,  insurance  and  reinsurance  undertakings  using  the  "standard 
approach"95 based  on  external  ratings  for  calculating  their  regulatory  capital  requirements, 
would  be  required  to  assess  if  the  inherent  credit  risk  of  an  exposure  is  significantly  higher 
than the one corresponding to the capital requirement assigned under the "standard approach" 
based on external ratings (or the absence thereof).  

Furthermore, the credit institutions, investment firms, insurance and reinsurance undertakings 
would  also  be  required  to  reflect  the  higher  degree  of  credit  risk  in  the  evaluation  of  their 
overall capital adequacy. This implies that these firms would have to check the quality of the 
rating assessments they use in the standardised approach and, if the outcome of the analysis is 
negative, would have to deviate from that rating assessment.  

Moreover,  all  credit  institutions,  investment  firms,  insurance  and  reinsurance  undertakings 
would  be  treated  equally  and  apply  the  same  rules  regardless  of  their  size  or  level  of  risk 
exposure.  This  would  contribute  to  improving  investor  confidence  in  financial  markets  and 
would mitigate the risk of cliff-effects on financial institutions and markets. 

assessment processes. FSB Report on Principles for Reducing Reliance on CRA Ratings, 27/10/2010. 
Available from:  http://www.financialstabilityboard.org/publications/r_101027.pdf.  

95  

"Standardised approach" for credit institutions (banks) and "standard approach" for (re) insurers.    

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One  disadvantage  of  this  option  is  the  cost  of  compliance  and  administrative  burden  on 
relevant  financial  sectors  as  a  whole.  However,  it  could  be  argued  that  the  cost  would  be 
proportional with respect to the individual financial firms.  

Option  3  –  Require  credit  institutions,  investment  firms,  insurance  and  reinsurance 
undertakings to use more than one rating if available  

This  option  has  a  number  of  advantages  over  option  1.  First,  requiring  credit  institutions, 
investment firms, insurance and reinsurance undertakings to use more than one rating issued 
by  different  CRAs  would  improve  the  accuracy  of  capital  requirement  calculations  as  the 
calculation would be based on more opinions.96 It may also possibly mitigate to some extent 
"cliff" effects since the effect of a significant downgrade by one CRA may be reduced by the 
fact that financial firms would also take into account ratings of other CRAs.  

However,  option  3  also  has  a  number  of  risks  and  disadvantages.  Some  respondents  to  the 
public  consultation  argued  that  certain  types  of  structured  finance  instruments  and  covered 
bonds are frequently only rated by one CRA  and this proposal would therefore have only a 
limited impact on markets. In order to compensate for this, a minimum of two credit ratings 
for  structured  finance  instruments  could  be  required.  Furthermore,  the  requirement  to  use 
more  than  one  rating  could  also  negatively  affect  competition:  investors  would  most  likely 
look for ratings available from the existing large CRAs which would be favoured over small 
CRAs  with  limited  availability  of  ratings  unless  the  rotation  of  CRAs  was  introduced. 
Moreover, the potential benefits of this individual option on reducing overreliance are likely 
to  be  limited  since  the  ratings  issued  by  different  CRAs,  with  regard  to  one  issuer  or 
instrument, tend to be similar.97 However, the requirement for two independent ratings would 
likely increase the quality of ratings of those instruments which require special expertise, such 
as in the case of structured finance instruments.    

Option 4 – Improve disclosure requirements for issuers of structured finance products 
on an ongoing basis 

This  option  would  provide  investors  on  an  ongoing  basis  with  information  on  structured 
finance instrument, and in particular information on the performance of the underlying asset 
pool.  This  would  enable  financial  firms  and  institutional  investors  to  conduct  own  due 
diligence  and  assess  the  credit/market  risk  of  a structured  finance  instrument  by  themselves 
and,  as  a  consequence,  reduce  their  reliance  on  external  ratings.  Additionally,  other  credit 
rating  agencies  (not  mandated  by  the  issuer)  would  be  in  a  position  to  provide  unsolicited 
ratings based on publicly available information. 

Many  responses  to  the  public  consultation  favoured  disclosure  of  information  on  structured 
finance  instruments  to  all  market  participants  as  they  felt  disclosure  under  the  current 
framework  was  not  sufficient  and  additional  disclosure  would  enhance  their  ability  to 
understand ratings and conduct their own assessments and due diligence. 

96  

97  

The Basel II rules already allow (but do not require) the use of more than one rating within the capital 
determination  process,  even  though  only  one  is  ultimately  used  to  set  risk  weights:  If  there  are  two 
assessments by ECAIs chosen by a bank that map two different risk weights, the higher risk weight will 
be applied. If there are three or more assessments, the determination of risk weights should refer to the 
assessments corresponding to the two lowest risk weights, with the higher of the two then applied. 
According to a 2006 report by the French AMF, even where ratings for a given issuer differ between 
CRAs, the difference is typically just one notch. AMF 2006 Report on rating agencies, Part II, Fund 
management rating, January 2007. Available at: http://www.amf-
france.org/documents/general/7641_1.pdf. 

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According to Article 11 and Annex VIII of the Commission Implementing Regulation of the 
Prospectus Directive98 issuers  of  asset-backed  securities  have  to  disclose  information  on  the 
securities,  the  underlying  assets,  structure  and  cash  flow  of  the  transaction.  However,  such 
disclosure  is  only  mandatory  when  asset  backed  securities  are  offered  to  the  public  or 
admitted to trading on a regulated market, while post issuance reporting is voluntary.99  

This  option  would  entail  some  costs  for  the  issuers  of  structured  finance  instruments  being 
required  to  disclose  existing  information  on  structured  finance  instruments  on  an  ongoing 
basis. Moreover, the impact on reducing overreliance as such could be limited by the capacity 
of investors to risk assess these complex financial instruments by themselves.  

The summary of the analysis of different options to achieve specific objective 1 (diminish the 
impact of “cliff" effects on financial institutions and markets by reducing reliance on external  

credit ratings) is presented in the table below. The analysis of the impact of these options on 
different stakeholder groups is given in Annex VIII. 

Option 1 (baseline) 

n.a. 

n.a. 

Effectiveness 

Efficiency 

Option 2 
(Reduce reliance on external ratings by 
promoting the use of alternative credit 
assessment models) 

(++) would reduce overreliance and cliff 
effects;Would improve quality of investment 
decisions and make herding behaviour and 
investment bubbles less probable. 

(+) increased costs for financial firms. 
However considered to be cost effective 
given the benefits for firms and financial 
stability. 

Financial firms with material credit risk 
would be required to develop and use 
internal models to calculate capital 
requirements. This would considerably 
reduce overreliance on external ratings and 
reduce cliff effects. 

However, the effectiveness would be limited 
if there is  a high correlation between 
internal and external ratings and/or re-
assessments do not lead to deviation from 
external rating. 

Option 3 
(Require credit institutions, investment 
firms, insurance and reinsurance 
undertakings to use more than one rating, 
if available) 

potentially 

(+/0) An effect of reducing reliance is likely 
to be limited due to converging ratings 
(-) 
on 
impact 
competition in the market as investors would 
most  probably  choose  for  another  large 
existing CRA. 

negative 

Option 4 
(Improve disclosure requirements for 
issuers of structured finance products on 
an ongoing basis) 

(+) more incentives for own due diligence, 
but the impact on reducing overreliance is 
likely to be limited. 

(-)  limited  effect  on  overreliance  combined 
with  increased  compliance  costs  for  market 
participants  to  search  and  use  available 
ratings that are not currently obliged to use 
more  than  one  rating  leads  to  a  conclusion 
that it is not a cost-effective option. 

(+/0) there would be additional compliance 
costs, but also indirect costs if there is 
unlimited access to critical price sensitive 
information data, but it is considered a cost-
effective option as it regards making existing 
information available to all interested 
parties. 

To  conclude,  based  on  the  analysis  above,  the  highest  scoring  options  in  terms  of 
effectiveness and efficiency are options 2 and 4 which are compatible with each other. If these 
options  were  pursued,  financial  firms  would  use  more  internal  models  for  measuring  credit 

98  

99  

Commission Regulation (EC) No 809/2004 of 29 April 2004 implementing Directive 2003/71/EC of the 
European Parliament and of the Council as regards information contained in prospectuses as well as the 
format,  incorporation  by  reference  and  publication  of  such  prospectuses  and  dissemination  of 
advertisements. 
According to Annex VIII item 4.1. of the Prospectus Implementing Regulation post issuance reporting 
is  voluntary  unless  it  is  considered  to  be  a  significant  new  factor,  material  mistake  or  inaccuracy 
according to Article 16 of Directive 2003/71/EC (Prospectus Directive).  

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risk and would re-assess capital requirements, which are currently based on external ratings. 
The  increase  of  information  disclosure  for  structured  finance  instruments  would  enable 
investors to perform an adequate risk assessment. Eventually, overreliance on external ratings 
would be reduced, thus leading to mitigation of "cliff effects" in the market. 

Furthermore, with regard to overreliance issues it should be acknowledged that there will be a 
degree  of  voluntary  reliance  on  ratings  by  small  and  individual  investors  which  cannot  be 
addressed  by  regulatory  measures.  Nevertheless,  automatic  and  mechanical  reliance  on 
external credit ratings by regulated financial firms could be reduced. 

The  first  of  these  policy  measures  (option  2)  to  limit  overreliance  are  in  line  with  the 
principles  of  the  Financial  Stability  Board  that  were  included  in  the  new  proposal  for  the 
modification of the Capital Requirements Directive (CRD IV100). The main provisions are (1) 
require that banks' investment decisions must never rely solely and mechanistically on ratings 
but always form their own internal credit opinion on every exposure; (2) require banks with a 
material number of exposures in a given portfolio (be it sovereigns, banks, or corporates) to 
develop internal ratings for that portfolio; (3) require (smaller) banks that do not use internal 
ratings  to  compare  their  internal  credit  opinion  to  the  capital  requirement  resulting  from  an 
external rating. If the internal assessment shows that for a given loan, the external rating and 
the resulting capital requirement are too favourable compared to the internal credit opinion, 
the bank will be required to hold additional capital; (4) supervision of CRD IV will performed 
by the European Banking Authority EBA to ensure proper application of these measures (see 
Annex XV). 

6.2. 

Policy options to mitigate the risks of contagion effects linked to sovereign debt 
ratings 

1. No policy change 

Policy options 

2. Require CRAs to publish a full research report on sovereign debt ratings and allocation of staff 

3. Require CRAs to publish sovereign ratings after closing of EU trading venues 

4. Require CRAs to conduct the sovereign debt ratings process more frequently 

5. Extend powers of competent authorities (ESMA) to scrutinise rating methodologies 

6. Require (EU) sovereigns to publish a standardised set of data on economic performance to enable credit risk assessment 

7. Grant ESMA the power to restrict or ban temporarily sovereign debt ratings in exceptional situations 

8. Encourage an existing, independent EU structure or a brand new European Credit Rating Agency to issue sovereign credit 
ratings 

9. Prohibit sovereign debt ratings 

The full description of policy options is presented in Annex VII. Options 2, 3, 4, 5, 6, 7 and 8 
can  be  combined  and  can  complement  each  other.  Option  9  is  not  compatible  with  the 
previous options which imply that the activity of issuing sovereign ratings is allowed. 

Option 1 - No policy change 

100  

The legislative proposal on Capital Requirement Directive IV was adopted by the Commission on 20 
July 2011.  

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Under this option, insufficient transparency would continue to exist in the area of sovereign 
debt ratings.  

Even though some initiatives to enhance the quality of the sovereign rating process have been 
undertaken on a voluntary basis by major CRAs, as described in Annex V, their effectiveness 
in mitigating the problem is expected to be in perspective. rather limited Indeed, the initiatives 
adopted  so  far  appear  to  be  limited  in  scope,  resulting  basically  in  an  update  and  improved 
disclosure of sovereign rating methodologies and do not provide any effective solution to all 
the  remaining  problem  drivers  presented  in  section  4.2  above.  Moreover,  measures  which 
have  been  adopted  individually  by  the  agencies  on  a  purely  voluntary  basis  would  raise 
serious issues concerning their harmonization and enforceability.   

As  a  result,  governments  would  continue  to  suffer  from  the  limited  time  to  assess  accuracy 
and  reliability  of  the  rating  process  and  to  verify  whether  all  relevant  information  has  been 
properly  factored  in  or  not  into  the  final  outcomes.  In  addition,  rating  agencies  would  be 
allowed  to  continue  issuing  sovereign  ratings  even  at  particularly  sensitive  times,  i.e. 
immediately  ahead  of  auctions,  during  the  syndication  process  or  just  before  the  close  of 
business of European trading venues.  

Investors would continue to have limited information on rating changes and might continue to 
(over)react to rating changes on the basis of an insufficient understanding of sovereign rating. 
As a result, considering also the interaction with the other problem drivers described above, 
the  risks  of  relevant  spill-over  effects  and  financial  markets  disruptions  linked  to  sovereign 
downgrades would continue to persist.  

Furthermore,  stability  of  EU  Member  States  would  remain  subject  to  the  risk  of  investors 
over-reactions  to  insufficiently  transparent  sovereign  rating  changes  with  the  potential 
negative spill-over effects described in par. 4.2 above.  

Option  2  -  Introduce  a  requirement  for  CRAs  to  publish  a  full  research  report  on 
sovereign debt ratings and allocation of staff 

This  option  would  enhance  the  capacity  of  investors  to  interpret  the  ratings  since  more 
detailed  information  on  the  underlying  analysis  and  on  the  justification  of  ratings  would  be 
made available to them. In the consultation process, overall, a large amount of stakeholders, 
including  some  rating  agencies  considered  that  sovereign  ratings  should  not  be  treated 
fundamentally  different  from  other  ratings.  However,  some  Member  States  and  industry 
stakeholders  considered  that  more  transparency  of  sovereign  rations  would  be  welcomed, 
particularly  regarding  methodologies  and  publication  of  the  full  research  reports  underlying 
ratings.  This  is  expected  to  enable  investors  to  better  understand  the  rationale  behind  the 
sovereign  debt  ratings  and  to  complement  the  judgement  of  the  CRAs  with  their  own 
assessment.  Consequently,  this  option  would  also  contribute  to  achieving  the  objective  of 
reducing reliance on ratings as investors would be in a better position to determine their own 
opinion  on  a  certain  sovereign.  As  a  result  the  risk  of  market  disruption  and  negative  spill-
overs following a downgrade of a sovereign would be reduced.  

In  order  to  enhance  the  transparency  of  the  process,  additional  figures  on  the  allocation  of 
staff  could  be  made  available  as  well.  This  would  enable  investors  and  market  actors  in 
general to better judge whether the CRAs devote adequate resources to the sovereign rating 
process and, consequently, reliability and quality of their sovereign ratings. 

Since rating agencies would be asked to disclose information which is already available, this 
option is expected to imply limited additional costs and administrative burden.  

Option 3 - Introduce a requirement for CRAs to publish sovereign ratings after closing 
of EU trading venues 

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Currently,  ratings  are  sometimes  published  at  sensitive  period  during  trading,  when  not  all 
investors can be always fully aware of changes of ratings and reasons for such changes. This 
could result in market disruption when ratings are published during or just before closing of 
trading when investors sell of based on unexpected rating changes.  

This  option  would  keep  these  risks  to  the  minimum  but  ensure  that  publication  of  ratings 
cannot happen during particularly sensitive trading hours, i.e. immediately ahead of auctions, 
during the syndication process or just before the close of business of European trading venues. 
Instead,  all  relevant  information  on  credit  ratings  would  be  disseminated  among  all  market 
participants and investors outside trading hours. 

All investors would thus have sufficient time to react properly to rating events on the basis of 
a  well  founded  assessment  of  the  underlying  analysis  and  assumptions  on  which  the  credit 
event has been based.  

As  a  result  this  provision  would  mitigate  the  risk  of  spreading  of  rumours  during  trading 
thereby  reducing  the  probability  of  herding  behaviour  and  market  distortion.  In  this  respect 
this measure is expected to limit risks of spill-over effects and contribute to enhance market 
stability.  

However,  since  the  measure  would  be  applicable  only  to  the  EU  markets,  its  effectiveness 
may be somewhat reduced  since ratings might continue to be published outside Europe and 
trading  of  sovereign  debt  instruments  can  continue  on  trading  venues  outside  the  EU. 
However,  ratings  which  published  outside  the  EU  and  which  would  fall  outside  the 
endorsement or equivalence regime for third countries as provide for in the CRA regulation 
would not be allowed to be used for the purpose of regulatory capital. 

Option  4  -Introduce  a  requirement  for  CRAs  to  conduct  the  sovereign  debt  ratings 
process more frequently 

Under  this  option  CRAs  would  be  required  to  conduct  a  full  review  of  sovereign  processes 
ratings  more  frequently  (every  6  months). 101 This  would  force  CRAs  to  follow  up  more 
regularly on the main political and economic developments in Member States and mitigate the 
risk  that  rating  agencies  react  too  late  to  such  developments  with  sudden  upgrades  on 
downgrades. This is turn would reduce the risk of over reactions from investors and of herd 
behaviour 

This  provision  would  make  sure  that  any  new  relevant  policy  measure  introduced  by  a 
sovereign which can entail positive effects on sovereign's fundamentals are timely reflected in 
the related debt rating.  

This  option  would  contribute  to  improving  the  communication  of  ratings  to  investors  by 
CRAs as they would be required to undertake a full rating assessment on a more regular basis. 
It should be noted that this would not necessary entail an increased number of rating changes 
and CRAs would continue to be allowed to revise ratings when it is fully justified on the basis 
of their methodology and analysis.  

For  CRAs  the  provision  would  entail  some  additional  costs  as  they  would  need  to  conduct 
more frequently the full rating process.  

Option  5  -  Extend  powers  of  competent  authorities  (ESMA)  to  scrutinise  rating 
methodologies 

101  

Existing  provisions  only  requires  a  credit  rating  agency  t o   ' monitor  credit  ratings  and  review  its 
credit ratings and methodologies on an ongoing basis and at least annually, in particular where material 
changes occur that could have an impact on a credit rating'.  (See art 8.f of CRA regulation n. 1060/2009). 

32/193 

 
 
 
                                                 
Under  this  option,  supervision  on  rating  methodologies  would  be  reinforced  since  any  new 
rating methodology developed by rating agencies  would require prior notification to ESMA 
before  its  actual  implementation.  ESMA  would  be  required  to  scrutinize  the  new  rating 
methodology and check its compliance with existing requirements for rating methodologies as 
outlined  in  article  8.3  of  the  CRA  Regulation.  This  option  could  apply  for  sovereign  debt 
ratings but also for ratings of other asset classes. 

Only  after  a  positive  assessment  by  ESMA,  rating  agencies  would  be  allowed  to  apply  the 
new methodology. As a result, this option is expected to contribute to substantially enhance 
transparency  and  quality  of  sovereign  ratings  since  it  would  enforce  the  existing  provision 
requiring  CRAs  to  adopt  rating  methodologies  which  are  'rigorous,  systematic,  continuous 
and  subject  to  validation  based  on  historical  experience,  including  back-testing'  (see  article 
8.3 of the CRA Regulation). It should be noted that in compliance with Article 23 of the CRA 
Regulation,  this  assessment  by  ESMA  would  be  limited  in  scope  and  would  not  entail  the 
interference with the content of rating methodologies. 

In  terms  of  efficiency  this  new  task  would  entail  some  (limited)  additional  costs  for  the 
ESMA to validate the methodologies and for CRAs to provide the necessary documentation to 
the ESMA. 

Option 6 - Introduce a requirement for (EU) sovereigns to publish a standardised set of 
data on economic performance to enable credit risk assessment by investors 

The benefit attached to this option would be making all relevant information on economic and 
financial performance of EU sovereigns freely available in a standardised form to interested 
stakeholders, including investors, through a centralised database.  

This would facilitate market participants to make their own assessment of creditworthiness of 
sovereigns, without excessively relying on external ratings.  

Furthermore,  credit  rating  agencies  would  be  facilitated  in  issuing  unsolicited  ratings  which 
could improve the number of credit opinions available to market participants.  

However,  it  should  be  noted  that  relevant  information  to  assess  creditworthiness  of  EU 
sovereigns is already available to investors through distinct sources, including the European 
Statistical  System  (ESS)  coordinated  by  EUROSTAT.  The  ESS  is  already  committed  in 
making  EU  economic  statistics  and  the  Principal  European  Economic  Indicators  (PEEI)102 
increasingly complete, comparable and timely. Consequently, a large amount of statistics and 
indicators on public finances are made available through EUROSTAT. There does not appear 
to exist any lack of data for the purpose of making credit assessment for sovereigns.   

Therefore  this  measure  would  not  considerably  improve  the  quantity  or  timeliness  of  the 
information  necessary  for  investors  to  make  their  own  assessment.  It  would  rather  aim  at 
improving  its  comparability  and  accessibility  for  investors  and  general  public.  Taking  also 
into consideration the existing work-streams which should improve the reliability and quality 

102  

PEEIs represent a comprehensive set of infra-annual macro economic statistics aiming to describe the 
economic and labour market situation as well as price developments in the euro area and the European 
Union, which are of particularly high importance for economic and monetary policy. The 
communication of the Commission to the European Parliament and the Council on Eurozone statistics 
“Towards improved methodologies for Eurozone statistics and indicators” of November 2002 has 
defined the list of PEEIs and their timeliness targets. Since 2002, achieved progress and remaining 
challenges have been constantly monitored. Each year Eurostat, in cooperation with the European 
Central Bank, drafts a Status Report on Information Requirements in the European monetary union 
(EMU) which is first submitted to the Economic and Financial Committee (EFC) and then to the 
Economic and Financial Affairs Council (ECOFIN).  See the annual EFC Status Report on information 
requirement in EMU available from: 
http://epp.eurostat.ec.europa.eu/portal/page/portal/euroindicators/peeis/efc_status_report.  

33/193 

 
 
 
                                                 
of  available  data  on  sovereigns,  the  added  value  of  the  measure  is  expected  to  be  rather 
limited  and  therefore  it  would  only  have  a  limited  impact  in  terms  of  reducing  reliance  on 
ratings and mitigating risks of spill-over effects.   

Option 7 - Grant ESMA the power to restrict or ban temporarily sovereign debt ratings 
in situations defined by the Regulation 

In  situations  where  the  objectivity  and  quality  of  sovereign  ratings  can  be  impaired  by 
upcoming  market  developments,  like  the  case  where  all  details  of  an  international  financial 
support  programme  (including  those  in  the  framework  of  the  European  Financial  Stability 
Mechanism)  to  stabilize  the  economy  of  the  sovereign  are  still  unknown,  ESMA  would  be 
given  the  power  to  temporarily  restrict  or  ban  the  issuance  of  sovereign  debt  ratings  while 
there is uncertainty with regard to timing, value, amount and conditions of the support.  Other 
cases  might  encompass  events  which  can  substantially  impact  on  market  confidence  and 
trigger excessive market volatility. 

This would reduce the risk for concerned sovereigns to be subject to a premature and not fully 
justified  downgrade  with  huge  negative  impact  on  their  financial  stability  and  further  spill-
overs to its economy and to that of neighbouring countries. Building on the previous example, 
the ban would be possible for ESMA until the complete information on timing, amount and 
conditions of the support is available.  

However,  it  has  to  be  observed  that  while,  on  one  side,  the  measure  might  contribute  to 
increasing the quality and accuracy of sovereign debt ratings thereby reducing the probability 
of unjustified downgrades, on the other side, as rating agencies operate at international level, a 
temporary ban could have limited effect. There exists a risk that regardless of a ban imposed 
on  EU  CRAs  to  issue  certain  sovereign  debt  ratings,  ratings  could  still  be  issued  by  CRAs 
established outside the EU. However, in view of the third country regime, which provides for 
endorsement  or  equivalence  of  third  country  ratings,  as  outlined  in  Article  5  of  the  CRA 
Regulation  this  risk  would  be  mitigated  and  limited  as  these  ratings  could  not  be  used  for 
regulatory purpose. Ratings which fall outside the third county regime already today cannot 
be used for regulatory purpose. 

The measure in discussion could raise some concerns with respect to its compatibility with the 
freedom  to  conduct  a  business  of  Credit  Rating  Agencies  and  of  investors  (protected  under 
Article  16  of  the  Charter  of  Fundamental  Rights  of  the  European  Union).  Subject  to  the 
principle of proportionality, the freedom to conduct a business may be limited, provided the 
limitations are necessary and genuinely meet objectives of general interest recognised by the 
Union or the need to protect the rights and freedoms recognised by the Charter (see Article 52 
of the Charter).  

Taking  into  account  the  relevance  of  the  objective  pursued  through  this  measure,  i.e. 
preserving  financial  stability  in  the  EU,  the  proposed  measures  would  comply  with  the 
principle of proportionality mentioned above if they are limited to clearly defined, exceptional 
circumstances, are limited in time, and constitute a measure of last resort. Conditions under 
which such restrictions and bans can be imposed would have be drafted with sufficient clarity 
and precision to prevent any potential arbitrariness or abuse. It has to be underlined that the 
expected  impact  of  the  measure  on  quality,  reliability  and  timeliness  of  sovereign  ratings 
would  depend  more  on  its  deterring  and  inhibiting  effects  rather  than  on  its  actual  use. 
Therefore, this measure can also be seen as the application of the precautionary principle.  

Option  8  -  Encourage  an  existing,  independent  EU  structure  or  promote  a  brand  new 
European Credit Rating Agency to issue sovereign debt ratings 

Under this option an existing independent EU structure with adequate resources and capacity 
or  a  brand  new  European  Credit  Rating  Agency  would  issue  credit  ratings  for  sovereign 

34/193 

 
 
 
issuers to provide market participants with a greater variety of opinions on credit worthiness 
of  issuers.  Sovereigns  would  get  an  additional  rating  from  an  independent  and  reputable 
source with a strong signalling effect to financial markets.  

Two implementing modalities (sub-options) are possible under this option: 

A  -  Encouraging  the  establishment  of  a  brand  new  European  Credit  Rating  Agency  (this 
option  is  further  analysed  in  section  6.3)  which  could  offer  the  whole  spectrum  of  rating 
services on all asset classes including sovereign bonds. 

B - Encouraging an existing EU structure to take over the specific task of issuing sovereign 
ratings  provided  it  has  adequate  skills  and  resources  and  is  already  active  in  the  areas  of 
macro  prudential  supervision,  macroeconomic  surveillance  or  in  that  of  financial  support  to 
EU  Member  States.  This  sub-option  is  distinct  to  the  European  Credit  Rating  Agency 
described in section 6.3 as the scope would be limited to sovereign ratings and ratings would 
be conducted by an existing EU structure.  

In  order  to  limit  the  costs  which  the  selected  structure  would  incur  to  be  fully  equipped  to 
perform  the  new  task  and  to  draw  on  the  expertise  already  available  within  the  EU 
institutional  framework  there  are  3  possible  institutions  which  could  fulfil  the  task:  the 
European  Central  Bank  (together  with  the  European  System  of  Central  Banks  (ESCB));  the 
European  Commission  (Directorate  General  for  Economic  and  Financial  Affairs),  and  the 
newly  established  European  Financial  Stability  Facility  (EFSF),  which  will  become  the 
European Stability Mechanism as from 2013.  

The ECB 

In  terms  of  effectiveness  it  would  make  sense  to  give  central  banks  the  task  of  issuing 
sovereign  ratings.  Historically,  the  two  main  objectives  of  central  banks  relate  to  the 
maintenance  of  monetary  and  financial  stability.  Both  objectives  are  closely  interlinked; 
monetary policy has significant implications for financial stability, while financial stability is 
an essential pillar for effective monetary policy. Identifying vulnerabilities in the financial and 
non-financial  sectors,  including  in  sovereign  debt  markets,  and  potential  shocks  in  these 
markets is therefore a vital part of the work of central banks.  

The  ECB  is  at  the  heart  of  the  newly  established  European  Systemic  Risk  Board  and  has 
already  a  wide-ranging  macro-prudential  expertise  together  with  adequate  resources  to  pool 
all  the  necessary  information,  to  carry  out  the  right  level  of  analytical  work,  including  the 
development of methodology and management of a complex and wide set of indicators at EU 
and Member State level.  

Moreover,  the  ECB  has  already  a  system  to  independently  assess  the  creditworthiness  of 
issues  eligible  for  credit  operations  and  for  critically  reviewing  external  assessments 
(Eurosystem  credit  assessment  framework  –  ECAF) 103  which  in  particular  allows  the 

103  

The  Eurosystem  credit  assessment  framework  (ECAF)  defines  the  procedures,  rules  and  techniques 
which ensure that the Eurosystem requirement of high credit standards for all eligible assets is met. In 
the  assessment  of  the  credit  standard  of  eligible  assets,  the  Eurosystem  takes  into  account  credit 
assessment information from credit assessment systems belonging to one of four sources, namely:  
(cid:131) 
(cid:131) 
(cid:131) 
(cid:131) 
Additionally,  in  the  assessment  of  the  credit  standard  the  Eurosystem  takes  into  account  institutional 
criteria and features guaranteeing similar protection for the instrument holder such as guarantees. 
Available from: http://www.ecb.int/paym/coll/risk/ecaf/html/index.en.html.  

external credit assessment institutions (ECAIs), 
NCBs’ in-house credit assessment systems (ICASs), 
counterparties’ internal ratings-based (IRB) systems, or 
third-party providers’ rating tools (RTs). 

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recognition internally to the Eurosystem of the four in-house credit rating assessments from 
the respective EU National Central Banks104. 

Considering the high reputation and solid experience in carrying out monetary policy in the 
UEM independently, its sovereign ratings would carry a strong signalling effect for investors 
and would be able to substantially influence markets developments. 

On the other hand, three major arguments can be presented against the attribution of the task 
to the ECB. First, there may be a conflict of interest between the activity of issuing sovereign 
debt  ratings  and  the  implementation  of  its  monetary  policy.  In  particular  there  might  be 
concerns  that  the  ECB  for  reasons  of  protecting  the  Eurosystem  against  financial  losses  in 
connection  to  its  credit  operations  (i.e.  depreciation  of  assets  accepted  as  collateral)  would 
issue  more  favourable  sovereign  rating  policy  than  justified  by  underlying  indicators  and 
sovereign's fundamentals.  

Second, there would be a reputational risk linked to the activity of issuing sovereign ratings. 
A perceived failure in assigning the 'right' rating to a sovereign might prove detrimental to the 
reputation of the ECB/ESCB, thereby jeopardising their credibility as a monetary authority as 
well. 

Third,  as  the  ECB  is  an  independent  institution  with  concrete  tasks  notably  in  terms  of 
monetary  policy  set  with  the  EU  Treaty,  in  order  to  attribute  a  task  of  issuing  sovereign 
ratings some institutional considerations would need to be addressed – which might possibly 
require a modification of the EU Treaty. 

Having regard to the efficiency criterion, giving to the ECB the mandate of issuing sovereign 
debt rating would allow to fully benefit from the available qualified resources to carry out the 
underlying analytical and statistical work. Therefore the costs linked to implementation of this 
option would be limited. 

European Commission (Directorate General Economic and Financial Affairs – DG ECFIN) 
DG  ECFIN  plays  a  key  role  in  macro-economic  surveillance105,  including  the  design  and 
implementation  of  large-scale  macro-financial  assistance  programmes  (often  in  cooperation 
with  the  IMF  and  the  World  Bank)  to  support  Member  States  and  partner  countries  facing 
severe financial or balance of payments difficulties. 

In that respect it could be well placed to take over the duty of issuing sovereign ratings since 
it would be in a position to properly assess risks to the financial system and to economy of 
Member States. 

104  
105  

Banque de France, Deutsche Bundesbank, Banco de Espana and Oesterreichische Nationalbanks. 
See Art. 99, §3 and 4 of the EC Treaty:  "3. In order to ensure closer co-ordination of economic policies 
and sustained convergence of the economic performances of the Member States, the Council shall, on 
the  basis  of  reports  submitted  by  the  Commission,  monitor  economic  developments  in  each  of  the 
Member States and in the Community as well as the consistency of economic policies with the broad 
guidelines referred to in paragraph 2, and regularly carry out an overall assessment. For the purpose of 
this  multilateral  surveillance,  Member  States  shall  forward  information  to  the  Commission  about 
important measures taken by them in the field of their economic policy and such other information as 
they deem necessary". 4. Where it is established, under the procedure referred to in paragraph 3, that the 
economic  policies  of  a  Member  State  are  not  consistent  with  the  broad  guidelines  referred  to  in 
paragraph 2 or that they risk jeopardising the proper functioning of economic and monetary union, the 
Council  may,  acting  by  a  qualified  majority  on  a  recommendation  from  the  Commission,  make  the 
necessary  recommendations  to  the  Member  State  concerned.  The  Council  may,  acting  by  a  qualified 
majority  on  a  proposal  from  the  Commission,  decide  to  make  its  recommendations  public.  The 
President of the Council and the Commission shall report to the European Parliament on the results of 
multilateral surveillance. The President of the Council may be invited to appear before the competent 
committee of the European Parliament if the Council has made its recommendations public” 

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However,  in  terms  of  effectiveness  it  could  be  argued  that  sovereign  ratings  issued  by  the 
Commission  could  lack  sufficient  credibility  vis-a-vis  markets.  Indeed  investors  might  have 
concerns on the objectivity of ratings in relation to potential political pressures from National 
Authorities and in relation to possible conflict of interests with the role of the Commission in 
support programmes to Member States (see above).  

As regards the cost efficiency this option would lead to quite substantial costs in relation to 
the  need  to  build  the  necessary  expertise  to  perform  credit  rating  activities,  including 
development of methodologies and pooling of all relevant information.  
The European Financial Stability Facility(EFSF) / European Stability Mechanism (ESM)106 

Taking into account the mandate of the EFSF/ESM, i.e. to facilitate or provide financing to 
Euro  Member  States  in  financial  difficulties107,  the  ESFS/ESM  could  provide  a  possible 
alternative to the two previous options to identify a European entity to be entrusted with the 
task of issuing sovereign ratings.  

However  it  can  be  argued  that  the  EFSF/ESM  would  face  in  perspective  a  serious  lack  of 
credibility  vis-à-vis  markets  and  investors.  On  one  side  investors  might  have  doubts  on  its 
independence  and  on  objectivity  and  candidacy  of  its  analysis  because  of  its  shareholders' 
structure  (the  Euro  Area  Member  States).  On  the  other  side  there  might  be  concerns  with 
respect  to  the  conflict  of  interest  with  both  its  lending  and  its  borrowing  operations  since  a  
downgrade of a Member country or of a borrower country could potentially impact negatively 
on the rating of the ESFE/EMS itself.108  

Finally, as the ESFE/EMS is an independent entity, some institutional considerations would 
need to be addressed (notably amendments to the legal instruments providing for the creation 
of this mechanism) before such a task could be attributed to this entity. 

Moreover in terms of cost efficiency, taking into account the limited resources available to the 
EFSF109,  this  solution  would  lead  to  substantial  costs  to  provide  for  adequate  expertise  and 
technical infrastructure to perform the task.  

Option 9 - Prohibit sovereign debt ratings 

Under  this  option  sovereign  issuers  would  remain  unrated.  As  a  result,  investors,  including 
credit  institutions,  willing  to  acquire  sovereign  debt  would  be  required  to  base  their 
investment  decision  on  their  own  exclusive  risk  assessment.  This  would  contribute  to  the 
objective  of  reducing  reliance  on  external  credit  ratings  by  investors.  However,  while  large 
credit  institutions  could  be  expected  to  have  the  capacity  and  processes  in  place  to  perform 
such an assessment, as highlighted by the responses to the public consultation, smaller credit 

106  

107  

108  

109  

The European Financial Stability Facility (EFSF) was created by the euro area member states following 
the  decisions  taken  May  9,  2010  within  the  framework  of  the  Ecofin  Council.  As  part  of  the  overall 
rescue  package  of  €750  billion,  EFSF  is  able  to  issue  bonds  guaranteed  by  EAMS  for  up  to  €  440 
billion  for  on-lending  to  EAMS  (Euro  Area  Member  States)  in  difficulty,  subject  to  conditions 
negotiated with the European Commission in liaison with the European Central Bank and International 
Monetary  Fund  and  to  be  approved  by  the  Eurogroup.  EFSF  is  a  Luxembourg-registered  company 
owned by Euro Area Member States. On 28 - 29 October the European Council agreed on the need to 
set  up  a  permanent  crisis  mechanism  to  safeguard  the  financial  stability  of  the  euro  area  as  a  whole. 
Eurogroup  Ministers  agreed  that  this  European  Stability  Mechanism  (ESM)  will  be  based  on  the 
European  Financial  Stability  Facility  capable  of  providing  financial  assistance  packages  to  euro  area 
Member States under strict conditionality functioning according to the rules of the current EFSF. The 
ESM will become operational as of mid-2013 following the expiry of the existing EFSF. 
See article 3 of EFSF Articles of Incorporation. Available from: 
http://www.efsf.europa.eu/attachments/efsf_articles_of_incorporation_en.pdf.  
It  must  be  underlined  that  the  EFSF  Framework  agreement  provides  for  various  credit  enhancement 
mechanisms to exclude the situation referred in the text 
At the time of drafting the EFSF had a staff of around 12 officials. 

37/193 

 
 
 
                                                 
institutions and smaller investors do not necessary have the skills and resources to carry out 
their own assessment for  all  sovereigns. This would put a disproportionate burden on them. 
Furthermore,  the  effective  enforcement  of  such  a  measure  could  be  effectively  limited  by 
unsolicited  ratings  carried  out  by  CRAs  licensed  in  jurisdictions  outside  the  EU.  Moreover 
CRAs would be confronted with the disappearing of an important source of revenues. 

The  permanent  prohibition  would  heavily  impact  on  the  freedom  to  conduct  a  business 
(Article 16 of the Charter of Fundamental Rights of the European Union) of both credit rating 
agencies  and  investors.  Indeed,  considering  the  general  nature  of  the  prohibition,  it  raises 
serious concerns as to its compatibility with the principle of proportionality. 

The  summary  of  the  analysis  of  different  options  to  achieve  specific  objective  2  (mitigate 
risks of contagion effects linked to sovereign debt ratings) is presented in the table below. The 
analysis of the impact of these options on different stakeholder groups is given in Annex VIII. 

Option 1 (baseline) 

n.a. 

n.a. 

Effectiveness 

Efficiency 

Option 2 
(Require CRAs to publish a full research 
report  on  sovereign  debt  ratings  and 
allocation of staff) 

(++) transparency on sovereign ratings will 
be improves. 
(++) 
increasing understanding of ratings. 

investors  would  get  a  better 

information  on  research 
(++)  detailed 
report would be made available to investors 
free of charge.  
(-) CRAs would face lower profits since they 
the 
would  not  be  allowed 
on 
underlying 
sovereigns. 

to  market 
information 

(detailed) 

Option 3 
(Require  CRAs  to  publish  sovereign 
ratings  after  closing  of  EU  trading 
venues) 

(++) publication of ratings during sensitive 
times  would  be  avoided  and  contagion 
effects of sovereign ratings reduced. 

(0) since the measure would only affect the 
timing  of  the  publication  of  the  rating  it 
would not entail additional costs for CRAs). 

(-)  measure  would  be  not  effective  in 
trading venues outside EU jurisdiction. 

Option 4 
(Require  CRAs  to  conduct  the  sovereign 
debt ratings process more frequently) 

(++) risks of contagion and spill over 
effects would be reduced.  

(+) CRAs would be confronted with the 
limited additional costs linked to doing the 
full rating process more frequently. 

Option 5  
(Extend  powers  of  competent  authorities 
rating 
to 
(ESMA) 
methodologies) 

scrutinise 

Option 6 
(Introduce  a  requirement 
(EU) 
sovereigns  to  publish  a  standardised  set 
of  data  on  economic  performance  to 
enable credit risk assessment) 

for 

Option 7 
(Grant  ESMA  the  power  to  restrict  or 
ban temporarily sovereign debt ratings in 
exceptional situations) 

Option 8 
(Encourage  an  existing  independent  EU 
structure  or  promote  a  brand-new 
European  Credit  Rating  Agency  to  issue 
sovereign debt ratings ) 

(++) transparency and quality of sovereign 
ratings enhanced.  

(+) limited additional costs for competent 
authorities to scrutinise ratings. 

(+) limited additional costs for this 
additional validation process for CRAs. 

(+) access to data on sovereigns and 
investors' own assessment would be 
facilitated. 

(-) duplication of costs with on going 
initiatives of the ESS to enhance reliability 
and quality of information on sovereigns. 

(++)  risks of contagion effects of sovereign 
ratings would be reduced.  
(+) accuracy and quality of sovereign 
ratings would be improved. 
(-) risks of  adverse market reactions 
enhanced. 

(0) no direct costs involved by the adoption 
of the measure.  

(++) financial stability enhanced through 
the availability of a credible alternative to 
existing commercial ratings for sovereigns.   

(+/0) additional costs for the establishment 
of a new EU  Agency (case of public 
funding) 

or 

(+)limited  additional costs for the existing 
EU structure  to build  the 
expertise/technical infrastructure necessary 
to perform rating activities  

(--) investors, particularly small investment 
firms and small credit institutions would be 
confronted with the costs of setting up their 
own risk assessment capacity.   
(-) CRAs would loose an important source 
of revenues. 

Option 9 
(Prohibit sovereign debt ratings) 

(+) reliance on sovereign ratings would be 
reduced. 
 (-) effectiveness would be limited by the 
continuous issue of sovereign ratings 
outside the EU jurisdiction. 

38/193 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Based  on  the  analysis  above  on  the  effectiveness  and  efficiency  of  the  various  options 
presented,  options  2,  3,  4,  5,  and  7  as  the  preferred  ones.  Indeed  their  joint  implementation 
would  provide  an  adequate  response  to  the  various  issues  (problem  drivers)  described  in 
section 4.2 above. Indeed measures included in options 2, 3, 4 and 5 are expected to improve 
transparency  of  sovereign  rating  process  and  therefore  enhance  the  quality,  objectivity,  and 
reliability  of  sovereign  ratings. In  terms  of  effectiveness  they  all  are  expected  to  reduce  the 
negative spill-overs and 'cliff' effect of sovereign ratings (downgrades). With respect to cost 
efficiency,  the  implementation  of  such  options  would  entail  limited  additional  costs, 
particularly for CRAs which would have to face a reduction in their sources of revenues and 
bear the costs of doing the full sovereign rating process more frequently and comply with the 
obligation  of  prior  validation  of  their  methodology  by  the  ESMA.  Furthermore,  publication 
after  closure  of  European  trading  venues  (option  3)  would  ensure  that  market  overreactions 
and  heard  behaviour  is  reduced.  In  exceptional  circumstances  which  could  trigger  market 
volatility or affect the reliability and completeness of the rating process, for instance pending 
the disclosure of the terms and conditions of a financial support package granted to a Member 
State, ESMA would be empowered to temporarily ban sovereign ratings as a measure of last 
resort, ensuring that risks of contagion effects of sovereign downgrades are mitigated.  

6.3. 

Policy options to improve credit rating market conditions 

Policy options 

1. No policy change 

2. Encourage the emergence of a network of small and medium size rating agencies 

3. Encourage the emergence of a new European rating agency 

4. Harmonise ratings scales to improve comparability of ratings between CRAs 

5. Establish a European Rating Index (EURIX) 

6. Require CRAs to issue joint ratings at the level of the rating committee 

7. Ban large CRAs from acquiring small and medium-sized CRAs 

8. Introduce temporary market share ceilings for CRAs  

9. Require CRAs to disclose pricing of ratings and ensure that prices are not discriminatory and based on costs  

The full description of policy options is presented in Annex VII. Options 2, 3, 4, 5, 6, 7, 8 and 
9 are not mutually exclusive and can be combined.  

Option 1 - No policy change 

Under  this  option,  existing  oligopolistic  market  structure,  with  three  main  rating  agencies 
dominating the market is expected to persist.  

The landscape of the rating industry would not be substantially modified by the outcomes of 
the ongoing registration process under the CRA Regulation. At this early stage, six small and 
medium rating agencies have been registered and it is too early to determine weather one of 
these agencies has the potential and the ambition to turn itself into a full-blown rating agency 
covering  a  wide  reach  in  terms  of  asset  classes  (including  sovereign  debt,  corporate  and 
structured finance products) and territory (see Annex IV). A preliminary assessment does not 
suggest that in the short term a true competitor, comparable in size, reputation and territorial 
reach to the three rating agencies with a dominant market share could emerge. 

39/193 

 
 
 
 
Recently,  there  have  been  signals  on  possible  market-driven  initiatives  for  the  future 
establishment of a European Rating Agency in the form of private Foundation110 which could 
be able to inflate more competition in the market of credit rating services.  

However, it is still too early to make any form of evaluation of these initiatives since they are 
merely at the stage of announcements and it is impossible to assess their concrete chances of 
success. 

Therefore  for  the  time  being  it  is  likely  that  issuers  and  investors  would  continue  to  be 
confronted  with  the  current  structure  of  the  market  which  implies  a  limited  availability  of 
ratings  and  limited  opportunities  to  compare  different  credit  opinions  for  investors.  Issuers 
would continue to have a limited choice as regards the service provider for the rating of their 
debt  instruments:  consequently  issuers  could  be  confronted  with  potential  abuses  on  prices. 
This  could  affect  small  and  medium  enterprises  for  which  the  access  to  financial  markets 
could become costly. Nevertheless, if any private initiative materialises and results in one or 
more  new  competitors  who  would  gain  ground  in  terms  of  client  basis  and  credibility,  this 
would  be  undoubtedly  a  positive  development  enhancing  competition  and  choice  for  the 
market.  

Option  2  -  Encourage  the  emergence  of  a  network  of  small  and  medium  sized  credit 
rating agencies 

Promoting through a EU-funded programme a network of small and medium rating agencies 
could  facilitate  this  type  of  CRAs  to  enter  the  market.  This  network  could  facilitate  the 
sharing of best practices and resources and eventually lead to the emergence of more sizeable 
market players which could compete in terms of size, instruments rated, geographic reach and 
reputation of the large CRAs. Entry into the market and survival of new competitors would be 
also  encouraged.  The  consultation  process  showed  that  the  majority  of  stakeholders  would 
welcome more choice and market players in the rating industry.  

Due  to  their  size  and  limited  scope  of  activities,  small  and  medium  sized  credit  rating 
agencies  lack  resources  to  create  such  a  network  by  market  forces.  However,  the  public 
consultation  on  this  initiative  outlined  great  interest  of  small  and  medium-sized  CRAs  in 
having  an  opportunity  to  share  knowledge,  enhance  capacities  for  growth  and  eventually, 
extend  the  scope  of  their  activities,  particularly  with  a  view  of  operating  in  a  cross-border 
context. There was therefore support from a group of small and medium-sized CRAS for the 
idea  of  a  European  Network  of  Small  and  Medium-sized  Rating  Agencies.  Furthermore,  a 
network could contribute for small and medium-sized rating agencies to obtain economies of 
scale  through  sharing  of  data  and  best  practices,  which  is  an  important  factor  currently 
limiting market entry. The European Parliament, in its own initiative report on rating agencies, 
supported  the  creation  of  such  a  network.  However,  some  regulators  and  governments 
questioned the effectiveness of such a network.  

For investors, such a measure would lead to more choice with respect to the ratings available 
for the same debt instrument or the same issuer. For issuers this option could over time result 
in an increased offer of rating services and easier (and less costly) access to capital markets.  

Moreover  it  can  be  argued  that  higher  competition  and  market  contestability  would  push 
incumbent CRAs and new entrants to compete both on the side of prices and on that of the 
quality of the services provided. This would induce CRAs to increase their investments on the 
collection  and  processing  of  the  information  and  on  the  methodological  tools.  This  in  turn 

110  

Recently the Consultancy Company Roland Berger has announced its intention to develop a European 
rating agency. Available from: 
http://www.rolandberger.com/media/press/releases/Initiative_to_establish_European_Rating_Agency.ht
ml.  

40/193 

 
 
 
                                                 
would reinforce the discipline exerted by the 'reputation mechanism' since CRAs would incur 
in higher reputational risks if they underinvested and did not keep pace with their competitors 
in carrying out their business properly111. 

It should be noted that any network of small and medium-sized rating agencies would have to 
adhere to existing competition rules112 which apply to all companies in the EU. More details 
on the implementing modalities are provided in Annex IX. 

Option 3 - Encourage the emergence of a brand-new European credit rating agency 

Under this option, the setting-up of a new European rating agency would be promoted either 
via the establishment of a public institution entirely financed through the Union budget or by 
providing direct funding to a European agency in the form of a private foundation.  

Some  Member  States  as  well  as  the  European  Parliament  suggested  that  the  idea  of 
public/private structures should be further considered and analysed. At the same time, some 
Member States noted the problems of credibility and conflicts of interest that could be caused 
by  direct  funding  arrangements  and  which  would  need  to  be  addressed.  Some  national 
regulators and several private enterprises opposed the creation of a new European CRA. 

Such  a  new  entity  would  provide  the  whole  range  of  rating  services  and  cover  all  the  asset 
classes. In this respect the EU structure issuing sovereign ratings envisaged under option 8 of 
the previous section  6.2 and  the  European rating agency could co-exist and  increase  further 
the offer of services  to issuers and investors. Eventually, this could lead to lower prices for 
investors  in  the  rating  market  and  could  increase  the  information  available  to  investors 
through a wider range of credit ratings. 

However, it would likely take at least 5 – 10 years for such new entity to become capable to 
compete  with  the  established  CRAs  by  offering  investors  and  issuers  a  real  alternative  for 
rating services, thereby enhancing competition within the market for such services.  

Details on the estimation of costs of the new entity are provided in Annex XI. 

Public European credit rating agency 

In  terms  of  effectiveness  a  European  rating  agency  entirely  public  would  raise  concerns  of 
distortion  of  competition  as  it  would  be  less  under  market  pressure  to  develop  competitive 
products  and  to  price  them  adequately  as  its  entire  costs  could  be  covered  and  thus  the 
bankruptcy  avoided.  Furthermore,  the  establishment  of  such  an  agency  could  hamper  new 
private market entrants that want to establish themselves on the market and progress gradually 
towards a sizeable competitor and thus further promote market concentration. In addition, the 
public  could  fear  a  preferential  treatment  or  a  more  accommodating  behaviour  from 
supervisors. Moreover investors could be concerned, despite existing rules provided for in the 
CRA Regulation113, about the conflict of interest that this model would entail particularly in 
the area of sovereign ratings (see analysis under option 8 in section 6.2 above).  This could be 
partially  addressed  by  an  appropriate  design  of  the  governance  to  ensure  the  Agency's 
independence. On the other side the public nature of the entity could positively impact on its 
credibility provided it is backed by a positive track record of rating activities. However, for 

111  

112  

113  

It  is  worth  mentioning  that  according  to  some  Authors  increased  competition  might  result  in  lower 
overall quality of ratings, i.e.  more issuer-friendly and less informative ratings. See B. Becker and T. 
Milbourn, 'Reputation and competition: evidence from the credit rating industry, 2009. 
Also this option would raise the same concerns of competition as option 3 as the EU-funded network 
would  be  competing  on  the  market  with  private  companies.  Further  information  exchange  between 
competitors  can  -  depending  on  the  market  characteristics  and  the  characteristic  of  the  information 
exchange - be in contradiction with European Competition rules.  
As described in section 4.5. 

41/193 

 
 
 
                                                 
the  reasons  mentioned  above,  it  remains  uncertain  if  a  purely  public  agency  would  obtain 
sufficient market confidence among investors. 

As regards the profile of cost efficiency this solution would be undoubtedly the least efficient 
and, taking into account the current EU budget constraints, it would raise serious concerns as 
regards its feasibility and sustainability in the long term.  

Private credit rating Foundation 

Alternatively, a European rating agency in the form of private foundation would have a lower 
capacity  to  distort  competition  within  the  market  of  rating  services  than  an  entity  of  public 
nature  and  being  potentially  more  independent  from  governments  (for  instance  in  issuing 
sovereign  ratings)  if  it  received  only  initial  funding  and  then  had  to  compete  on  the  market 
and generate revenues from the sale of its own products. On the other side, this model might 
raise  concerns  as  regards  potential  conflicts  of  interest  since  the  new  agency  would  have  a 
financial interest in developing business with issuers114 which could lead to 'inflated ratings'. 

In  order  to  facilitate  its  establishment,  the  European  Rating  Agency  could  be  granted  EU 
financing to cover part of the start-up costs in the form of a Union loan, via a grant agreement 
of  following  a  competitive  procedure  (open  call  for  tenders),  or  coming  from  the  European 
Investment  Bank.  In  this  context  it  is  important  that  any  financial  support  provided  by 
Member States is in compliance with the provisions of Articles 107-109 TFEU on state aid. 

As  regards  the  efficiency  profile,  this  solution  would  imply  a  lower  recourse  to  public 
resources  even  though,  taking  into  account  the  budget  constraints  mentioned  above,  its 
feasibility should be carefully assessed trough an in-depth preparatory analysis.  

Option 4 - Harmonise ratings scales to improve comparability of ratings between CRAs 

This measure would facilitate investors in comparing ratings from distinct agencies through a 
harmonised standard reference scale to be used by registered and authorised rating agencies. 
This  would  enable  investors  to  compare  ratings  from  smaller  market  players  with  the 
dominant  market  players  more  easily.  Furthermore,  it  would  also  contribute  to  the 
understanding of ratings by investors.  

As a result, market access for small rating agencies would be facilitated to some extent which 
could  increase  competition.  Furthermore,  this  option  could  improve  transparency  on  ratings 
and their interpretation for stakeholders including rating agencies and issuers.  

The technical standard setting out harmonised rating scale would be developed by the ESMA. 
All  CRAs  would  need  to  produce  and  publish  tables  showing  the  correspondence  between 
their existing rating scales and the newly established rating scale. 

Option 5 - Establish a European Rating Index (EURIX) 

Under this option, rating agencies would have to communicate each newly issued rating to a 
central entity such as the ESMA, which could take care of the centralised publication of the 
rating  and  related  information.  This  would  be  made  freely  available  to  investors,  possibly 
though the ESMA website. 

This  measure  would  improve  visibility  for  investors  of  the  available  ratings  for  debt 
instruments  particularly  for  newly  established  rating  agencies.  Therefore  it  would  help  new 
market  entrants  to  gain  visibility  among  investors  and  increase  their  reputation  over  time. 
Investors would be helped in comparing credit opinions and make their own assessment. This 
would indirectly contribute to the objective of reducing reliance on ratings. It should be noted 

114  

In the case of the "issuer-pays" model. 

42/193 

 
 
 
 
                                                 
that  the  creation  of  harmonised  standards  on  rating  scales  would  be  instrumental  to  the 
development of the EURIX. 

Option 6 - Require CRAs to issue joint ratings at the level of a rating committee 

Under this option, large CRAs would be required to issue ratings jointly with a smaller CRA. 
Both  credit  rating  agencies  would  have  joint  responsibility  for  the  credit  ratings  issued.  As 
small and medium-sized CRAs would be required to participate in the rating process together 
with  large  CRAs,  this  option  would  improve  reputation  of  small  CRAs  and  promote  the 
development of new market entrants in the credit rating industry.  

Furthermore, the joint credit ratings could improve quality of ratings through complementary 
and combined expertise in the preparation of the joint ratings as well as in the analysis of the 
findings and conclusions. 

However, as rating agencies would issue jointly ratings, the number of views and opinions on 
credit  risk  would  be  limited.  Therefore,  this  option  would  risk  limiting  competition  in  the 
rating  industry.  Furthermore  this  option  could  generate  additional  conflicts  of  interests  and 
competition  policy  issues  as  small  and  large  rating  agencies  would  have  to  cooperate  and 
exchange information.  

As  this  option  would  imply  involvement  of  only  smaller  CRAs  at  the  level  of  rating 
committee  this  option  could  add  up  roughly  10%  to  the  costs  of  a  credit  rating.  These 
additional  costs  would  most  likely  make  ratings  more  expensive  and  be  transferred  to 
issuers.115 

Option 7 - Ban large CRAs from acquiring small and medium-sized CRAs 

The growth of the three biggest CRAs over the last decade can be partially explained by their 
acquisition of other firms (see Annex IV. Section 2). Under this option, a CRA with a relevant 
market  position  would  therefore  not  be  allowed  to  acquire  smaller  rivals.  The  EU  Merger 
Regulation116 which is only applicable to transactions with Union dimension and which reach 
the  merger  control  thresholds  appears  insufficient  to  tackle  this  issue.  A  temporary  ban  on 
acquisition  and  mergers  could  limit  the  growth  of  large  CRAs  and  let  new  market  entrants 
enter the market and gradually develop their market share. The ban should be temporary, but 
long  enough  –  at  least  ten  years  -  to  enable  smaller  CRAs  to  build  up  their  necessary 
reputation. 

Taking into account the current market structure, this measure, on its own, is likely to have a 
limited effect. However, this option could become important if other measures were taken to 
promote the growth of small CRAs or entrance of new rating market players. Finally, mergers 
and  acquisitions  can  be  justified,  in  some  cases,  by  the  quest  for  increased  efficiency  as  a 
result of the combination of resources of the companies involved.  

Option 8 - Introduce temporary market share ceilings for CRAs 

Under  this  option  large  CRAs  would  need  to  accommodate  a  maximum  ceiling  of  market 
share,  transferring  business  to  smaller  competitors.  As  a  result,  smaller  CRAs  would  be 
facilitated to acquire business and build reputation, enhancing the level of competition in the 
market.  Therefore,  this  option  could  substantially  increase  the  number  of  sizable  market 
players in the rating industry. 

115  
116  

The approximate costs are calculated on the information on joint audits in France. 
Council  Regulation  (EC)  No  139/2004  of  20  January  2004  on  the  control  of  concentrations  between 
undertakings,  OJ  L  24/1,  29.01.2004.  Pursuant  to  Article  2(3)  of  the  merger  regulation  only  a 
concentration which would  significantly  impede  effective competition,  in  the  common  market  or  in a 
substantial  part  of  it,  in  particular  as  a  result  of  the  creation  or  strengthening  of  a  dominant  position, 
shall be declared incompatible with the common market. 

43/193 

 
 
 
                                                 
However, it is worth underlining that in the short-run this measure could result in a reduced 
offer  of  services  for  issuers  and  potential  increase  of  prices  together  with  lower  availability 
(and  quality)  of  ratings  for  investors  that  might  cause  further  instability  in  the  financial 
markets. Indeed, all along this initial phase, while small and medium-sized CRAs would need 
enough time and resources to build up adequate capacity and reputation, large CRAs would be 
required to start reducing market share. This might force small CRAs to replace incumbents in 
providing  certain  typologies  of  services  when  they  are  not  as  efficient  as  their  competitors 
(lower economies  of scale,  lower economies  of scope)  or  even  are  not  able  to  provide  such 
services. 

These  negative  effects  could  be  mitigated  by  the  introduction  of  a  phase-in  period  (e.g. 
transition  period  5  years)  ensuring  that  both  the  supply  and  the  demand  side  would  have 
enough time to adjust to new requirements.  

However such a measure would go beyond Article 102 of the TFEU which only prohibits the 
abuse of a dominant position and not a dominant position as such.  It would also amount to an 
artificial  engineering  of  market  structures  which  might  have  evolved  naturally  based  on 
competition on the merits. 

Option  9  -  Require  CRAs  to  disclose  pricing  of  ratings  and  ensure  that  prices  are  not 
discriminatory and based on costs  

Require CRAs to disclose policy on pricing of ratings 

This option would require CRAs to provide investors, issuers and competing CRAs with the 
information on the policy of ratings pricing, including objective pricing criteria. CRAs would 
be  required  to  extend  existing  disclosures  of  the  current  transparency  report 117  with  the 
aggregate  information  on  the  actual  fees  charged  for  different  asset  classes.  This  limited 
disclosure of pricing information would further facilitate potential customers to compare the 
prices  they  would  have  to  pay  for  the  services  rendered  by  different  CRAs  and  in  this  way 
promote competition.  

Require CRAs to ensure that the fees they charge for their services are not discriminatory 

This option would also imply price regulation thereby a CRA would be required to ensure that 
the prices and fees they charge for their services are not discriminatory and based on costs, i.e. 
different  consumers  are  not  charged  a  different  price  for  an  identical  service  taking  into 
account  the  actual  costs.  In  this  regard  CRAs  would  have  to  provide  ESMA  with  detailed 
information on fees. This option would also contribute to addressing conflicts of interests due 
to the issuer's pays model as pricing for rating services would be more transparent for issuers 
and  the  fees  would  not  based  on  any  form  of  contingency.  This  measure  would  be 
indispensable  to  effectively  tackle  inherent  conflicts  of  interest  in  the  "issuer  pays"  model. 
Information  on  fees  would  also  enable  all  market  participants  as  well  as  ESMA  to  better 
assess  the  risks  of  possible  hidden  pricing  practices  which  could  be  conducted  against  the 
interests of some issuers, investors or products. 

However  such  rules  need  to  be  carefully  drafted  to  make  sure  that  they  do  not  facilitate 
collusive behaviour among CRAs. 

The  summary  of  the  analysis  of  different  options  to  achieve  specific  objective  3  (improve 
credit rating market conditions) is presented in the table below. The analysis of the impact of 
these options on different stakeholder groups is given in Annex VIII. 

117  

Art  12  of  Regulation  1060/2009  requires  rating  agencies  to  publish  an  annual  transparency  report. 
Annex I section E (III) outlines that the transparency report should include financial information on the 
revenue of the credit rating agency divided into fees from credit rating and non-credit- rating activities 
with a comprehensive description of each. 

44/193 

 
 
 
                                                 
Option 1 (baseline) 

n.a. 

n.a. 

Effectiveness 

Efficiency 

Option 2 
 (Encourage 
the  emergence  of  a 
network  of  small  and  medium  size 
rating agencies) 

(++)  facilitate  market  entry  of  small  and 
medium rating agencies.  
(++)  create  more  choice  for  investors  and 
issuers reducing reliance on ratings.  

(+)  costs  to  set  up  a  network  are 
estimated moderate and proportionate.  

Option 3 
(Encourage the emergence of a new 
European rating agency) 

Option 4  
(Harmonise ratings scales to improve 
comparability of ratings between 
CRAs) 

Option 5 
(Establish a European Rating Index 
(EURIX)) 

Option 6. 
(Require CRAs to issue joint ratings at 
the level of the rating committee) 

Option 7  
(Ban large CRAs from acquiring small 
and medium-sized CRAs) 

Option 8  
(Introduce temporary market share 
ceilings for CRAs) 

(+)  creation  of  more  choice  to  investors  and 
issuers reducing reliance of ratings. 

(+) increased transparency which would 
enable investors to make own assessment and 
compare distinct ratings. 
(+) small market entrants would be  facilitate 
in entering the  market. 

(+) increased possibilities to compare distinct 
ratings available in the market. 
(+) small market entrants would gain  better 
market access due increased visibility. 

(+) it  would increase the visibility and build 
trust on quality of ratings by smaller CRAs. 
(-)  it is quite likely that there would be no 
change regarding concentration and choice in 
the market.  
(0/+) the credit rating market would remain 
highly concentrated. Though development and 
growth of small CRAS would be facilitated. 
Furthermore, risks that successful new market 
entrants would be taken over by larger market 
players would be mitigated, which would 
contribute to more choice in the rating 
industry..  
(+) effective in reducing market concentration. 

Option 9  
(Require CRAs to disclose pricing of 
ratings and ensure that prices are not 
discriminatory and based on costs ) 

 (+) Price transparency and regulation of 
prices would contribute to more intense 
competition.   

(--)  substantial  costs  for  EU  budget 
(funding  of  start-up  costs)  and  possible 
distortion of competition (Public agency.) 

(+) limited costs for all CRAs to enable 
the mapping of new rating scales. 

(+) limited costs for ESMA to establish 
and manage and update  index on an 
ongoing basis. 
(+) limited  costs CRAs to communicate 
information to centralised entity. 

(-)additional costs for CRAs to comply 
with the provision. 

(0) costs are likely to appear in terms 
reduced economies of scale due to 
banned acquisitions. 

(0 )significant costs are likely to appear 
in terms reduced economies of scale due 
to giving up their businesses to smaller 
CRAs; disruptions in the market cannot 
be excluded either. 

(+) Limited costs for CRAs to comply 
with the provision. 

Based on the analysis above, option 2, 4, 5 and 9 are the preferred options in order to improve 
choice and enhance competition within the market of rating services. Under this package, 
small and medium size rating agencies would be stimulated to exchange information which 
could facilitate new market entrants in the market. Furthermore, common standards for rating 
scales would facilitate comparison of ratings among investors. Additionally, visibility of 
ratings by new market entrants would be improved through the establishment of a European 
Rating Index. In addition, improved transparency on pricing policies and fees would enable to 
avoid potential conflicts of interest in the provision of rating services and would facilitate 
competition in the rating market. Option 7, The ban for large CRAs from acquiring small and 
medium-sized CRAs would be necessary to ensure effectiveness of other preferred options, 
including those addressing issues on CRAs' independence. However, this ban on its own 
would not be effective to change the market structure and could be circumvented by CRAs. 

6.4. 

Policy options to ensure right of redress for investors 

1. No policy change 

2. Introduce civil liability of CRAs into EU legislation 

Policy options 

45/193 

 
 
 
 
 
 
 
 
 
 
 
 
 
3. Ensure civil liability of CRAs towards users of credit ratings before national courts 

Option 1 – no policy change 

Without  a  policy  change  the  current  situation  would  persist,  i.e.  investors  in  many  Member 
States  would  face  legal  difficulties  in  claiming  damages  from  CRAs,  even  if  the  latter 
infringed its obligations with gross negligence that resulted in faulty ratings.118 Investors' right 
of redress and, accordingly, the level of exposure of CRAs to civil liability claims would vary 
considerably from one Member State to another. This could incentivise CRAs to favour the 
application  of  laws  of  such  Member  States  where  their  exposure  to  potential  civil  liability 
claims is more limited.  

It  could  be  argued  that  the  fact  that  the  CRA  Regulation  has  empowered  ESMA  to  impose 
sanctions  on  CRAs  for  having  infringed  the  CRA  Regulation  already  provides  sufficient 
incentives  to  CRAs  to  comply  with  the  CRA  Regulation.  However,  the  possibility  of 
sanctioning CRAs is not a substitute for an efficient right of redress for investors and does not 
compensate investors for their losses. 

Accordingly,  several  respondents  from  various  stakeholder  groups  encompassing  some 
governments, regulators and banking industry bodies supported the possibility of civil liability 
claims  against  CRAs,  but  only  for  gross  negligence  or  intent.  Overall,  there  seemed  to  be 
general support (with the notable exception of the CRAs themselves, arguing that this would, 
for instance, increase reliance) for the notion that it should be possible to pursue civil action, 
in the case of both solicited and unsolicited ratings, but that such action should be reserved for 
severe infringements. 

Option 2 – Introduce civil liability of CRAs into EU legislation 

Under this option a new specific provision on which investors could directly base claims for 
damages against CRAs resulting from gross negligence or misconduct would be introduced in 
the CRA Regulation. This provision would directly define the conditions under which CRAs 
can be held liable. The specificities of the rating activity would need to be taken into account. 
Ratings  contain  to  a  certain  extent  a  prognosis  for  the  future,  and  in  some  situations  there 
could be a virtually unlimited number of investors who could claim damages from a CRA that 
infringed the CRA Regulation. This might suggest that only cases of gross negligence should 
trigger civil liability. The advantages of this option over option 1 include that civil liability of 
CRAs to investors would be possible throughout the EU and under the same conditions. This 
would  ensure  an  equal  right  of  redress  for  investors  against  CRAs.  By  granting  access  to 
justice in these cases, this option would positively impact on the right to an effective remedy 
and to a fair trial as guaranteed by Article 47 of the Charter of Fundamental Rights.  

As CRAs would be equally exposed to civil liability, there would be no incentive for forum 
shopping.  The  fact  that  civil  liability  of  CRAs  would  be  possible  (under  the  conditions 
defined in the CRA Regulation) would provide additional strong incentives for CRAs to avoid 
misconduct and comply with the CRA Regulation.  

The disadvantage of this option is that, depending on the level of detail of EU rules, it could 
increase  the  complexity  of  civil  law  systems  of  the  Member  States.  Civil  law  systems  in 
general  cover  all  types  of  activities,  and  are  often  based  on  principles  which  horizontally 
apply  to  all  claims  (e.g.  the  appropriate  standard  of  fault,  causality  link).  Regulating  civil 
liability of CRAs on the EU level while most other areas stayed at the national level would 
increase the complexity of the civil law systems and could make it more difficult to apply in 

118   

See table in Annex VI, section 2.4 describing on what legal basis and to what extent investors can claim 
damages against CRAs having infringed the CRA Regulation. 

46/193 

 
 
 
                                                 
practice. In any case, liability claims would need to be brought before national courts, under 
national procedural rules. In addition this option may go beyond what is necessary to ensure 
that users of ratings have a sufficient right of redress.   

Option 3 – Ensure civil liability of CRAs towards users of credit ratings before national 
courts 

Under  this  option,  a  provision  in  the  CRA  Regulation  would  ensure  civil  liability  of  CRAs 
towards  investors  before  national  courts.  This  provision  would  set  the  principle  and  some 
conditions  under  which  civil  liability  of  CRAs  should  be  possible.  For  instance,  it  could 
stipulate  that  CRAs  infringing  requirements  of  the  CRA  Regulation  by  gross  negligence 
should be held liable and that it should not be permitted to exclude civil liability. As in the 
case  of  option  2,  this  option  has  the  advantage  that  it  would  ensure  that  investors  in  all 
Member States have a sufficient right of redress against CRAs before national courts.119 By 
granting access to justice in these cases, this option would positively impact on the right to an 
effective remedy and to a fair trial as guaranteed by Article 47 of the Charter of Fundamental 
Rights. 

Furthermore,  the  possibility  of  civil  liability  of  CRAs  would  create  additional  strong 
incentives for CRAs to comply with the requirements of the CRA Regulation. 

In comparison with option 2 this has the advantage of taking into account the specificities of 
national civil law orders. In fact, option 3 requires the supplementary application of national 
rules. This option would thus be in accordance with the principle of subsidiarity. On the other 
hand option 2 may be more effective in ensuring a uniform right of redress for all European 
investors as there would be only one legal basis for claims throughout the EU. 

A summary of the analysis of the different options to ensure a right of redress for investors is 
presented in the table below. 

Effectiveness 

Efficiency 

n.a. 
(++) objective to ensure right of redress fully met.  
(++) uniform provision in EC legislation excludes 
forum shopping.  

n.a. 
(+) uniform provision in CRA Regulation ensures 
harmonised approach.  
(-) may go beyond what is necessary and  increase 
complexity within the national civil law systems. 

(++) objective to ensure right of redress fully met.  

(+) respect specificity of national civil law orders. 

(+) risk of forum shopping reduced. 

Option 1 (baseline) 

Option 2 

civil 
(Introduce 
liability  of  CRAs  into 
EU legislation) 

Option 3 

(Ensure civil liability 
of CRAs towards users 
of credit ratings before 
national courts) 

Based  on  the  analysis  above  option  3  would  be  the  preferred  option.  Both  option  2  and 
option 3 provide clear advantages compared to the status quo in achieving the operational and 
specific objective. In particular, both would ensure  that investors profit from an appropriate 

119  

An efficient right of redress under this option (and also option 2) presupposes that the applicable law 
under private international law rules (Rome II Regulation) would be the law of a Member State. Under 
Art. 4 of Rome II the applicable law is the law of the country where the damage occurs, which could be 
in case of financial instrument purchases either the place of purchase, the place where the securities are 
deposited or  where  the  account  is  located. Following  these  criteria  purchases by  EU  investors  on  EU 
markets will in most cases lead to the application of the law of a Member State which will ensure an 
efficient  right  of  redress  under  this  option.  It  should  also  be  considered  in  this  context  that  other 
important  jurisdictions  have  recently  strengthened  the  civil  liability  of  credit  rating  agencies.  For 
instance in the US , the Dodd-Frank Wall Street Reform and Consumer Protection Act, Subtitle C, Sec 
931 ff, stipulates that CRAs should be accountable in the same way as accounting firms or securities 
analysts.  

47/193 

 
 
 
 
 
 
                                                 
right  of  redress  against  CRAs,  reduce  the  risk  of  forum  shopping  and  provide  strong 
incentives for CRAs to comply with their legal obligations and to issue good quality ratings. 
While  option  2  would  have  the  benefit  of  creating  a  completely  harmonised  basis  for 
investors' claims against CRAs, option 3 may achieve the objectives in a more efficient way 
by relying more on national rules which is preferable in view of the principle of subsidiarity. 
Both, option 2 and 3 would impact positively on the right to an effective remedy and to a fair 
trial as guaranteed in Article 47 of the Charter of Fundamental Rights. 

6.5. 

Policy options to reinforce independence of credit rating agencies and improve 
credit rating methodologies and processes 

Policy options 

1. No policy change 

2. Require investors to pay for  ratings ("investor-pays model") 

3. Require trading venues to set up and ensure the administration of the "Trading venues pay" model 

4. Require CRA selection to be undertaken by an independent board 

5. Introduce rotation rules for the CRAs engaged by an issuer to rate its own products and to rate the issuer itself  

6. Introduce specific requirements on CRAs' independence and objectivity in relation to their shareholders 

7. Strengthen rules on disclosure of rating methodologies 

8. Require CRAs to inform issuers sufficiently in advance of the publication of a rating 

The  policy  options  presented  above  are  not  necessarily  mutually  exclusive,  hence 
combinations of two or more options are also analysed where appropriate. 

As explained in the problem definition, the issuer pays model's conflicts of interest are highly 
sensitive to all market participants and should therefore be carefully assessed. In this context 
it is important to consider the steps taken in the US under the Section 939 F(b) of the Dodd-
Frank  Act  of  July  2010,  requiring  the  SEC  to  carry  out  a  study  of  CRA  compensation  and 
remuneration models within two years of that date.120 

Option 1 – No policy change 

Even if the CRA Regulation neither imposes nor favours a specific remuneration model, the 
issuer pays model would without a policy change, possibly, continue being the most dominant 
in the market and conflicts of interest related to this model would persist. Since CRAs have a 
financial interest in generating business from rated firms, they may tend to give issuers that 

120  

Specifically, the Dodd-Frank Act requires that: "The Commission (SEC) shall carry out a study of 1) 
the credit rating process for structured finance products and the conflicts of interest associated with the 
issuer-pay and the subscriber-pay models; 2) the feasibility of establishing a system in which a public or 
private  utility  or  a  self-regulatory  organization  assigns  nationally  recognized  statistical  rating 
organizations to determine the credit ratings of structured finance products, including (a) an assessment 
of  potential  mechanisms  for  deter-mining  fees  for  the  nationally  recognized  statistical  rating 
organizations;  (b)  appropriate  methods  for  paying  fees  to  the  nationally  recognized  statistical  rating 
organizations; (c) the extent to which the creation of such a system would be viewed as the creation of 
moral  hazard  by  the  Federal  Government;  and  (d)  any  constitutional  or  other  issues  concerning  the 
establishment of such a system; 3) the range of metrics that could be used to determine the accuracy of 
credit  ratings;  and  4)  alternative  means  for  compensating  nationally  recognized  statistical  rating 
organizations that would create incentives for accurate credit ratings". 

48/193 

 
 
 
                                                 
account for a large proportion of their income higher ratings than justified121, even if the CRA 
Regulation partially addresses this issue by disclosure rules and procedural requirements.122  

Moreover,  without  a  policy  change,  conflicts  of  interest  related  to  a  CRA's  shareholders 
structure  may  potentially  occur  as  the  current  CRA  Regulation  does  not  explicitly  include 
controlling shareholders in the provisions that prohibit specific rating actions.123 

Without  a  policy  change  investors  would  not  always  be  well  informed  and  be  able  to 
understand the underlying assumptions and limits of rating methodologies.   

Finally, without a policy change, it would still be possible for CRAs to notify issuers outside 
working  hours  of  an  imminent  rating  action,  which  does  not  allow  the  issuers  to  check  the 
accuracy of the underlying assumptions.   

Option 2 – Require investors to pay for ratings ("investor pays model")  

The  advantage  of  this  option  would  be  that  conflicts  of  interest  related  to  the  issuer-pays 
model would be avoided. Since in general investors should have an interest in accurate ratings, 
an investor-pays model would potentially enhance the quality of ratings. 

On  the  other  side,  there  are  also  potential  disadvantages  related  to  the  investor-pays  model. 
First, investors may have their own interests124, so ratings paid by investors would not be free 
of potential conflicts of interest.  

Furthermore,  investors  are  likely  to  ask  for  "compensation"  for  increased  rating  costs  by 
requiring higher returns on investments, so the likely outcome of this model is an increased 
cost of funding for issuers. Moreover, in contradiction to FSB principles, investors' reliance 
on ratings could further increase.  

Finally, an obligatory investor-pays model could make it difficult for smaller issuers of less 
liquid  issuances  to  find  a  CRA  willing  to  rate  them  and,  consequently,  to  raise  funds  at  the 
capital markets. CRAs may refuse to rate such issuances due to the uncertainty whether there 
will be enough investors willing to pay for them. Also many respondents to the consultation 
opposed  an  obligatory  investor-pays  model,  pointing  to  conflicts  of  interest  that  are  related 
also to this model.  

Option  3  –  Require  trading  venues  to  set  up  and  ensure  the  administration  of  the 
"Trading venues pay" model 

The  advantage  of  this  option  would  be  that  conflicts  of  interest  related  to  the  issuer-pays 
model and the investor pays model would be avoided as it would be the trading venue (and 
not the issuer or investor) which would select and pay the rating agency. Trading venues do 
not have an own interest in the rating and are impartial. This model would therefore remove 
the incentives for a CRA to issue favourable ratings in hope of repeated rating services for the 
same issuer. 

121  
122  

123  

124  

See above Section 4.5.1. and Annex VI, 2.5. 
For instance, credit rating agencies have to undertake all necessary steps to ensure that their ratings are 
not  affected  by  any  existing  or  potential  conflict  of  interest  (Art.  6  (1)  of  the  CRA  Regulation  in 
conjunction  with  Annex  I,  Section  B  1).  They  have  to  disclose  to  the  public  the  names  of  the  rated 
entities from which they receive more than 5 % of their annual income (Art 6 (2) in conjunction with 
Annex  I  Section  B  2).  Rating  analysts  may  not  be  involved  in  any  negotiation  regarding  fees  with  a 
rated entity and their remuneration shall not depend on the remuneration received from the rated entity 
(Art. 7 (2), (5) of the CRA Regulation). 
Art. 6 in connection with Section B 1.-3 of the CRA Regulation.  It would for instance not be explicitly 
prohibited  that  a  CRA  issues  a  credit  rating  on  an  instrument  in  which  the  CRA's  controlling 
shareholder has a direct ownership interest.  
See Section 4.5 and Annex VI, 2.5. 

49/193 

 
 
 
                                                 
However, the trading venues-pay model has several disadvantages. First, the effectiveness of 
this  model  can  be  questioned  as  it  would  only  cover  securities  that  are  traded  on  trading 
venues,  but  not  those  which  are  traded  over-the-counter.  Currently,  a  large  proportion  of 
securities are not traded on trading venues.125 In order to avoid the trading venues-pay model 
to apply, issuers may even decide to delist from trading venues. 

Secondly,  it  would  be  difficult  to  find  criteria  that  trading  venues  could  use  in  order  to 
attribute rating mandates to credit rating agencies. Where CRAs are allocated to issuers on a 
pure random basis, CRAs would win business, even if they were not responding to the needs 
of  investors.  If  a  trading  venue  would  have  discretion  in  selecting  a  CRA  they  could 
potentially face civil liability claims for having selected an inappropriate CRA. Finally, this 
model  would  require  trading  venues  to  substantially  restructure  their  business,  and  hire 
experts which would be able to select appropriate CRAs. It is not sure whether trading venues 
currently have sufficient capacity and experience to administer such a model. Trading venues 
would  probably  pass  those  costs  onto  their  clients  which  could  make  public  listing  more 
expensive. Making public listing more expensive would go against the strategic objective to 
facilitate access to capital markets, particularly for smaller and medium enterprises (SMEs). 
Last but not least, trading venues would be subject to civil liability claims for the choice of a 
given CRA. 

Option 4 – Require CRA selection to be undertaken by an independent board 

Under  this  option  an  independent  "Credit  Rating  Agencies  Board"  comprising  supervisors, 
issuer representatives, subscribers/investors and CRAs would be empowered to select a CRA 
for  an  issuer. 126  The  issuer  would  remain  free  not  to  be  rated  at  all,  or  to  mandate  an 
additional CRA apart from the one selected by the board.    

The advantage of this option would be that conflicts of interest related to the issuer-pays and 
investor-pays  models  would  be  avoided  as  it  would  be  an  independent  board  (and  not  the 
issuer or investor) which would select the rating agency. Due to its balanced composition the 
board could be expected to be impartial when selecting a CRA. 

However, the effective functioning of the rating market requires that securities issuers are free 
to  choose  their  rating  provider.  If  ratings  are  centrally  allocated,  incentives  for  CRAs  to 
maximize  their  operational  performance  and  to  compete  on  the  basis  of  price  and  service 
quality could significantly be reduced. Similar concerns were raised by some respondents to 
the public consultation.   

125  

126  

In Europe, the ratio of listed to unlisted companies is 1:3.  Data from Property Funds Research, 
Bloomberg and Macquarie Research, cited in Compatible not competing, 19 November 2010. Available 
from: http://www.ipe.com/realestate/compatible-not-competing_37991.php?categoryid=1056. 
In the US, there is currently a debate whether conflicts of interest due to the issuer pays model should 
be  addressed  by  creating  a  ratings  oversight  board  to  select  CRAs  for  rating  structured  finance 
instruments:  The "Franken Amendment" calls on the Securities and Exchange Commission to create a 
ratings oversight board, with investor representatives in the majority. The board could choose a rating 
agency  to  conduct  the  initial  evaluation  of  each  new  set  of  asset-backed  bonds  or  other  structured-
finance  products.  Assignments  would  be  based  on  objective  measures  of  rating  accuracy  over  time. 
Securities issuers would not be allowed to play a role in the assignment process. There would be two 
objective measures to evaluate the accuracy of rating agencies: (1) one standard of comparison is long-
term yield: if two securities have the same risk profile, they ought to produce similar rates of return over 
time;  (2)  another  simple  gauge  is  the  frequency  with  which  investment-grade  bonds  default  or  lose 
significant value. Under the Franken Amendment, simple, transparent measures of this kind would be 
used  to  reward  the  most  accurate  rating  agencies  with  additional  assignments,  while  those  with  the 
poorest  records  could,  in  extreme  cases,  be  suspended  or removed from  the  pool.  See Key  Questions 
and  Answers,  The  rating  agencies  and  the  Franken  Amendment,  Demos,  June  2010.  Available  from: 
http://www.demos.org/publication.cfm?currentpublicationID=F68A14B1-3FF4-6C82-
51CF8955309A97FD.  

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Moreover,  there  would  be  similar  concerns  as  the  ones  related  to  the  trading  venues-pays 
model (option 3). It would be difficult to find the right criteria for attributing rating mandates 
to  individual  credit  rating  agencies.  The  selecting  board  would  be  exposed  to  civil  liability 
claims. In addition, the establishment and the administration of such a board would be costly 
and require taxpayers' money.  

Option 5 - Introduce rotation rules for the CRAs engaged by an issuer to rate its  own 
products and to rate the issuer itself and introduce mandatory separation between them 

The system involving the external rotation of credit rating agencies would prevent conflicts of 
interest  arising  from  "issuer  pays"  model  and  long  business  relations  with  rated  companies, 
but would also eliminate "lock-in" effect whereby an issuer has difficulties to switch a rating 
agency.      As  issuers  would  be  legally  required  to  change  credit  rating  agencies,  this  action 
would not raise concern of investors regarding the creditworthiness of the issuer. This would 
also help CRAs to better resist any pressure from issuers to issue more favourable ratings by 
reducing independence threats that result from long business relationship between a CRA and 
an issuer.  Secondly, one could also increase the independence of CRAs by ensuring, where 
necessary, that a different CRA rates an issuer and its products.  

In  addition  to  reinforcing  CRA's  independence,  mandatory  rotation  of  CRAs  would  also 
create more opportunities for an issuer to solicit ratings from different CRAs and would offer 
CRAs the opportunity to rate more different issuers and instruments, potentially gaining more 
experience in different areas and should give an opportunity for smaller CRAs to compete by 
producing a track record of quality ratings. 

The disadvantages would include a small additional burden on issuers to administer the more 
frequent  change  of  CRA,  and  making  information  available  to  different  parties.  For  CRAs 
there  may  be  some  additional  cost  associated  with  the  initial  analysis  of  an  issuer  or  its 
products in order to issue a rating. 

The  introduction  of  external  rotation  would  require  reviewing  current  CRA  Regulation 
requirements on internal rotation for CRAs analysts. 

Option  6  -  Introduce  specific  requirements  on  CRAs'  independence  and  objectivity  in 
relation to their shareholders 

A  CRA  would  be  prohibited  from  issuing  ratings  of  any  person  or  of  financial  instruments 
issued by a person that owns shares of that CRA or directly or indirectly controls that CRA. 
Also, shareholders would be prohibited to accrue potentially controlling stakes, individually 
or in voting blocs in more than one CRA. In view of the potential influence that these persons 
might  have  on  the  management  of  a  CRA,  these  requirements  would  remove  the  potential 
conflict of interest that a CRA could otherwise have when issuing ratings of these persons.  

Moreover, any person that directly or indirectly controls a CRA would be prohibited to invest 
in products and entities rated by the CRA and to provide advisory services to the entity which 
or whose products were rated. This requirement would reduce a risk that a CRA is influenced 
by these persons – individually or jointly – with respect to ratings of financial instruments / 
issuers that these persons have interest in.  

One  disadvantage  of  this  option  is  possible  costs  for  tracking  important  shareholdings.  The 
CRAs should be aware of their main shareholders whom they also have to report to ESMA 
during  the  registration  process. 127  A  minimum  threshold  of  participation  holding  in  the 
shareholder's equity of a CRA could be determined to limit the scope of this option to material 
shareholdings.  

127  

See Annex II Nr. 5 of the CRA Regulation. 

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Option 7 - Strengthen rules on disclosure of rating methodologies 

Extend disclosure requirements on methodologies and underlying assumptions of structured 
finance ratings to ratings of all asset classes 

This  extension  would  harmonise  requirements  between  different  asset  classes  and  would 
make  ratings  clearer  to  users  of  ratings.  This  would  also  provide  for  greater  stakeholder 
engagement  and  would  eventually  reduce  uncertainty  in  the  market  regarding  the  meaning 
and  the  quality  of  a  credit  rating.  It  would  also  reduce  overreliance  on  credit  ratings  if 
investors  are  in  a  position  to  better  understand  and  evaluate  a  rating  –  and  form  their  own 
opinion. 

Enhance  the  requirement  to  disclose  material  changes  in  methodologies  by  additionally 
requiring the publication of clear reasoning and justification for the changes 

This would require CRAs to disclose material changes to their methodologies by publishing 
detailed  justifications  and  reasoning  alongside  the  changes,  disseminating  this  information 
especially  to  all  rated  entities  that  would  be  affected  by  the  changes,  as  soon  as  these  are 
known.  A requirement to attach such explanations and justifications to any further updates on 
ratings  could  also  be  introduced.  This  would  have  the  advantage  of  increasing  investors' 
understanding  of  the  methodologies,  enhancing  dialogue  of  CRAs  with  stakeholders  and 
could potentially also reduce market disruption that rating changes may cause.  

Enhance  disclosure  requirement  regarding  errors  in  methodologies  or  their  application  by 
requiring immediate disclosure directly to the affected parties including investors, issuers and 
competent authorities 

If a CRA discovers an error in a methodology or its application the CRA would be required to 
disclose  this  directly  to  the  affected  parties  including  investors,  issuers  and  ESMA.  Firstly, 
this  would  provide  incentives  to  CRA  to  avoid such  errors  in  the  first  place.  Secondly,  this 
requirement would benefit the market participants by informing them of errors.  

Option 8 – Require CRAs to inform issuers sufficiently in advance of the publication of 
a rating 

Option 8 has the advantage over option 1 that it may help to reduce the risk of factual errors 
before  publication  of  ratings.  This  option  would  extend  the  current  pre  notification  period 
provided for in Annex I D (3) of the CRA Regulation ("12 hours-rule"). The advantage would 
be that issuers (including sovereigns) are informed sufficiently in advance of the publication 
of  a  rating  publication in  order  to  draw  the  CRA's  attention  on  any  factual  errors.  A 
notification 12 hours before the publication of a rating, but outside normal working hours, for 
instance  over  night,  would  not  be  sufficient.  Option  8  is  favoured  by  some  Member  States. 
Participants who responded to the public consultation had many different views on the time 
span  between  informing  the  issuer  and  informing  the  public  to  be  covered  under  such  an 
option.  However,  there  was  a  significant  perception  that  12  working  hours  would  be 
preferable than a provision of 12 hours without explicitly specifying them as "working hours".   

The disadvantage of this option is the potential for negative impacts on market stability due to 
the greater risk of market abuse / insider dealing before the publication of a rating. However, 
such  risk  could  be  mitigated,  by  limiting  the  timeframe  to  12  working  hours  and  not  3 
working  days  as  suggested  in  the  public  consultation  and  through  introducing  some 
safeguards  in  the  forthcoming  review  of  the  Market  Abuse  Directive  review.  Furthermore, 
requiring  CRAs  to  inform  issuers  about  rating  changes  in  advance  may  open  room  for 
pressure from the rated entities on the CRAs. 

The  summary  of  the  analysis  of  different  options  to  achieve  objective  5  (reinforce 
independence of credit rating agencies and improve ratings quality) is presented in the table 

52/193 

 
 
 
below. The analysis of the impact of these options on different stakeholder groups is given in 
Annex VIII. 

Option 1 (baseline) 
Option 2 
Require  investors  to  pay  for  ratings 
("investor-pays model") 

Option 3 
(Require trading venues to set up and 
ensure the administration of the 
"Trading venues pay" model) 
Option 4 
(Require CRA selection to be undertaken 
by an independent board) 

Option 5 
(Introduce rotation rules for the CRAs 
engaged by an issuer  

Effectiveness 

Efficiency 

n.a. 
(+/-)  could  help  to  reduce  the  issuer-pays 
conflicts, but may replace these with others 
or  possibly  increase  investors'  reliance  on 
ratings. 

n.a. 
(-)  funding  could become  more  difficult  for 
some types of issuers. 
(+)  issuer  pays  conflicts  would  be  avoided 
for a section of the market. 

(+) removes issuer-pays conflict. 
(-)does  not 
listed 
instruments. 

target  non 

financial 

(--)  cost  and  difficulty  for  venues  to  set  up 
and administer such a model. 

(+) the issuer-pays model conflict would be 
eliminated. 
(--)  there  could  be  significantly  reduced 
incentives  to  compete  on  quality  of  ratings 
depending  on  specific  arrangements  of 
model. 

 (--)  potential  entrants    could  face  further 
difficulties  establishing  themselves  in  the 
market. 
 (--)  cost  of  developing  the  independent 
body. 

(++) reduces incentive for CRAs to inflate 
ratings in return for repetitive business. 
(-) potential downward effect on rating 
quality as CRAs incentives to meet highest 
quality standards may decrease. 
(++) reduces conflicts due to issuer pays 
model. 
(++) reduces lock in effects. 

(++)effectively  reduces conflicts through 
relatively simple measures. 

(-) increased costs for issuers/rating 
agencies. 

Option 6  
(Introduce specific requirements on 
CRAs independence and objectivity in 
relation to their shareholders) 

Option 7 
(Strengthen rules on disclosure of rating 
methodologies) 

Option 8 
(Require CRAs to inform issuers 
sufficiently in advance of the publication 
of a rating) 

(++) from the perspective of ownership and 
control of CRAs,, ensures independence of 
CRAs and integrity of the market.  

(+) some additional costs supervision 
justified by the achievement of this 
objective.  

(++) ensures that market properly 
understand and be in a position to 
scrutinise methodologies for all asset 
classes. 
(+) in addition it should also reduce 
overreliance on external ratings. 

 (+) increase quality of ratings by making 
factual mistakes less probable. 
(-) on the other hand, the requirement to 
notify issuers about a rating decision in 
advance opens room for insider 
dealing/market manipulation. 

(+) extends existing provisions to cover 
further asset classes.   

(-) increased costs for CRAs. 

(++)enhance existing provision of CRA 
Regulation and  makes the rating process 
more transparent without causing further 
costs. 

Based on the above analysis, the options 5 – 8 score better than other options and are assessed 
as efficient and effective. The options requiring significant interventions in and alterations of 
the  market  (for  example,  3  and  4)  have  potentially  prohibitive  costs.  While  they  might 
eliminate some conflicts, they could also engender others. Options 5 – 8 are complementary. 
Option 7 goes some way to mitigating the concern that option 5 could in some circumstances 
cause  a  risk  that  the  quality  of  ratings  could  fall:  by  ensuring  transparency,  the  rating 
methodologies would be subject to more market scrutiny and encourage CRAs to justify and 
correctly  monitor  their  ratings.  However,  the  effectiveness  of  these  measures,  in  particular 
mandatory rotation of CRAs, can only be ensured if the market conditions are conducive to 
the growth of small CRAs and the entrance of new players in the rating market. 

53/193 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
7. 

OVERALL IMPACT OF THE PACKAGE  

7.1. 

Cumulative impacts and synergies 

This  section  presents  the  cumulative  impacts  from  the  implementation  of  the  package  of 
preferred  policy  options.  The  package  of  preferred  policy  options  has  been  developed  in  a 
way to ensure the achievement of the overall objective to "contribute to reducing the risks to 
financial  stability  and  restoring  investor  and  other  market  participants'  confidence  in 
financial markets and ratings quality".  

The preferred options are expected to reduce overreliance on external ratings by reducing the 
importance  of  external  ratings  in  financial  services  legislation.  This  is  expected  to  reduce 
reliance  on  external  ratings  by  credit  institutions128,  insurance  undertakings129,  investment 
funds  and  the  asset  management  sector. 130  In  addition,  the  preferred  policy  measure  to 
introduce a requirement for issuers to improve disclosure regarding the underlying asset pools 
of structured finance products is expected to facilitate investors to make their own credit risk 
assessment, rather than leaving them to rely solely on external ratings. 
Furthermore, the preferred options would improve transparency and quality of sovereign debt 
ratings  through  verification  of  underlying  information  with  a  sovereign.  A  first  measure 
would  require  CRAs  to  verify  the  accuracy  of  information  with  sovereigns  to  ensure  that 
potential  errors  of  sovereign  ratings  are  avoided.  Moreover,  transparency  and  quality  of 
sovereign  ratings  would  be  enhanced  through  the  publication  of  the  full  research  report 
accompanying  the  rating.  The  publication  of  sovereign  ratings  after  closure  of  European 
trading venues would ensure that new rating information can reach all market participants and 
thus  would  limit  major  market  disturbances.  Additionally,  to  mitigate  the  risk  of  contagion 
effects of sovereign downgrades ESMA, in specific situations determined by the regulation, 
would  be  allowed  to  temporarily  ban  sovereign  ratings.  This  measure  should  be  temporary, 
exceptional and subject to very strict conditions. 

The  preferred  policy  measures  are  also  expected  to  improve  choice  and  optimize  rating 
industry structure. Small and medium size rating agencies would  be stimulated to exchange 
information which could facilitate new market entrants entering the rating industry and offer a 
wide range of services. In addition, comparison of ratings from distinct rating agencies could 
be  facilitated  by  promoting  common  standards  for  rating  scales.  Furthermore,  improved 
transparency on pricing policies and fees would not only facilitate competition in the rating 
market,  but  would  also  enable  ESMA  to  effectively  monitor  potential  conflicts  of  interest 
resulting from the "issuer pays" model. Finally, mandatory rotation of CRAs would not only 
substantially reduce the familiarity threat to CRA independence resulting from long business 
relationship between a CRA and an issuer, but would also have a significant positive effect on 
improving  choice  in  rating  industry  by  providing  more  business  opportunities  for  smaller 
CRAs.. 

In  terms  of  investor  protection,  the  preferred  options  would  ensure  that  investors  have  an 
appropriate  right  of  redress  against  CRAs  before  national  courts.  This  would  also  provide 
strong incentives for CRAs to comply with legal obligations and ensure high quality ratings.  

Independence  of  ratings  would  be  improved  by  introducing  a  requirement  for  issuers  to 
change  CRA  periodically.  Risks  of  conflicts  of  interest  would  be  further  reduced  by  the 
requirement that a CRA should not be able to rate an issuer and his products simultaneously. 

128  
129  
130  

Through an amendment of the Capital Requirements Directive. 
Through implementing measures of the insurance regulation II. 
Ensured  through  technical  standards  and  implementing  measures  subject  to  extensive  scrutiny  by 
ESMA and in cooperation with national competent authorities. 

54/193 

 
 
 
                                                 
Furthermore,  independence  would  be  improved  by  enhancing  the  ownership  structure  of 
CRAs. In addition, transparency and quality of ratings would be improved by strengthening 
the rules on disclosure of rating methodologies, by introducing a process for the development 
and  approval  of  rating  methodologies,  including  the  requirement  for  CRAs  to  communicate 
and  justify  the  reasons  for  modifications  to  their  rating  methodologies.  Finally,  quality  of 
ratings would be enhanced by requiring CRAs to inform issuers sufficiently in advance of the 
publication of a rating. 

7.2. 

Proportionality of the package 

In order to, on the one hand, reduce reliance on ratings and, on the other hand, increase their 
quality  it  is  necessary  to  improve  transparency  and  choice  for  investors  and  to  increase  the 
independence of credit rating agencies. 

To achieve the objective of reducing reliance on ratings, the preferred options would ensure 
that financial institutions are required to enhance internal risk management and promote the 
use  of  internal  rating  models,  which  would  require  improved  disclosure  by  rating  agencies 
and  issuers.  To  this  end  the  requirement  for  issuers  to  improve  disclosure  on  structured 
finance products, the most complex financial instruments, on an ongoing basis is necessary to 
enable  internal  risk  management.  The  requirement  for  the  publication  of  the  full  research 
report  on  sovereign  ratings  also  contributes  to  internal  risk  management,  which  is 
proportionate  particularly  in  view  of  the  important  impact  of  sovereign  ratings  on  financial 
markets. Disclosure for corporate asset classes remains unchanged. 

However,  financial  institutions  of  smaller  size  or  with  non-complex  exposure  or  private 
investors  would  continue  to  require  and  use  external  ratings.  This  requires  availability  of  a 
wide choice of ratings based on high quality rating methodologies performed by independent 
rating agencies.  

To  improve  the  choice  in  rating  industry  the  package  proposes  to  encourage  small  and 
medium-sized rating agencies to grow in size and scope by creating a network. These smaller 
agencies  would  benefit  from  improved  visibility  and  comparability  through  the  European 
Rating  Index  which  would  be  easily  accessible  for  all  interested  stakeholders.  To  ensure 
comparability of available ratings through the EURIX would require harmonised rating scales 
based on a technical standard determined by ESMA. To ask rating agencies to provide such 
rating scales is therefore a proportionate measure.  

Additionally,  the  quality  of  ratings  and  the  quality  of  rating  methodologies  would  be 
improved  by  a  number  of  measures  within  the  package.  Improved  disclosure  of  rating 
methodologies would improve the understanding of all stakeholders of rating methodologies. 
For sovereign debt ratings, issuers would be required to inform issuers sufficiently in advance 
of underlying information used to rate the product which is a precautionary measure to ensure 
rating quality for sovereigns. Additionally, the requirement to scrutinize rating methodologies 
of sovereign ratings would be a proportionate additional measure to ensure quality of ratings 
for this asset class which can have important implications for the stability of financial markets. 
Furthermore,  high  quality  rating  methodologies  for  sovereigns  would  contribute  to  limiting 
the use of the proposed power, for ESMA, to temporarily ban sovereign ratings. Consequently, 
it is proposed to limit this latter power to temporary and exceptional that would be subject to 
very strict conditions. 

Concerning the proportionality of the introduction of a rotation requirement it is important to 
point out that rotation of rating agencies would only apply for "solicited ratings", which are 

55/193 

 
 
 
 
 
 
 
paid  by  the  issuer.  Furthermore,  if  this  requirement  were  to  be  introduced,  it  would  be 
proportionate  and  consistent  to  remove  the  rules  on  internal  rotation  of  staff  for  solicited 
ratings.  For  (unpaid)  unsolicited  ratings,  the  existing  requirement  to  internally  rotate  staff 
would need to be maintained to ensure independence for this type of ratings. 

Independence  would  be  further  reinforced  by  a  prohibition  on  CRAs  rating  the  products  of 
firms  which  are  themselves  controlling  shareholders  of  the  CRA.  The  latter  entails  an 
important  risk  as  controlling  shareholders  could  influence  rating  decisions  or  exploit 
preferential information on ratings. This could damage the interests of regular investors. This 
measure  is  considered  proportionate  as  the  number  of  controlling  shareholders  of  a  CRA  is 
limited. Furthermore, the impact would depend on the activity of the shareholders concerned. 
Independence  will  also  be  reinforced  by  improved  disclosure  on  prices.  To  avoid  possible 
collusion  in  addition  to  pricing  methodologies  it  is  proposed  to  to  disclose  aggregate 
information on fees to the general public. This would enable CRAs clients to better compare 
prices between CRAs and select CRAs also on the basis of prices. Furthermore, it would be 
required  for  CRAs  to  provide  detailed  information  to  ESMA  on  individual  fees.  This 
information  would  enable  ESMA  to  enforce  the  practical  application  of  non-discriminatory 
fees  by  CRAs.  Moreover,  pricing  on  basis  of  the  actual  costs  would  reduce  conflicts  of 
interest due to the "issuer pays model" and thus strenghten independence of rating agencies. 

7.3. 

Impact on different stakeholders groups 

i) 

ii) 

iii) 

iv) 

Investors confidence in financial markets is expected to improve as a risk of "cliff" 
effects on financial institutions would be mitigated. Furthermore, investors would 
benefit  from  enhanced  transparency  which  would  increase  their  capacities  to 
determine  their  own  credit  assessment  without  relying  solely  on  external  credit 
ratings.  Furthermore,  investors  would  benefit  form  better  understanding  of 
sovereign  ratings, 
improved 
in 
independence  of  rating  agencies.  Finally,  investors  would  benefit  from  the 
improved  possibilities  of  civil  liability  in  case  of  infringements  of  the  CRA 
regulation.    

the  rating  market  and 

improved  choice 

Financial  institutions  would  gain  comfort  that  both  enhanced  credit  risk 
management  systems  and  external  credit  ratings  would  mitigate  exposures,  but 
would  need  to  adapt  their  systems  and  processes  to  ensure  compliance. 
Furthermore, 
transparency  of  rating 
methodologies. 

they  would  benefit  from  enhanced 

finance 

issuers  would  benefit  from 

Corporate  and  structured 
increased 
independence  of  CRAs  ensuring  that  their  debt  instruments  are  rated  with  high 
quality methodologies and would benefit from improved understanding of ratings 
by investors. However, issuers would need to change rating agency periodically to 
ensure compliance. Issuers of structured finance products would need to enhance 
transparency to investors on underlying asset pool.  

Sovereign  issuers  would  benefit  from  improved  communication  between  CRAs 
and  sovereigns  avoiding  eventual  errors  in  underlying  information  which  would 
contribute to high quality sovereign ratings. Furthermore, sovereigns would benefit 
from  reduced  risks  of  market  disruption  in  case  of  sovereign  downgrades  due  to 
better understanding of sovereign risks among investors.  

v) 

CRAs:  would  need  to  comply  with  a  range  of  policy  measures.  First  of  all  they 
would need to comply with increased transparency and of sovereign debt ratings. 

56/193 

 
 
 
 
 
In  addition,  CRAs  would  be  subject  to  more  harmonised  civil  liability  rules. 
through  additional 
independence  would  be  enhanced 
Moreover,  CRAs 
requirements  on  CRAs'  ownership  and  remuneration.  Finally, 
increased 
transparency of rating methodologies would mean enhanced communication with 
investors, issuers and supervisors which would eventually increased ratings quality. 

-  Small and medium-sized rating agencies would benefit from enhanced market 
conditions  and  would  find  it  easier  to  establish  themselves  on  the  market, 
particularly  due  to  the  requirement  for  issuers  to  change  rating  agencies 
the  exchange  of 
periodically.  Furthermore, 
information  when  participating  in  the  network  of  small  and  medium  sized 
agencies  and  from  increased  visibility  through  common  standards  on  rating 
scales. Over time this could contribute to having more competitors in the rating 
market  providing  and  a  wider  range  of  services.  Small  and  medium-sized 
rating agencies would benefit from increased visibility through a EURIX. 

they  would  benefit  from 

-  Large  CRAs  are  likely  to  face  more  competition  in  the  market  due  to  a 
requirement for issuers to change periodically their rating agency. They would 
also face more competition due to increased transparency and the ban on price 
discrimination.  

vi) 

Supervisors  (ESMA)  would  benefit  from  more  increase  supervisory  powers  to 
scrutinize rating methodologies and to temporarily ban sovereign ratings in case of 
specific  situations.  However,  ESMA  would  need  to  adapt  their  supervisory 
processes to ensure that all new rules are applied. 

7.4. 

Assessment of administrative burden and compliance costs  

The table below provides for administrative burdens and other compliance costs for individual 
preferred options that aim to reduce the overreliance on external credit ratings, to mitigate the 
risks  of  contagion  effects  of  sovereign  debt  ratings,  to  promote  competition  in  the  credit-
rating  market,  to  ensure  the  right  of  redress  for  investors  and  to  enhance  independence  of 
CRAs.  It  should  be  noted  that  administrative  burdens  are  those  compliance  costs  that  result 
from  meeting  legal  obligations  to  provide  information  to  public  authorities  or  to  private 
parties. 

57/193 

 
 
 
Policy Areas

Preferred Options

One-Off

recurring

One-Off

recurring

AVERAGE COMPLIANCE 
COSTS

of which: 
ADMIN BURDEN

OVERRELIANCE Reduce reliance on external ratings by enhancing 

SOVEREIGN

internal risk management and promoting the use of 
internal rating models for regulatory purposes

Improve disclosure requirements for issuers of 
structured finance products on an ongoing basis

Require CRAs to publish a full research report on 
sovereign debt ratings and allocation of staff
Require CRAs to publish sovereign ratings after 
closing of EU trading venues
Require CRAs to conduct the sovereign debt ratings 
process more frequently
Extend powers of competent authorities (ESMA) to 
scrutinize rating methodologies
Grant ESMA the power to restrict or ban temporarily 
sovereign debt ratings in exceptional situations

COMPETITION Encourage the emergence of a network of small and 

medium size rating agencies
Harmonise ratings scales to improve comparability of 
ratings between CRAs
Establish a European Rating Index (EURIX)
Require CRAs to disclose pricing of ratings and 
ensure that prices are not discriminatory and based on 
costs 

CIVIL LIABILITY Ensure civil liability of CRAs towards users of credit 

ratings in civil law of Member States
INDEPENDENCE Introduce rotation rules for the CRAs engaged by an 
issuer to rate its own products and to rate the issuer 
itself and in introduce mandatory separation between 
them
Introduce additional and specific requirements on 
CRAs' independence and objectivity in relation to their 
shareholders

Strengthen rules on disclosure of rating methodologies

Require CRAs to inform issuers sufficiently in advance 
of the publication of a rating

Low

High

MLN €

MLN €

MLN €

MLN €

MLN €

0,00

substantial substantial

0,00

0,00

1,70

1,92

0,00

0,00

0,00

0,00

5,21

0,00

3,12

0,15

1,92

5,21

0,00

3,12

0,15

1,70

0,00

0,00

0,00

0,00

1,92

0,01

0,00

0,00

0,00

0,00

0,00

0,00

0,00

0,00

0,00

1,08

0,30

0,90

0,00

0,45

0,00

0,03

1,95

0,00

0,45

0,03

0,00

0,00

0,00

0,00

0,00

0,63

0,38

0,03

0,00

substantial substantial

0,00

0,00

0,00

0,01

0,01

0,00

0,01

0,00

0,01

0,01

0,00

0,00

0,00

0,00

0,00

0,00

11,8

0,00

0,00

12,8

0,00

0,00

1,7

0,00

0,00

3,0

TOTAL : 

3,1

The  full  explanation  of  the  methodology,  assumptions  and  calculation  of  the  administrative 
burden and compliance costs can be found in annex XII. 

There would be additional costs for financial firms resulting from the requirements to enhance 
internal risk management and the use of internal rating models for regulatory purposes. These 
costs  would  be  substantial  for  relevant  financial  sectors  as  a  whole,  but  proportional  with 
respect  to  individual  financial  firms.  There  would  also  be  additional  costs  to  issuers  due  to 
enhanced disclosure requirements, the total of which could amount to EUR 1.7 million one-
off cost and EUR 1.92 million annually.  

A set of options to mitigate risks of contagion effect linked to sovereign ratings, would lead to 
some  additional  compliance  costs  to  CRAs,  which  could  amount  to  EUR  3.27  million 
annually to the industry.  

Measures  to  improve  competition  would  not  significantly  increase  the  costs  for  CRAs  (the 
annual  compliance  cost  of  the  rating  industry  is  expected  to  be  around  1.38  Million).  The 
costs would only relate to promoting the emergence of a network of small and medium sized 
CRAs (see Annex X) that could range annually between €0.9 to 1.95 million, for which the 
Commission would explore possibilities for EU funding/instrument. 

58/193 

 
 
 
 
The  policy  option  related  to  civil  liability  of  CRAs  towards  investors  is  expected  to  cause 
compliance costs due to need to insure their civil liability or, in the absence of the insurability, 
to create a financial buffer to cover potential claims from investors.  

Finally, the preferred options dealing with CRA independence are not expected to entail any 
significant costs. 

7.5. 

Impact on EU budget  

Only  the  policy  measure  to  introduce  a  network  of  small  and  medium  rating  agencies  is 
expected  to  affect  the  EU  Budget.  However,  this  policy  measure  would  rely  on  existing 
programmes. Therefore, these policy measures would not have an impact on the EU budget.   

All  other  preferred  policy  measures,  including  additional  powers  granted  to  ESMA  have 
already been covered by the existing EU budget.  

7.6. 

Impact on fundamental rights 

An  assessment  was  made  of  the  policy  options  to  ensure  compliance  with  fundamental 
rights.131  Most of the options considered in this impact assessment have no relevant impacts 
on fundamental rights. By ensuring a better regulation and reliability of the service provided 
by the CRAs to businesses and individuals, the measures generally impact positively on the 
right to consumer protection and the freedom to conduct business. 

As  far  as  the  Credit  Rating  Agencies'  freedom  to  conduct  a  business  (Article  16  Charter  of 
Fundamental Rights of the European Union) is concerned, the preferred option would lead to 
more effective and harmonised regimes for provision of financial risk management and CRAs 
activities  with  the  objective  of  improving  financial  stability  and  compliance  with  CRA 
Regulation  rules,  in  line  with  the  principle  of  proportionality.  In  particular,  as  regards 
sovereign debt ratings, the preferred option - providing for powers to temporarily restrict or 
ban  sovereign  debt  ratings  in  clearly  defined  exceptional  circumstances,  thus  avoiding 
arbitrariness,-appears as a less intrusive means compared to a blanket and general prohibition 
of  issuing  sovereign  debt  ratings.  One  could  argue  that  this  option  restricts,  to  some  extent, 
the  freedom  of  expression  or  information  (Article  11  Charter  of  Fundamental  Rights  of  the 
European Union) of credit rating agencies. However, limitations to this right are possible, in 
accordance  with  Article  10(2)  of  the  Convention  for  the  Protection  of  Human  Rights  and 
Fundamental  Freedoms  as  referred  to  by  Article  52(3)  of  the  Charter.  Article 10(2)  of  that 
Convention provides that the exercise of the freedom of expression carries with it duties and 
responsibilities and may be subject to restrictions prescribed by law necessary for, inter alia, 
the  prevention  of  disorder.  Indeed,  the  objectives  of  general  interest  pursued  by  the 
prohibition to issue sovereign ratings or review of existing ones are covered by the concept of 
prevention of disorder referred to in Article 10(2) of that Convention. By ensuring a right of 
redress and access to justice to businesses and individuals having suffered loss due to actions 
that  may  give  rise  to  civil  liability  by  CRAs,  the  preferred  option  impacts  positively  on  the 
right  to  an  effective  remedy  and  to  a  fair  trial  in  line  with  Article  47  of  the  Charter  of 
Fundamental Rights. 

As regards data protection (Article 8 of the Charter and Directive 95/46/EC on the processing 
of  personal  data)  the  proposal  would  ensure  that  if  personal  data  are  processed  in  any  way 
such processing would be carried out in line with the Charter and Directive 95/46/EC. 

131  

Based on (COM (2010) 573), Strategy for the effective implementation of the Charter of Fundamental 
Rights by the European Union, October 2010, particularly the check list. 

59/193 

 
 
 
                                                 
7.7. 

Social impact  

The framework proposed is expected to reduce risk to financial stability. As far as the options 
considered  in  this  initiative  would  mitigate  the frequency  or  the  duration  of  future  financial 
crises and their impact on the real economy, they would also reduce the social costs of these 
crises, mainly through a lower level of unemployment.  

7.8. 

Environmental impact  

The proposal would not have any direct or indirect impacts on the environment. 

7.9. 

Impact on SMEs  

The proposals would affect two types of SMEs: CRAs that are SMEs and SMEs wishing to be 
rated.  The  proposal  takes  into  account  the  size  of  firms.  For  example,  as  the  planned 
obligation for financial institutions to develop internal models to assess credit risk would not 
apply  to  SME  financial  institutions  without  material,  complex  credit  risk  exposures.  Those 
however  that  did  have  material,  complex  exposures  would  need  to  reduce  their  reliance  on 
external  ratings.  However,  the  problem  of  distinguishing  complex  and  material  exposures 
from immaterial exposures remains to be resolved. 

In the case of CRAs that are also SMEs, a network of smaller CRAs would help them develop 
by promoting best practice and experience. However, due to existing economies of scale and 
reputation in the rating sector, the effectiveness of a CRAs network to stimulate competition 
with  large  CRAs  may  be  limited.  Development  of  SME  CRAs  could  also  be  stimulated  if 
issuers were required to rotate between CRAs, as more rating opportunities would be created 
for smaller CRAs. 

The proposals regarding civil liability of CRAs towards investors affect SME CRAs equally 
with  larger  CRAs.  Both  SME  and  large  CRAs  would  be  subject  to  civil  liability.  The  large 
CRAs would indeed be more exposed to civil liability claims due to the size of the rated firms 
and larger value of the rated debt instruments, their wide range of ratings provided and their 
market presence and reputation. SME CRAs, on the other hand, generally rate smaller firms 
and  debt  instruments  of  smaller  value.  They  also  usually  have  a  much  smaller  market 
presence  in  terms  of  territorial  aspects,  asset  classes  and  reputation  among  investors. 
Therefore they are likely to be less affected by civil liability claims. Furthermore, it should be 
stressed that civil liability would be imposed upon large and SME CRAs only in case of gross 
negligence  or  intent  on  their  part.  SME  CRAs  can  therefore  avoid  liability  by  taking 
precautionary measures. Lastly, SME CRAs can also insure their liability with proportionately 
lower  costs  since  their  ratings  are,  as  stressed  above,  generally  related  to  smaller  money 
values. 

Finally, the proposals in this impact assessment would not affect the competitiveness of SMEs 
in  general  as  it  would  contribute  and  help  SMEs  to  make  sustainable  decisions  for 
investments while relying less on ratings by making their own due diligence assessments and 
evaluations of the ratings issued.  

7.10.  Coherence with other proposals 

This proposal is in strong relation with other policy initiatives in the EU. A detailed list of the 
main legislative initiatives and analysis of the coherence with the legislative initiative CRA3 
is presented in the Annex XIII.   

The Commission services are coordinating their different exercises to make sure that they are 
based on compatible data and models.  

60/193 

 
 
 
7.11.  Choice of legal instrument 

The  current  initiative  encompasses  a  wide  range  of  measures.  They  can  be  divided  in 
five categories. 

Measures requiring amendments to the current CRA Regulation 

A  first  group  of  proposed  measures  strengthen  and  build  on  provisions  in  the  current  CRA 
Regulation. 

Requirement to publish full research reports on sovereign debt ratings and disclose the allocation of staff  

Measure 

Requirement to publish sovereign ratings after closing of EU trading venues  

Requirement to conduct the sovereign debt rating process more frequently  

Enhanced disclosure requirements for rating methodologies  

Extending the powers of ESMA to scrutinize rating methodologies and temporarily ban sovereign debt ratings 

Requirement to disclose pricing of ratings and prohibit price discrimination  

Requirement to regularly rotate the CRA  

Provisions to mitigate conflicts of interests related to the shareholder structure  

Requirement for a CRA to inform an issuer sufficiently in advance of a rating change  

Relevant 
section 
section 6.2, 
option 2 
section 6.2, 
option 3 
section 6.2, 
option 4 
section 6.5, 
option 7 
section 6.2, 
option 7 
section 6.3, 
option 9 
section 6.5, 
option 5 
section 6.5, 
option 6 
section 6.5, 
option 8 

Implementation of those measures would require amendments to the current CRA Regulation. 
They could not be achieved by non binding measures (e.g. ESMA guidelines) as those rules 
need to be enforceable by ESMA in order to be effective. More specifically, one group of the 
proposed  amendments  to  the  CRA  Regulation  complement  or  extend  the  application  of 
provisions included in the current CRA Regulation. This refers to all requirements related to 
transparency  and  enhanced  disclosure  (publication  of  a  full  research  report,  publication  of 
ratings  outside 
related  disclosure  of  methodologies, 
communication with the issuer in advance of a rating change), the rating process (frequency 
of  the  rating  process),  prevention  of  conflicts  of  interest  and  corporate  governance 
requirements (rotation of CRAs, shareholder structure). Consequently, an amendment in form 
of a Regulation is necessary.132 

trading  hours, 

requirements 

Enhancing  ESMA's  powers  to  scrutinize  in  more  detail  or  temporarily  ban  sovereign  debt 
would also require a change to the current CRA Regulation. Enforcement measures can only 
be based on a binding legal act according to the rule of law. 

The  proposed  requirement  to  disclose  pricing  and  prohibit  price  discrimination  would  also 
require  an  amendment  to  the  CRA  Regulation.  A  recommendation  through  an  ESMA 
guideline would not be sufficient as in this case it would not be certain that all CRAs comply 

132  

This applies to the requirement to publish full research reports on sovereign debt ratings and disclose 
the allocation of staff which will complement Articles 10, 11, Annex I section D I 2 and section E III 3 
of  the  CRA  Regulation;  -  the  requirements  to  publish  sovereign  ratings  after  closing  of  EU  trading 
venues  which  builds  on  Article  10  (1)  of  the  CRA  Regulation;  -the  requirement  to  conduct  the 
sovereign  debt  rating  process  more  frequently  which  enhances  Article  8  (5)  of  the  current  CRA 
Regulation;  -  enhanced  disclosure  requirements  for  rating  methodologies  which  specifies  Article  10, 
Annex I D 2 (b) of the CRA Regulation; -the requirement to regularly rotate the CRA which builds on 
Article  7  (4)  of  the  CRA  Regulation;  -provisions  to  mitigate  conflicts  of  interests  related  to  the 
shareholder structure which concretize Article 6 (2), Annex I Section B, 3,4 of the CRA Regulation; -
the requirement to inform an issuer sufficiently in advance of a rating change which enhances Article  
10, Annex I Section D I  3 of the CRA Regulation. 

61/193 

 
 
 
                                                 
with the rule which would jeopardize the effectiveness of the measure and cause an unlevel 
playing field. 

Measures  requiring  amendments  to  the  current  CRA  Regulation  coupled  by  technical 
standards 

Three measures would require a change of the CRA Regulation including an empowerment of 
ESMA to prepare draft technical standards. These are: 

- 

- 

requirements  for  CRAs  to  use  a  harmonised  rating  scale  and  to  report  rating 
information to the European Rating Index (section 6.3, option 4 and option 5); 

specifying  the  content  and  format  of  periodic  reporting  on  fees  charged  by  credit 
rating agencies (section 6.3, option 9);   

-  disclosure  requirements  for  issuers  of  structured  finance  instruments  (section  6.1, 

option 6). 

These  proposed  measures  could  not  be  achieved  by  non  binding  measures  (e.g.  ESMA 
guidelines) as they need to be enforceable by ESMA in order to be effective. A harmonised 
rating  scale  makes  only  sense  if  it  is  strictly  applied  by  all  CRAs.  Therefore,  a  simple 
recommendation  would  not  be  sufficient.  Similarly,  disclosure  requirement  with  regard  to 
structured  finance  products  need  to  be  applied  by  all  issuers  in  order  to  be  effective. 
Otherwise the objective to allow investors to assess and compare different instruments could 
not be met. 

Details  of  the  proposed  measures  (the  detailed  calibration  of  the  harmonised  rating  scale, 
details  of  the  information  to  be  disclosed  by  issuers)  could  be  determined  by  regulatory 
technical  standards  (to  be  drafted  by  ESMA)  as  they  are  technical  and  do  not  imply  policy 
choices which would be determined by amendments to the CRA Regulation. 

F i e ld  

L eg a l   ins t r u me nt  

P r e l imi na ry 
t i me l i n e  

Credit Rating Agencies 

Amendments of  CRA 
Regulation (CRA III) 

Proposal to be adopted 
Q4 2011  

Measures requiring 
amendments to the 
current CRA 
Regulation   

•  Policy measures to 
mitigate the risks of "cliff" and 
contagion effects linked to 
sovereign debt ratings 

•  Policy measures to 
improve credit rating market 
conditions (except, a policy 
option to support  the small 
and medium sized CRAs 
network) 

•  Policy measures to ensure 
right to redress for investors 

•  Policy measures to 
reinforce independence of 
credit rating agencies    

Measures requiring amendments to sectoral legislation 
The  proposed  measures  to  reduce  reliance  on  credit  ratings,  require  changes  to  sectoral 
financial legislation. The amendments regulate to what extent financial firms may or may not 
use external ratings, that financial firms have to carry out their own credit risk management 
and  which  alternatives  to  ratings  should  be  used.  Requirements  on  financial  firms  are  in 
general regulated in the respective sectoral financial legislations. However, a comprehensive 

62/193 

 
 
 
 
provision  could  be  included  in  the  CRA  Regulation  preventing  financial  firms  from  over-
relying on credit ratings.  

In addition, a sectoral approach should be chosen as any alternatives to external ratings have 
to  be  specific  to  the  sectoral  context  where  external  ratings  are  being  used.  This  sectoral 
approach is also followed by the US SEC.133 

More  specifically,  it  would  be  necessary  to  implement  the  measures  against  overreliance  in 
sectoral legislation for credit institutions and investment firms (where relevant modifications 
have  been  included  in  the    proposal  for  amendments  to  the  Capital  Requirements  Directive 
(CRD  IV) of 20 July 2011), for insurance and reinsurance undertakings and in the investment 
management sector. 

Measures against 
overreliance 

•  Strengthening own internal 
risk management of financial 
firms 

•  Requiring firms with 
material credit risk exposure 
to develop internal models 
(applies to credit institutions, 
investment firms and 
insurance and reinsurance 
undertakings) 

•  Regular reporting by ESAs  
on  efforts by firms and 
supervisors to reduce risk of 
overreliance 

F i e ld  

L eg a l   ins t r u me nt  

P r e l imi na ry 
t i me l i n e  

Credit institutions and 
investment firms 

CRD IV-Banking 
Directive/Regulation 

Proposal adopted on 20 
July 2011 

Insurance and reinsurance 
undertakings 

Solvency II framework 
Directive (Omnibus II) 

Currently negotiated in 
Council/Parliament 

Implementing measures 

Summer 2012 

Alternative investment fund 
managers 

AIFM Directive Implementing 
measures (tbd) 

Summer 2012 

Investment managers 

Technical standards of 
UCITS Directive (tbd) 

Summer 2012  (to be 
confirmed by ESMA 
which has the right of 
initiative in this regard 

In  the  remaining  areas  of  financial  regulation  where  ratings  are  referred  to134 changes  to 
sectoral  legislation  should  be  proposed  where  these  references  have  the  potential  to  trigger 
undue reliance on ratings. Any changes would be subject to a separate impact assessment. 

Measures building on an existing European Union funding program  

In order to enhance competition on the market for rating services and lower entry barriers for 
small players it is proposed to support the establishment of a network among small/medium 
CRAS  to  share  best  practices  and  develop  capacity  (section  6.3,  option  3).  Such  a  network 
would require Union funding and thus would need an adequate legal basis in a Union legal act 
(usually  decision  or  regulation).  Taking  into  consideration,  on  the  one  hand,  constraints  in 
Union financing and, on the other hand, that funds could possibly become available by using 
existing Union programmes, this network could be supported making recourse to one of the 
two instruments under which the actions of the existing CIP (competitiveness and Innovation 
Framework Programme) will continue as from 2014 onwards135, i.e.: 

- 

- 

the common strategic framework for research and innovation funding, called 'Horizon 
2020"; 

the  new  Competitiveness  and  SME  programme  for  the  continuation  of  the  non-
innovative actions of the CIP mentioned above. 

133  
134  
135  

US SEC Report on the Review of Reliance on Credit Ratings, July 2011. 
See complete list of references to external ratings in EU financial Regulation in Annex IV 2.1. 
See the multiannual financial framework 2014-2020 "A budget for Europe 2020" COM (2011) 500 final 
of 29.6.2011. 

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The  identification  of  the  programme  which  would  fit  the  best  the  funding  of  the  proposed 
network  will  be  done  at  a  later  stage  when  all  the details  of  the  two  instruments  mentioned 
will be known.   

Measures on an 
existing EU funding 
program  

F i e ld  

L eg a l   ins t r u me nt  

•  Enhance competition on 
the market for rating services 

Establishment of a network 
among small/medium CRAs 

CIP – independent 
initiative/program 

P r e l imi na ry 
t i me l i n e  

Programme could be 
adopted in course of 
2012  

Measures  requiring  changes  to  the  CRA  Regulation  and  implementation  in  national  legal 
orders 

In order to ensure civil liability of credit rating agencies vis-à-vis investors non-binding rules 
would  not  be  effective.  This  could  result  in  a  situation  where  investors  in  some  Member 
States would not be enabled to engage in civil liability claims against a CRA that has violated 
the  CRA  Regulation  thereby  causing  damage  to  the  investor.  Therefore,  only  binding 
legislative  instruments  would  be  appropriate.  The  proposed  amendment  of  the  CRA 
Regulation136   would  ensure  civil  liability  of  CRAs  vis-à-vis  investors  exist  and  is  effective 
according to the national civil law orders (section 6.4. option 3). 

Measures to ensure 
right of redress for 
investors 

•  Ensure civil liability of 
CRAs towards users of credit 
ratings in civil law of Member 
States 

F i e ld  

L eg a l   ins t r u me nt  

P r e l imi na ry 
t i me l i n e  

Credit Rating Agencies 

Amendments of  CRA 
Regulation (CRA III) 

Proposal to be adopted 
Q4 2011 

7.12. 

Impact on third countries 

The proposed policy measures against overreliance shall implement in the EU legal order the 
FSB's principles to reduce the reliance on ratings, as requested by the FSB in October 2010. 
Following the FSB principles, other jurisdictions and international standard setters, including 
the US and the Basel Committee on Banking Supervision (BCBS), are also taking measures 
against  overreliance.  Compliance  with  the  FSB  principles  and  coordination  by  international 
standard setting bodies should ensure international consistency of these measures.    

Also  most  of  the  other  areas  that  the  proposed  measures  would  strengthen  are  currently 
reviewed  and  enforced  by  third  country  regulators,  including  the  US.  For  instance,  the  US 
SEC  is  currently  investigating  ways  to  reduce  conflicts  of  interests  due  to  the  issuer-pays 
model.  Measures  to  improve  disclosure  of  structured  finance  instruments,  to  increase 
competition in the rating market and to strengthen civil liability of CRAs have already been 
taken in the US.  

136  

It was assessed that the CRA Regulation would be more appropriate legal instrument versus Directive. 
It is neither legally necessary nor practical and proportionate to propose an extra directive for the single 
provision that we have in mind on civil liability. According to the settled case-law of the ECJ (Eridania, 
judgement of 27.9.1979 – case 230/78) the fact that a regulation is directly applicable does not prevent 
the  provisions  of  that  regulation  from  requiring  Member  States  to  take  implementing  measures.  For 
instance, Art 36 of the first CRA Regulation (2009) required Member States Member to "…lay down 
the rules on penalties applicable to infringements of the provisions of this Regulation and … to take all 
measures necessary to ensure that they are implemented". 

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If following this IA the EU regulatory regime on CRAs was enforced, this would have to be 
considered in subsequent equivalent assessments according to Article 5 (6) and also by ESMA 
when deciding on whether a third country regulatory regime can be considered as stringent as 
the EU regulatory framework according to Article 4 (3) of the CRA Regulation. Ratings from 
third  country  CRAs  can  only  be  endorsed  if  the  third  country  CRA  complies  with 
requirements  of  the  third  country  regulatory  regime  being  as  stringent  as  the  EU  CRA 
Regulation.  Given  the  proportionality  of  the  proposed  measures  and  the  fact  that  third 
countries are also enforcing the relevant areas, we do not assume that the proposed measures 
would make the access of third country CRAs to the EU much more difficult.  

On the other hand, third country CRAs would also benefit of access to more information due 
to increased disclosure, especially for structured finance issues, which would allow CRAs to 
compete with solicited ratings by issuing their own ratings. 

For  third  country  investors  there  would  be  the  added  benefit  of  being  able  to  use  ratings 
issued by CRAs subject to enhanced transparency and procedural requirements.  Establishing 
liability of CRAs towards investors would also allow third country investors to benefit from 
this  added  investor  protection  if  enacted.  Successful  adoption  of  measures  to  increase 
competition  could  also  see  a  greater  choice  in  ratings  for  investors.  Finally,  third  country 
investors  would  benefit  from  increased  disclosure  regarding  structured  finance  instruments, 
allowing them to further improve their own credit risk assessments. 

For  issuers  in  third  countries,  there  may  be  the  possibility  of  soliciting  ratings  by  a  greater 
number  of  CRAs  subject  to  a  high  level  of  oversight.    Both  issuers  and  investors  stand  to 
benefit  from  increased  independence  and  transparency  of  CRAs  and  the  resulting 
improvement in the quality of ratings. 

Market  participants  in  general  should  benefit  from  a  reduced  risk  of  negative  impacts  of 
sudden ratings corrections, flawed ratings and inappropriate sovereign ratings and potentially 
negative market consequences. 

8. 

MONITORING AND EVALUATION 

When  the  recommended  policy  options  are  put  into  practice,  the  Commission  will  monitor 
how  Member  States  apply  the  proposed  policies.  When  necessary,  the  Commission  will 
pursue the procedure set out in  Article  226  of the Treaty in case any Member State  fails to 
respect its duties concerning the implementation and application of Union Law.  

In order to assess the effectiveness of the proposed policies, the Commission will propose to 
set  up  the  following  system  of  monitoring  to  facilitate  an  evaluation  three  years  after  the 
transposition date (possibly in the form of a report to the Council and the Parliament).  

As  part  of  the  monitoring  exercise,  ESMA  would  receive  quarterly  reports  from  national 
competent  authorities  on  the  various  policy  areas.  The  evaluation  would  be  built  on  this 
information. The main indicators and sources of information that could be the following: 

•  Regarding the measures designed to increase the number of unsolicited ratings issued: 
The number or proportion of solicited and unsolicited rating issued for various asset 
classes. 

•  To  monitor  the  'stabilisation'  of  sovereign  ratings:  The  frequency  of  review  and 

issuance of ratings, particularly sovereign debt ratings. 

•  To  assess  the  achievement  of  better  transparency  and  use  of  rating  methodologies: 
Frequency and types of changes to methodologies, and how often these were rejected 
or challenged. 

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•  To  assess  the  effectiveness  of  increasing  new  market  entry:  The  number  of  new 
entrants  and  changes  to  the  market  structure.    This  could  include  market  share  of 
existing players in terms of both revenue and number of outstanding ratings in various 
classes. 

•  As  regards  reliance  on  ratings,  a  report  on  the  use  of  the  standardised  and  internal 
ratings  based  approaches  could  investigate  impact  of  the  use  ratings  for  regulatory 
purposes by firms.  

In other areas, such as liability of CRAs, it may be difficult to assess the impact of proposals 
three years after transposition, as case law developments are likely to take more time. 

66/193 

 
 
 
 
ANNEX I. OVERVIEW  OF  EXISTING CRA REGULATION  AND POSSIBLE  NEW  INITIATIVES  ON 

CRAS (PREFERRED OPTIONS) 

CRA I + CRA 
II reference 

CRA I (Regulation 1060/2009) 
and CRA II (Regulation 
513/2011) 

New initiatives (in 
addition to CRA 
Regulation)  

Instrument 
where new 
policy will be 
included 

REGISTRATION – SUPERVISION – ENFORCEMENT POWERS 

ESMA is in charge of registering and supervising credit rating agencies in the EU from 1 July 2011. ESMA 
has  to  ensure  that  the  CRA  Regulation  is  correctly  applied  by  CRAs.  If  a  CRA  does  not  comply  with  the  
CRA Regulation, ESMA has to take supervisory measures and impose a fine on the CRA. 

Art. 14-
17 of 
CRA 
Regulatio
n137 

 Art. 21-
23d  

Art. 24, 
36a,  

Art. 19 

Art. 40, 
40a 

Registration and supervision: CRAs 
must  apply  to  register  with  ESMA, 
which will decide on each application. 

Supervision:  ESMA  will  supervise 
the  CRAs 
to  ensure 
in  order 
compliance  with  the  requirements  of 
  ESMA's 
the  CRA  Regulation. 
include 
powers 
supervisory 
information 
requests  and  on-site 
inspections.  ESMA  can  delegate 
specific 
to 
competent  authorities  of  the  Member 
States. 

supervisory 

tasks 

can 
(up 

take 
ESMA 
Sanctions: 
supervisory  measures 
the 
withdrawal of the registration) against 
a CRA infringing the CRA Regulation 
and can also impose fines.   

to 

Fees are levied from CRAs to pay for 
the supervision. 

Transitional regime  

-According to the CRA Regulation 
ESMA is in charge of supervising all 
registered CRAs from 1 July 2011.  
- From 1 July 2011 any new 
applications from CRAs are to be 
decided by ESMA  
- Applications from existing CRAs 
(those that have been operating in the 
Union before 7 June 2010) had to be 
submitted by  7 September 2010; their 
examination will be finalised by 
colleges composed of national 
competent authorities. ESMA is 
involved in the registration process 
but the final decision is taken by 

137  

Regulation 1060/2009 on credit rating agencies as amended by Regulation 513/2011. 

67/193 

 
 
 
 
 
 
 
 
 
 
 
 
 
                                                 
CRA I + CRA 
II reference 

CRA I (Regulation 1060/2009) 
and CRA II (Regulation 
513/2011) 

New initiatives (in 
addition to CRA 
Regulation)  

Instrument 
where new 
policy will be 
included 

national competent authorities.  

CORPORATE GOVERNANCE  

A  CRA  should  maintain  arrangements  for  sound  corporate  governance  which  shall  ensure  that  the 
CRA issues ratings that are independent, objective and of good quality. 

  Annex I.A.9 

to 

review 

function 

Rating  policy  review  function:  An 
internal 
the 
methodologies, models and significant 
changes 
and 
models.    This  function  should  be 
independent  of  the  business  lines  and 
report to the independent members of 
the board.  

to  methodologies 

  Annex I.A.5-6  Compliance  function:  A  permanent 
and  effective  compliance  function 
operating 
the 
independently 
business  lines  is  required.  It  reports 
regularly  to  senior  management  and 
the 
the 
independent  members  of 
board.  

of 

  Annex I.A.2 

of 

or 

Independent  members 
the 
supervisory 
administrative 
board: At least 1/3 but not less than 2 
independent  members  required.  They 
have  the  specific  task  of  monitoring 
the  development  of  the  rating  policy 
and  methodologies,  effectiveness  of 
the  rating  internal  quality  systems, 
effectiveness  of  procedures  dealing 
with  conflicts  of  interest,  compliance 
and governance processes.  

CONFLICTS OF INTERST 

Conflicts of interest have to be identified and either eliminated or properly managed and disclosed. 
Conflicts of interests arise for instance from remuneration models used by CRAs, from the provision 
of advisory or ancillary services and from CRAs, its staff or important shareholders having an own 
interest in the rated instruments. 

  Art. 6, Annex 

I B 1 

General  policy:  CRAs  to  ensure  that 
conflicts  of  interest  will  not  affect 
ratings.    Actual  or  potential  conflicts 
of  interest  to  be  (i)  identified  and 
either 
(ii.2) 
(ii.1)  eliminated  or 
properly managed and disclosed. 

Annex 
I.B.3 

interest: 
Prohibited  conflicts  of 
Ratings not to be issued and existing, 
potentially compromised ratings to be 
immediately flagged as such.  

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CRA I + CRA 
II reference 

CRA I (Regulation 1060/2009) 
and CRA II (Regulation 
513/2011) 

New initiatives (in 
addition to CRA 
Regulation)  

Instrument 
where new 
policy will be 
included 

Annex 
I.B.4 

Annex 
I.B.4 

  Art. 7(5) 

of 

provision 

of 
Prohibition 
consulting/advisory  services:  It  is 
prohibited 
provide 
consulting/advisory  services  to  the 
rated entity or its related third party.  

to 

Provision of ancillary services: Only 
specific  ancillary  services  may  be 
provided  (market  forecasts,  estimates 
of  economic  trends,  pricing  analysis 
and other general data analysis as well 
as  related  distribution  services).  CRA 
to  ensure  that  ancillary  service  does 
not  present  a  conflict  of  interest  with 
the  rating  activity  and  to  disclose  in 
the  final  ratings  report  any  ancillary 
services provided to the rated entity.  

Compensation  and  performance 
analysts: 
of 
evaluation 
performance 
Compensation 
and 
to  be 
evaluation  of  analysts  not 
contingent  on  the  amount  of  revenue 
generated.  

  Art. 7(2) 

Rating  staff  engagement 
negotiations: Prohibited.  

in  fee 

  Annex I.C.1, 

3, 4, 6. 

in 

in 

the 
ratings 
transactions 

Rules  on  conduct  of  the  staff 
the  rating  process:  
engaged 
Prohibition for the rating analysts and 
to 
person  approving 
engage 
in 
any 
instruments related to the rated entity. 
Prohibition  to  accept  money,  gifts  or 
favours  from  anyone  the  CRA  does 
of 
business 
information 
confidential 
(incl. 
unpublished 
ratings).  Look-back 
reviews of ratings after an analyst has 
left to work for the rated entity.  

Handling 

with. 

  Annex I.C.2  Rules excluding employees from the 
rating  process:  Prohibition  for  the 
rating analysts and persons approving 
ratings  to  be  engaged  in  rating  an 
entity triggered by conflicts of interest 
financial 
arising 
instruments, 
employment, 
business or other relationship. 

owning 

recent 

from 

  Art. 7(4), 

Annex I.C.8 

of 

rating 

is 
Rotation 
mandatory.  Lead  analysts  to  rotate 
every  four  years,  ratings  analysts 
and  persons 
every 

five  years, 

staff 

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Instrument 
where new 
policy will be 
included 

CRA III – Q4 
2011 

III  – 

CRA 
Q4 2011 

CRA I + CRA 
II reference 

CRA I (Regulation 1060/2009) 
and CRA II (Regulation 
513/2011) 

New initiatives (in 
addition to CRA 
Regulation)  

approving ratings every seven years. 

Rotation  of  CRAs:  An  issuer's 
own credit worthiness could  not 
be  rated  by  the  same  CRA  for 
more than 3 consecutive years.  
Another  CRA  would  take  over 
thereafter and the outgoing CRA 
issuer  would  make 
and 
the 
information 
all 
available 
accessed in the rating process. 

A  CRA  would  not  be  able  to 
rate  more  than  5  consecutive 
issues  of  any  asset  class  by  the 
same  issuer,  or  if  fewer  than  5 
issues  are  made,  it  would not  be 
able  to  rate  the  issues  of  one 
issuer  over  a period  exceeding 3 
years.   

to 

on 

that: 

relation 

additional 
Introduce 
requirements 
CRAs' 
independence  and  objectivity 
their 
in 
shareholders.  ESMA  would  be 
required 
(1) 
to  ensure 
shareholders  could  not  either 
individually  or  in  voting  blocs 
accrue  potentially  controlling 
stakes in more than one CRA (2) 
CRAs could not issue ratings for 
any  firm  that  has  a  significant 
shareholding  of  that  CRA,  even 
indirectly  (3)  a  firm  that  has  a 
significant  shareholding 
in  a 
CRA  would  not  be  allowed  to 
invest  in  products  rated  by  this 
CRA. 

ENSURE THE QUALITY OF RATINGS AND OF RATING METHODOLOGIES 

CRAs are required to monitor ratings in order to keep them up to date. The information used by CRAs 
to produce ratings has to be of sufficient quality, where this is not the case CRAs have to refrain from 
issuing  ratings.  Finally,  rating  methodologies  have  to  comply  with  certain  qualitative  requirements. 
Supervision by ESMA will be strengthened in this respect.  

Art. 8(5)  Monitoring  activity:  Monitoring  of 
ratings required on an on-going basis 
(as well as at least an annual review). 

Art. 8(6) 

Impact of methodology changes on 
a 
existing 
methodology,  model  or  key  rating 

ratings:  When 

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CRA I + CRA 
II reference 

CRA I (Regulation 1060/2009) 
and CRA II (Regulation 
513/2011) 

New initiatives (in 
addition to CRA 
Regulation)  

Instrument 
where new 
policy will be 
included 

assumption is changed, a CRA shall: 

(a) 
immediately,  using  the  same 
means of communication as used for 
the distribution of the affected credit 
ratings,  disclose  the  likely  scope  of 
credit ratings to be affected; 

(b) 
review  the  affected  credit 
ratings  as  soon  as  possible  and  no 
later 
the 
than  six  months  after 
change,  in  the  meantime  placing 
those ratings under observation; and 

re-rate  all  credit  ratings  that 
(c) 
have 
those 
been 
based 
methodologies,  models  or  key  rating 
assumptions if, following the review, 
the  overall  combined  effect  of  the 
changes affects those credit ratings.  

on 

Quality  of  data  used:  A CRA shall 
state  clearly  and  prominently  when 
disclosing  any  credit  rating  whether 
it considers satisfactory the quality of 
information  available  on  the  rated 
entity  and  to  what  extent  it  has 
verified information provided to it by 
the  rated  entity  or  its  related  third 
party. 

Limits  to  rating  activity:  CRAs 
shall  refrain  from  issuing  a  rating  or 
withdraw  an  existing  rating when  (i) 
lack of robust data, (ii) complexity of 
the  structure  of  a  new  instrument  or 
(iii)  quality  of  information  is  not 
satisfactory 
serious 
questions  as  to  whether  a  credible 
rating can be produced.  

raises 

or 

structured 

For 
finance 
instruments,  a  CRA  is  expected  to 
state  what  level  of  assessment  it  has 
performed 
due 
concerning 
diligence processes carried out at the 
level 
financial 
underlying 
instruments  or  other  assets  of 
structured finance instruments.  

the 

of 

Annex 
I.D.I.4 

Annex 
I.D.I.4 

Annex 
I.D.II.2 

Art. 8(3) 
CRA 
Regulatio
n 

A  credit  rating  agency  shall  use 
rating  methodologies 
are 
rigorous,  systematic,  continuous  and 
subject 
to  validation  based  on 
historical  experience,  including  back-

that 

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CRA I + CRA 
II reference 

CRA I (Regulation 1060/2009) 
and CRA II (Regulation 
513/2011) 

New initiatives (in 
addition to CRA 
Regulation)  

testing.  

Requiring  registered  CRAs  to 
notify  in  advance  any  change 
of  rating  methodologies.  Only 
after  a  positive  assessment  by 
ESMA  the  CRA  may  proceed 
with the new methodology.  

ESMA  shall  be  empowered  to 
restrict for a limited period the 
issuance  of  ratings  where  a 
sovereign 
financial 
requests 
support by the EFSF. 

Instrument 
where new 
policy will be 
included 

CRA III – Q4 
2011  

CRA III – Q4 
2011 

Art. 23(1) 

Principle  of  non 
interference: 
Prohibition  for  ESMA  or  any  other 
public  authority  to  interfere  with  the 
content 
or 
credit 
methodologies.  

ratings 

of 

TRANSPARENCY – DISCLOSURES 

The CRA Regulation sets various disclosure and transparency requirements in order to allow investors 
and issuers to properly understand rating actions and supervisors to assess the rating activity. Rules 
on the timing of rating publications shall ensure that all market participants are informed at the same 
time. 

Art. 10(1)  Disclosure  of  credit  ratings:  Any 
credit  rating  should  be  disclosed  on 
in  a 
a  non-selective  basis  and 
timely  manner  (also  applicable  to 
credit 
by 
subscription) 

distributed 

ratings 

CRA III – Q4 
2011 

Require  CRAs 
to  publish 
sovereign  debt  ratings  only 
after  the  close  of  business  of 
venues 
European 
all  market 
ensuring 
participants  can  obtain  a  full 
understanding of any change of a 
rating. 

trading 

that 

Art.8(1), 
Annex I.E.I.5 

Annex I 
D I 2 b 

Disclosure 
of  methodologies, 
models  and  key  assumptions  in 
use:  CRA required to disclose on an 
on-going  basis  the  methodologies, 
and  descriptions  of  models  and  key 
such 
rating 
as 
mathematical 
correlation 
assumptions  used  in  its  credit  rating 
activities  as  well  as  their  material 
changes.  

assumptions 

or 

Also  the  CRA  has  to  indicate  the 

72/193 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
CRA I + CRA 
II reference 

CRA I (Regulation 1060/2009) 
and CRA II (Regulation 
513/2011) 

New initiatives (in 
addition to CRA 
Regulation)  

Instrument 
where new 
policy will be 
included 

principle methodology that was used 
in determining a specific rating.  

Annex I 
D II 1-4 

the 

due 

Disclosure  obligations  in  relation 
to  credit  ratings  of  structured 
finance  instruments:  1.  provide  in 
the credit rating all information about 
loss  and  cash-flow  analysis;  2.  level 
it  has  performed 
of  assessment 
diligence 
concerning 
processes  carried;  3.  accompany  the 
disclosure  of  methodologies,  models 
and  key  rating  assumptions  with 
guidance which explains assumptions 
and uncertainties of the models used; 
4.  disclose,  on  an  ongoing  basis, 
information  about  all 
structured 
finance  products  submitted  to  it  for 
their initial review or for preliminary 
rating. 

the 

requirement 

Extend 
to 
and 
disclose  methodologies 
underlying  assumptions  behind 
ratings from structured finance 
products to all asset classes. 

Require the publication of clear 
reasoning  and  justification  for 
changes 
rating 
of 
methodologies. 

by 

errors 
or 

in 
Disclose 
their 
methodologies 
application 
requiring 
immediate  disclosure  directly  to 
the  affected  parties 
including 
investors,  issuers  and  competent 
authorities. 

Art. 10(3)  Differentiation 

of 

that  are  attributed 

structured 
finance ratings: When a CRA issues 
credit  ratings  for  structured  finance 
instruments, it shall ensure that rating 
categories 
to 
structured  finance  instruments  are 
an 
clearly 
differentiated 
additional 
which 
symbol 
rating 
them 
distinguishes 
categories used for any other entities, 
financial 
instruments  or  financial 
obligations.  

using 

from 

Annex I 
D (3) 

The  credit  rating  agency  shall 
inform  the  rated  entity  at  least  12 
hours before publication of the credit 

to 

inform 

issuers  and 
CRAs 
for 
specifically 
which  they  are  in  the  process  of 

sovereigns 

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CRA III – Q4 
2011 

CRA III – Q4 
2011 

 
 
 
 
 
 
 
 
 
 
 
 
 
CRA I + CRA 
II reference 

CRA I (Regulation 1060/2009) 
and CRA II (Regulation 
513/2011) 

New initiatives (in 
addition to CRA 
Regulation)  

Instrument 
where new 
policy will be 
included 

rating  and  of  the  principal  grounds 
on which the rating is based in order 
to  give  the  entity  an  opportunity  to 
draw  attention  of  the  credit  rating 
agency to any factual errors.  

issuing  a  rating  sufficiently  in 
advance  (12  working  hours)  of 
the  publication  of  the  rating,  of 
the  principle  grounds  on  which 
the rating is based.  

  Annex 

I.E.III.(3) 

A  credit  rating  agency  shall  make 
available  annually  statistics  on  the 
allocation  of  its  staff  to  new  credit 
reviews, 
ratings, 
methodology  or  model  appraisal  and 
senior management.  

rating 

credit 

In  addition,  require  CRAs  to 
publish 
the 
allocation  of  staff  to  ratings  of 
different asset classes. 

information  on 

CRA III – Q4 
2011 

Art. 
11(2), 
Annex 
I.E.II.1 

Historical performance data: CRAs 
to  make  available  every  six  months 
in a central repository established by 
ESMA  information  on  its  historical 
including 
performance  data 
the 
frequency  and 
transition 
ratings 
information  about  credit 
ratings 
issued  in  the  past  and  on  their 
changes. .  

III  – 

CRA 
Q4 2011 

the 

and 

CRAs  would  be  required  to 
the  actual 
publicly  disclose 
prices 
pricing 
their  ratings 
methodology  of 
services. CRAs will also have to 
ensure  that  the  prices  and  fees 
they charge for their services are 
(a)  not  discriminatory,  i.e.  fully 
based on the costs; (b) not based 
on any form of contingency. 

Harmonised  rating  scale  to  be 
including  a 
set  by  ESMA, 
common  definition  on  sovereign 
default. 

CRA III – Q4 
2011 

CRA III – Q4 
2011 

for 
Disclosure  requirements 
issuers  of  structured  finance 
products  will  be  on  an  ongoing 
basis,  enabling  the  disclosure  of 
the  main  elements  of  underlying 
asset pools for structured finance 
products  necessary  for  investors 
to  make 
credit 
assessment  and  thus  not  rely  on 
Issuers  will 
external 
disclose 
information  by 
means of a website. 

ratings. 
this 

their  own 

OVERRELIANCE ISSUES OUTSIDE CRA REGULATION 

  Enhanced internal risk management 

institutions, 

Credit 
investment 
firms,  insurance  and  reinsurance 

CRD IV – July 
2011; Solvency II 

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CRA I + CRA 
II reference 

CRA I (Regulation 1060/2009) 
and CRA II (Regulation 
513/2011) 

New initiatives (in 
addition to CRA 
Regulation)  

undertakings, asset managers and 
investment 
investment 
funds' 
decisions  must  not  rely  solely 
and  mechanistically  on  ratings 
but  always 
their  own 
form 
internal  credit  opinion  on  every 
exposure.  

Instrument 
where new 
policy will be 
included 

– Q1 2012; 
UCITS and 
AIFMD – Q2 -
2012 

Internal  ratings  based  approaches  to  calculate 
capital requirements 

Institutions  with  a  material 
number  of  exposures  in  a  given 
asset  class  will  need  to  develop 
internal models. 

CRD  IV  –  July 
2011;  Solvency 
II – Q1 2012 

  Verify external ratings internally 

Even  if  institutions  do  not  use 
they  will  be 
internal  ratings 
required 
their 
internal  credit  opinion  with  the 
capital 
resulting 
requirement 
from an external rating. 

compare 

to 

SOVEREIGN DEBT RATING ISSUES OUTSIDE CRA REGULATION 

  ECB and ESM 

independent 

Encourage  the  ECB  or  ESM  to 
credit 
establish 
for 
assessments,  particularly 
European 
and 
systemic credit institutions.  

sovereigns 

COMPETITION ISSUES OUTSIDE CRA REGULATION 

  A  network  of  European  small  and  medium  size 

rating agencies 

of 

Industry 

A  network  of  European  small 
and medium size rating agencies 
would  be  promoted  under  a 
European  Programme.  This 
could  consist  of 
the  future 
SME 
and 
Competitiveness 
programme to be established (as 
successor 
the  CIP 
programme)  by  the  Enterprise 
Directorate 
and 
General  or  by  the  "Horizon 
for 
2020" 
innovation 
actions 
managed  by  DG  Research;  in 
both  cases,  the  financing would 
be  possible  as  of  2014  at  the 
earliest.  This  network  would 
enable  participating  small  and 
medium rating agencies to share 
data,  best  practice  on  rating 
methodologies and resources. 

programme 
related 

CRD  IV  –  July 
2011;  Solvency 
II – Q1 2012 

EFSF 
Regulation 

The common 
strategic 
framework for 
research and 
innovation 
funding 
(Horizon 2020) 

or 

the new 
Competitiveness 
and SME 
programme for 
the continuation 
of the non-
innovative 
actions of the 
CIP 

75/193 

 
 
 
 
 
 
 
 
Annex II. Stakeholder Consultation 

1 – Summary of Responses to the Public Consultation Paper on new initiatives of CRAs 

The purpose of this annex is to summarise the responses to the Public Consultation on Credit 
Rating  Agencies  launched  by  the  European  Commission  services  on  5  November  2010  and 
closed  on  7  January  2011.  The  consultation  attracted  approximately  100  responses  from  a 
range  of  respondents  including  Member  States'  competent  authorities,  academics,  firms, 
citizens, registered and non-registered associations in addition to CRAs themselves. 

The  non-confidential  responses  to  the  consultation  are  published  on  the  EU  Commission's 
website: http://ec.europa.eu/internal_market/consultations/2010/cra_en.htm. 

The chart below shows the distribution of the approximately 100 respondents among different 
categories: 

Respondents to the public consultation on CRA3 - 2011

Regulators
8%

Other
2%

Academics
4%

Associations  
/Non Registered 
Organisations
9%

Governments
12%

Firms
6%

CRAs
9%

Citizens
8%

Associations / 
Registered 
Organisations
42%

1. OVERRELIANCE ON EXTERNAL CREDIT RATINGS 

1.1  Reference  to  external  ratings  in  regulatory  capital  frameworks  for  credit  institutions, 
investment firms, insurance and reinsurance undertakings 

Many responses echoed concerns about overreliance on ratings, and although there is support 
for reducing references to ratings in legislation gradually, so as to avoid a shock, even from 
some CRAs as well as some regulators. Respondents including regulators noted that part of 
the challenge will lie in finding suitable measures to  replace  them.   Using market measures 
instead  of  ratings  was  seen  as  inappropriately  pro-cyclical  and  volatile  by  many  including 
industry  groups  and  governments,  but  at  the  same  time  they  could  be  taken  into  account 

76/193 

 
 
 
 
 
 
 
 
 
 
 
alongside  other  measures  and  or  good  quality  ratings  according  to  national  regulators, 
governments,  banks  and  industry  groups.  Respondents  including  banks  also  felt  that  good 
quality  ratings  were  helpful  and  should  continue  to  be  used,  but  that  it  was  important  to 
incentivise  the  development  of  internal  ratings  abilities  for  firms  with  sufficient  resources.  
There  was  concern  from  respondents  such  as  investor  groups  and  governments  about  firms 
investing  in  instruments  whose  credit  risk  was  difficult  to  assess  independently,  although 
several  respondents,  especially  industry  representatives  felt  that  this  was  sufficiently 
addressed  in  CRD  II.  However  respondents  noted  that  risk  is  necessary  in  the  financial 
markets and that external ratings alongside internal ratings models could continue to be used 
so  long  as  they  were  of  reliable  quality.    There  was  opposition  to  the  idea  of  requiring 
multiple  ratings  from  most  sectors  of  respondents,  including  banks,  governments,  industry 
associations. 

Many  responses  drew  the  attention  to  ongoing  work  in  Basel  (in  particular  on  the  capital 
framework for securitisations) and suggested waiting for the outcome of this work.  

1.2 Use of external ratings for internal risk management purposes 

There was widespread support for a requirement for firms to conduct their own due diligence 
without  relying  exclusively  on  ratings  from  respondents  in  several  categories,  including 
industry associations, governments and regulators and rating agencies. However, there was a 
small  amount  of  concern  regarding  smaller  firms’  abilities  to  perform  such  analysis.  It  was 
mentioned  that  current  sectoral  legislation  already  contains  such  requirements  which  have 
recently  been  strengthened.  A  range  of  different  stakeholders,  among  them  governments, 
industry  associations  and  regulators,  offered  support  for  increased  transparency  including 
disclosure  of  firms’  reliance  on  external  ratings.  There  was  also  strong  support  for  all 
information used by CRAs for rating structured finance instruments to be made available to 
everyone  while  some  expressed  concern  about  the  costs  of  such  a  measure,  confidentiality 
issues  and  international  consistency.    While  there  were  mixed  views  on  whether  or  not 
sovereign debt ratings were based on publically available information – some felt that private 
meetings were also involved, or that even if based on public information, CRAs added value, 
not all respondents thought this meant that all firms would have the capacity to analyse this 
information similarly. 

1.3 Use of external ratings in the mandates and investment policies of investment managers 

There was considerable support for avoiding mechanistic use of ratings, with some regulators, 
governments  and  several  industry  associations  supporting  a  'flexibility  clause',  while  other 
respondents  from  the  same  groups  did  not  support  such  a  clause.  However,  industry 
associations,  several  governments  and  regulators  CRAs  were  mostly  cautious  regarding  the 
introduction  of  specific  legislation  to  mandate  flexibility  and  proportions  of  portfolios 
dependent on ratings, with support for market-led approaches and for investment managers to 
rely on their judgment. There was again caution from some governments, CRAs and industry 
groups  against  relying  on  market  data  to  measure  credit  risk,  though  few  proposals  for 
alternatives  to  external  ratings.    On  the  other  hand,  some  of  the  same  stakeholder  groups 
proposed that cautiously, and for the right assets only, market measures could be used. 

2. SOVEREIGN DEBT RATINGS 

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2.1 Enhance transparency and monitoring of sovereign debt ratings 

There  was  a  general  consensus  that  sovereign  issuers  should  not  receive  fundamentally 
different treatment to corporate issuers. There were calls from some governments and industry 
stakeholders  for  increased  transparency  regarding  methodologies  and  publication  of  the  full 
research reports underlying ratings, although a small number in this group opposed this idea.  
Some governments wished to propose a maximum period of time for the review of sovereign 
ratings. On the other hand, many respondents, across all stakeholder groups, including some 
rating agencies, was that sovereigns should not be treated significantly differently from other 
issuers,  albeit  a  few  stating  that  CRAs  should  be  more  alert  to  changes  in  all  cases.  The  3 
days’ notice measure, while supported by some Member States and regulators, caused to some 
others Member States and regulators concern, in particular because of risks of market abuse 
and conflict of interest issues. 

2.2 Enhanced requirements on the methodology and the process of rating sovereign debt 

In terms of ratings methodologies, there was strong support from various kinds of respondents 
for an improved transparency, and further calls to treat sovereign issuers in a similar way to 
corporate  issuers.  There  was  some  support  including  from  some  regulators  for  postponing 
publication until close of business, but on the other hand, many respondents, including other 
regulators  and  Member  States'  considered  this  less  effective  when  trading  continues  around 
the globe. Fewer respondents approached the issue of Member States not paying for ratings, 
with  no  real  discernible  trends  of  groups  in  favour  or  against: some  felt  that  this  would  not 
reduce  conflicts  of  interest,  while  others  supported  the  measures  and  asked  for  a  common 
European approach.  

3. ENHANCING COMPETITION IN THE CREDIT RATING INDUSTRY 

Overall, there was general concern about the lack of competition in the credit rating industry, 
but  caution  against  interventions  in  this  commercial  market,  with  importance  placed  on 
maintaining  a  level  playing  field.  On  the  other  hand  there  were  some  propositions  for 
increasing  competition,  such  as  driving  demand  by  requiring  more  ratings  by  a  greater 
number  of  agencies,  encouraging  specialists,  but  there  was  similarly  some  representation 
against specific legislation in this area.  

3.1 European Central Bank or National Central Banks  

There  was  opposition  among  a  wide  range  of  stakeholders  for  the  ECB  or  National  Central 
Banks  to  establish  ratings.  The  ECB  itself  appears  to  oppose  to  the  idea  to  publicly  issue 
ratings for reasons of independence. Governments and regulators, while some were supportive 
to this idea; others were sceptical of public sector involvement in the ratings sphere. 

3.2 New National Entrants  

A limited number of stakeholders responded in this area. Some governments, finance industry 
groups  said  that  if  such  an  option  would  be  pursued,  operational  independence  would  be  a 
key factor. On the other hands, some other governments, finance industry groups and CRAs 
were against state intervention to stimulate new entrants. 

3.3 Public/Private structures  

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Some Member States proposed the idea of Public/private structures to be further considered 
and  analysed.  At  the  same  time,  some  of  these  respondents  further  noted  the  problems  of 
credibility and conflicts of interest that could be caused by direct funding arrangements and 
which would need to be addressed. Some national regulators and several  private enterprises 
opposed the creation of a new European CRA.  

3.4 European Network of Small and Medium-sized Credit Rating Agencies 

There  was  some  support  from  a  group  of  Small  and  Medium-sized  CRAS  for  the  idea  of  a 
European Network of Small and Medium-sized Rating Agencies. However, some regulators, 
and governments felt this would not be effective.  

4. CIVIL LIABILITY OF CREDIT RATING AGENCIES 

Several  respondents  from  various  stakeholder  groups  encompassing  some  governments, 
regulators  and  banking  industry  bodies  supported  the  possibility  of  civil  liability  claims 
against  CRAs,  but  only  for  gross  negligence  or  intent.    Several  respondents  including 
respondents  from  all  stakeholder  groups  expressed  concerns  about  respecting  existing  legal 
systems,  and  the  difficulty  in  establishing  and  disruption  that  caused  by  simply  applying  a 
common  standard  across  all  of  them.  Taking  responses  as  a  whole  to  this  section,  there 
seemed  to  be  general  support  (with  the  notable  exception  of  the  CRAs  themselves,  arguing 
that  this  would,  for  instance,  increase  reliance)  for  the  notion  that  it  should  be  possible  to 
pursue civil action, in the case of both solicited and unsolicited ratings, but that this should be 
reserved  for  severe  cases  only,  not  simply  where  investors  suffer  loss.  Other  measures 
proposed  included  increased  regulatory  scrutiny  and  punishment  of  offenders.    There  was 
very little support for introducing the concept of an ‘incorrect’ rating. . 

5. POTENTIAL CONFLICTS OF INTEREST DUE TO THE “ISSUER-PAYS” MODEL 

Respondents  agreed  that  the  “issuer-pays”  model  inherently  contains  conflicts  of  interest, 
although  respondents  of  all  kinds  also  stated  that  it  should  be  possible  to  manage  and 
minimise these conflicts, and in addition, other models were also conflicted. 

5.1. “Subscriber/Investor-Pays” model  

Some  financial  firms  and  their  industry  bodies  felt  that  increasing  the  cost  of  investment 
risked  reducing  demand  for  securities.    Further  respondents  including  competent  authorities 
and governments noted that this model could reduce the independence of CRAs.   

5.2. “Payment-upon-results” model  

Some  national  authorities,  government  and  trade  bodies  of  financial  firms  were  opposed  to 
this idea and expressed scepticism as to the feasibility of implementing such a system.  One 
trade  body  and  one  national  authority  were  concerned  that  this  model  could  lead  to  the 
erroneous notion of "right" or "wrong" ratings. 

5.3. “Trading venues Pay” model  

There was some support from the academic sphere for this model. However, among market 
participants,  public  authorities  and  interested  third  parties,  this  model  was  not  a  favoured 

79/193 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
option,  especially  in  view  of  the  large  number  of  unlisted  securities  which  would  not  be 
covered. 

5.4. Government as Hiring Agent model  

Governments  responding  to  this  question  felt  that  this  model  had  negative  implications  for 
conflicts  of  interest.    There  were  also  concerns  about  cost  and  how  the  model  could  be 
operated. 

5.5. Public Utility model  

The  trade  bodies  and  public  authorities  responding  to  this  option  were  concerned  at  the 
expense of such an option, and some of these had concerns about increasing overreliance and 
regarding conflicts of interest, particularly rating of sovereign debt during a crisis. 
General outcome 

Overall,  throughout  the  responses  to  the  consultation,  there  were  occasional  calls  for  the 
Commission  to  wait  for  the  full  effect  of  CRA  I  and  CRA  II  to  become  known,  and  some 
respondents called for the work of the G20 and Basel to be taken into account.  

80/193 

 
 
 
 
 
 
 
 
 
2 – Roundtable on Credit Rating Agencies  

6 July 2011, Berlaymont Building, Rue de la Loi 200 – 1049 Brussels 

Summary of points raised in the roundtable 

The  purpose  of  the  roundtable  was  to  gather  views  from  various  shareholders  in  order  to 
shape  future  policy  in  the  field  of  credit  rating  agencies  (hereafter  referred  to  as  CRAs) 
complementing  existing  EU  regulation.  The  roundtable  was  chaired  by  Deputy  Director 
General  of  the  Directorate  General  for  Internal  Market  and  Services,  Mrs  Nadia  Calviño. 
Conclusions were drawn by Maria Velentza, Head of Unit of "Financial Stability" of the same 
Directorate  General.    It  was  attended  by  approximately  60  participants,  representing  all 
relevant  stakeholder  groups  (European  institutions  and  agencies,  Member  States,  rating 
agencies,  issuers,  including  various  industry  federations  and  representatives  of  the  financial 
services industry, academia etc).  

We  have  not  attributed  particular  statements  to  individuals  present,  but  have  tried  to 
represent  the  views  expressed  by  various  stakeholder  groups.    The  following  is  only 
intended as a summary of the discussion that occurred on this day, and does not try to 
represent  the  official  lines  taken  by  particular  industry  representatives,  bodies  or 
Member States. 

Overreliance on CRAs 

Issues debated: 

•  What  alternative  measures  of  credit  risk  could  be  used  instead  of  external  credit 
ratings?    Does  the  answer  differ  across  asset  classes:  corporate,  financial,  sovereign, 
structured finance?   

•  Should  alternative  measures  of  credit  risk,  including  internal  models  and  enhanced 

risk management, be used in isolation or in combination with external ratings? 

•  How  do  you  assess  transparency  and  data  availability  in  structured  finance?  Is  there 
enough  transparency  to  allow  financial  firms  to  assess  the  credit  risks  of  structured 
finance instruments themselves? 

In this section of the discussion, participants were unanimous on the importance of reducing 
overreliance on ratings, particularly mechanistic reliance.  Although there was consensus that 
action  should  be  taken,  some  participants  cautioned  against  overreacting  in  the  wake  of  the 
crisis.  

A number of participants said that market players including investors did not perform enough 
of  their  own  due  diligence  and  risk  analysis  or  did  not  have  sufficient  understanding  of 
ratings,.   

In  order  to  facilitate  improved  due  diligence  and  credit  risk  assessment,  many  proposed 
greater transparency and access to information.  However, some warned that simply providing 
more information would not lead to greater understanding and less overreliance, stressing the 
need  to  incentivise  market  participants'  own  due  diligence,  including  in  the  area  of  product 
innovation.  

Some participants raised the issue of intellectual property in relation to transparency, though 
not all agreed this was an issue. 

81/193 

 
 
 
 
 
 
 
A large number of participants said that references to ratings in legislation were important in 
driving overreliance and that they should be removed, though some called for this to be done 
gradually.  However,  the  general  consensus  was  that  removing  references  to  ratings  in 
legislation is just one step and is not an immediate cure. 

Some cautioned that a move to internal ratings could take time in order to first ensure quality 
or because such ratings would also be subject to conflicts and quality issues.  Some of these 
participants  mentioned  that  in  particular  some  SMEs  do  not  currently  have  the  capacity  to 
perform their own ratings and process large amounts of information. 

Participants  acknowledged  the  difficulty  in  finding  suitable  alternatives  to  ratings  in 
legislation. A few participants drew a link between overreliance and competition. In addition, 
the presence of ratings in private contracts, particularly in the asset management sector was 
raised, although this falls outside of the remit of EU legislation. 

A  number  of  participants  raised  the  importance  of  supervision  and  enforcement  to  ensure 
appropriate use of and to prevent overreliance on ratings. 

Sovereign debt ratings 

Issues debated: 

•  Do  you  agree  that  the  specificities  of  sovereign  debt  ratings  justify  enhanced 
requirements for sovereign debt ratings compared to other rating classes? If this is the 
case, what kind of requirements would you suggest? 

•  How can the transparency and monitoring of sovereign debt ratings be improved? 

•  How can investors' understanding of sovereign debt rating actions be enhanced? 

Many  participants  expressed  serious  concerns  with  some  sovereign  ratings  issued  by  large 
CRAs.  Some  referred  to  concrete  examples  of  recent  European  downgrades  that  they  found 
inexplicable  since  some  CRAs  appeared  to  fail  to  take  account  or  assess  in  a  consistent 
manner  all  relevant  information,  such  as  support  initiatives  and  other  factors,  when  issuing 
ratings.  Others  did  not  understand  why  major  rating  changes  were  made  when  no  new 
information  was  available.    Participants  said  that  some  ratings  issued  by  CRAs  were  'not 
logical', 'questionable' 'disruptive' and 'not credible'.   

Some participants countered that some inaccurate statements were made, and that ratings are 
imperfect  due  to  their  forward-looking  nature,  adding  further  that  methodologies  were 
publicly available. 

There  was  no  consensus  as  to  whether  sovereign  ratings  should  be  subject  to  a  specific 
regulation.  Some  participants  felt  that  sovereign  rating  should  be  distinguished  from  other 
rating classes, whereas others felt that it should not be treated differently. 

Some  said  it  was  important  to  take  into  account  spillover  effects  and  that  in  general,  more 
understanding of sovereign ratings was needed. 

One participant said that not only references to ratings in legislation, but risk weightings for 
sovereign  debt  had  encouraged  a  cycle  of  irresponsible  borrowing,  but  also  irresponsible 
lending. A few participants considered possible to set up a European body to rate sovereign 
debt, though others were against, stressing the importance of maintaining a level playing field. 

There  were  several  calls  for  increased  transparency.  There  was  general  consensus  on 
publication of full reports and explanation and justification behind sovereign rating changes, 
and also detail on the staff involved and time devoted to the rating.  

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There was opposition to the possible measure included in the consultation to requests 3 days' 
notice  to  be  given  for  sovereign  rating  changes,  mainly  because  of  market  abuse  risks.  
However, some called for notice to be given with sufficient working hours to respond, rather 
than the current 12 hour requirement. 

Some said it was important to increase competition to increase the number of opinions in the 
market. One participant suggested distinguish between issuer pays and investor pays models 
when drafting rules, as an advanced notice rule would not be suitable for an investor solicited 
rating. 

Enhancing competition in the CRA industry 

Issues debated: 

•  How can new players be encouraged to enter the credit rating agency sector? 

•  What are your views about creating a network of CRAs? Do you consider that such a 

network could help increase competition in the credit rating agency sector? 

•  What  are  your  views  about  creating  a  new  independent  European  Credit  Rating 

Agency? 

Many participants expressed concern at the oligopolistic structure of the credit rating market, 
despite the existence of strong regional or specialist players, and stressed the need to increase 
competition and to encourage more players in the market. One cited a past example of large 
corporations  downgraded  by  some  rating  agencies,  whereas  other  agencies  maintained 
investment  grade  ratings,  allowing  the  corporations  to  continue  to  raise  funding  and  to 
continue to be profitable today. Some noted the importance of local knowledge in this respect. 

A few participants said that more players would not necessarily improve competition or that 
more  competition  could  be  stimulated  within  the  current  structure.  One  participant  thought 
that more competition could worsen the quality of ratings, though this was contested by other 
participants. 

A representative of the European Parliament explained the proposals regarding the creation of 
a publicly supported new European rating agency in the form of a foundation for which the 
European Parliament requested the Commission to conduct an in-depth assessment. 

The  majority  of  participants  were  against  a  European  rating  agency  as  a  public  initiative, 
regardless of how it was funded. Some cited the long timeframe of around 10 years it might 
take for such an institution to gain credibility, while others thought it never would due to the 
questions about its independence and absence of conflicts of interest.  Some felt that one new, 
large player would not increase competition. Others felt it was not appropriate to give public 
support to one specific agency or project over the rest, as this would distort competition. 

A  number  of  participants  called  for  regulation  to  reduce  and  not  increase  barriers  to  entry. 
One  participant  noted  that  despite  private  ownership,  CRAs  have  an  important  public 
responsibility  and  should  base  their  actions  on  the  public  good.  One  proposed  stimulating 
more competition by promoting comparability of the performance of ratings issued by CRAs. 

Conflicts of interest in the issuer pays model 

Issues debated: 

•  What are your views about the model currently discussed in the US (selection of the 

CRA by an independent board)? 

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•  What  are  your  views  with  respect  to  a  regular  rotation  between  CRAs  in  order  to 

mitigate conflicts of interests due to the issuer-pays model? 

Some  participants  noted  that  no  model  is  free  of  conflicts  of  interest.    One  proposed  the 
creation of a private not for profit investor-pays model foundation, suggesting that by having 
several  stakeholders  with  different  interests,  conflicts  could  be  minimised.  Several 
participants called for more focus on conflicts in the registration process. 

Some participants called for greater transparency to counter conflicts. 

A few participants drew comparisons to the audit industry, with some advocating mandatory 
rotation. However others cautioned against this. A few participants cautioned against conflicts 
created  by  the  shareholding  structure  of  the  largest  CRAs,  and  the  similarity  between  their 
shareholders. 

One  said  that  the  issuer  pays  model  had  allowed issuers to bribe for favourable ratings, but 
this statement was strongly rejected by others. 

Civil liability of CRAs 

Issues debated: 

•  Do  you  think  that  credit  rating  agencies  should  be  held  liable  if  they  infringe 
negligently or intentionally the CRA Regulation, thereby causing damage to investors? 

•  Do  you  see  benefit  in  introducing  a  civil  liability  regime  for  CRAs  in  the  CRA 

Regulation or should national legal orders provide for such a regime? 

Some  supported  more  stringent  liability  for  CRAs,  a  few  drawing  parallels  to  the  audit 
industry.  A  standard  of  gross  negligence  or  intent  was  suggested.  The  opinion  was  also 
expressed  that  it  would  be  easier  to  pursue  liability  claims  against  CRAs  by  moving  to  an 
investor-pays based model. 

There  were  calls  in  various  parts  of  the  discussion  by  participants  for  CRAs  to  take 
responsibility for their actions, especially in view of the serious potential consequences. Some 
noted that CRAs can be sued, and that they sometimes are. 

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ANNEX III. INTERNATIONAL CONTEXT  

This  annex  contains  information  regarding  international  legislation  and  policy  initiatives  in 
the field of CRAs. 

1 – Overview 

At the international level, the International Monetary Fund released (October, 2010) a global 
financial  stability  report  with  a  specific  focus  on  sovereign  debt  ratings.138 The  Financial 
Stability  Board  (FSB)  has  endorsed  (October,  2010)  principles139 to  reduce  authorities’  and 
financial  institutions’  reliance  on  CRA  ratings  and  the  G20  already  approved  the  FSB's 
principles on reducing reliance on external credit ratings.140 

The  FSB  principles  cover  five  types  of  financial  market  activity:  prudential  supervision  of 
banks;  policies  of  investment  managers  and  institutional  investors;  central  bank  operations; 
private sector margin requirements; and disclosure requirements for issuers of securities. The 
goal  of  the  principles  is  to  reduce  the  "cliff"  effects  from  CRA  ratings  that  can  amplify 
procyclicality  and  cause  systemic  disruption.  The  principles  call  on  authorities  to  do  this 
through:  

•  Removing  or  replacing  references  to  CRA  ratings  in  laws  and  regulations,  wherever 

possible, with suitable alternative standards of creditworthiness assessment;  

•  Expecting  that  banks,  market  participants  and  institutional  investors  make  their  own 

credit assessments, and not rely solely or mechanistically on CRA ratings.  

The FSB has asked standard setters and regulators to consider next steps that could be taken 
to  translate  the  principles  into  policy  approaches  tailored  to  specific  financial  sectors  and 
market participants.  

The Basel Committee on banking supervision is currently working on specific policy actions 
to reduce reliance on ratings in the regulatory framework. The Toronto G20 statement on 26-
27  June  2010141 called  on  the  FSB  to  reduce  the  reliance  on  credit  rating  agency  (CRA) 
ratings,  and  on  the  Basel  Committee  to  address  adverse  incentives  arising  from  the  use  of 
CRA ratings in the regulatory capital framework. In response to this request, the Committee 
established  a  working  group  (the  Ratings  and  Securitisation  working  group)  to  review  the 
Basel  framework’s  reliance  on  ratings  and  made  several  recommendations  to  the  Basel 
Committee, most of which were ultimately included in the Basel III rules text.142  

138  

139  

140  

141  

142  

International Monetary Fund, World Economic and Financial Surveys Global Financial Stability Report, 
October 2010. Available from: http://www.imf.org/external/pubs/ft/gfsr/2010/02/pdf/text.pdf.  
FSB,  principles  for  reducing  reliance  on  CRA  ratings,  adopted  on  27  October  2010.  Available  from: 
http://www.financialstabilityboard.org/publications/r_101027.pdf.  
G20 Seoul Summit leaders' Declaration, 11-12 November 2010. Available from: 
http://www.g20.org/Documents2010/11/seoulsummit_declaration.pdf.  
G20, Toronto G20 summit declaration, 26-27 June 2010. Available from:  
http://www.g20.org/Documents/g20_declaration_en.pdf.  
These included, for example, proposals to remove or reduce certain cliff effects related to ratings from 
the internal-ratings based (IRB) approach and standardised approach (SA). In particular, the RS group 
is now working on addressing adverse incentives and cliff effects arising from the use of CRA ratings 
through:  (i)  the  recalibration  of  the  risk  weights  for  securitisation  exposures  under  the  ratings-based 
approach,  including  to  reduce  ‘cliff  effects’;  (ii)  the  review  of  the  hierarchy  of  approaches  in  the 
Securitisation framework with the aim of reducing the predominant role played by external ratings; and, 

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In parallel, the USA has also introduced more rigorous requirements on credit rating agencies. 
The  adopted  Dodd-Frank  Wall  Street  Reform  and  Consumer  Protection  Act 143  which 
strengthens  provisions  on  accountability  and  transparency  of  credit  rating  agencies  to  rate 
structured  finance  instruments144,  including  rules  on  corporate  governance,  presentation  of 
ratings, methodologies. In addition, Section 939A of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act requires federal agencies to review how existing regulations rely on 
credit ratings and remove such references from their rules as appropriate. The Securities and 
Exchange Commission145 (SEC) is currently exploring ways to reduce regulatory reliance on 
external credit ratings and replace them with alternative criteria. For instance, SEC proposed 
amendments  to  its  rules  that  would  remove  credit  ratings  as  one  of  the  conditions  for 
companies seeking to use  short-form  registration when registering securities for  public sale. 
One  of  the  criteria  that  allowed  US  issuers  to  use  this  registration  for  their  public  offerings 
was  that  the  securities  to  be  offered  had  to  be  rated  investment  grade  by  at  least  one 
NRSRO.146 

2 – Summary of FSB Report on overreliance to external credit ratings 

On 14th of October 2010, FSB has released a report to G20 Finance Ministers and Governors 
on reducing reliance on CRA ratings.147  

The  principles  have  been  developed  by  the  FSB,  in  consultation  with  international  standard 
setters: 

I. Reducing reliance on CRA ratings in standards, laws and regulations 

Standard setters and authorities should assess references to credit rating agency (CRA) ratings 
in  standards,  laws  and  regulations  and,  wherever  possible,  remove  them  or  replace  them  by 
suitable alternative standards of creditworthiness. 

II. Reducing market reliance on CRA ratings 

Banks, market participants and institutional investors should be expected to make their own 
credit assessments, and not rely solely or mechanistically on CRA ratings. 

III.1. Central bank operations 

Central banks should reach their own credit judgements on the financial instruments that they 
will  accept  in  market  operations,  both  as  collateral  and  as  outright  purchases.  Central  bank 
policies  should  avoid  mechanistic  approaches  that  could  lead  to  unnecessarily  abrupt  and 
large  changes  in  the  eligibility  of  financial  instruments  and  the  level  of  haircuts  that  may 
exacerbate "cliff" effects. 

III.2. Prudential supervision of banks 

Banks  must  not  mechanistically  rely  on  CRA  ratings  for  assessing  the  creditworthiness  of 
assets. This implies that banks should have the capability to conduct their own assessment of 

143  
144  
145  
146  

147  

(iii) the enhancement of internal assessment and due diligence requirements. Final proposals on these 
topics are expected to be completed in time for the September 2011 meeting of the Basel Committee. 
Dodd-Frank Wall Street Reform and Consumer Protection Act, 29 June, 2010.  
Ibid, Sec. 932. 
SEC Initiatives under New Regulatory Reform Law.  
SEC Proposes First in Series of Rule Amendments to Remove References to Credit Ratings, 9 February 
2011. Available from: http://www.sec.gov/rules/proposed/2011/33-9186.pdf.  
FSB  Report  on  Principles  for  Reducing  Reliance  on  CRA  Ratings,  27/10/2010.  Available  from: 
http://www.financialstabilityboard.org/publications/r_101027.pdf.  

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the  creditworthiness  of,  as  well  as  other  risks  relating  to,  the  financial  instruments  they  are 
exposed to and should satisfy supervisors of that capability. 

III.2.a. Larger, more sophisticated banks within each jurisdiction should be expected to assess 
the  credit  risk  of  everything  they  hold  (either  outright  or  as  collateral),  whether  it  is 
for investment or for trading purposes. 

III.2.b. Smaller, less sophisticated banks may not have the resources to conduct internal credit 
assessments for all their investments, but still should not mechanistically rely on CRA ratings 
and should publicly disclose their credit assessment approach. 

III.3.  Internal  limits  and  investment  policies  of  investment  managers  and  institutional 
investors 

III.3.a. Investment managers should conduct risk analysis commensurate with the complexity 
and  other  characteristics  of  the  investment  and  the  materiality  of  their  exposure,  or  refrain 
from  such  investments.  They  should  publicly  disclose  information  about  their  risk 
management approach, including their credit assessment processes. 

III.3.b.  Senior  management  and  boards  of  institutional  investors  have  a  responsibility  to 
ensure that internal assessments of credit and other risks associated with their investments are 
being  made,  and  that  the  investment  managers  they  use  have  the  skills  to  understand  the 
instruments that they are investing in and exposures they face, and do not mechanistically rely 
on  CRA  ratings.  Senior  management,  boards  and  trustees  should  ensure  adequate  public 
disclosure of how CRA ratings are used in risk assessment processes. 

III.3.c Regulatory regimes should incentivise investment managers and institutional investors 
to avoid mechanistic use of CRA ratings. 

III.4. Private sector margin agreements 

Market  participants  and  central  counterparties  should  not  use  changes  in  CRA  ratings  of 
counterparties or of collateral assets as automatic triggers for large, discrete collateral calls in 
margin agreements on derivatives and securities financing transactions. 

III.4.a.  Supervisors  should  review  the  margining  policies  of  market  participants  and  central 
counterparties to guard against undue reliance on CRA ratings. 

III.5. Disclosures by issuers of securities 

Issuers  of  securities  should  disclose  comprehensive,  timely  information  that  will  enable 
investors to make their own independent investment judgements and credit risk assessments 
of those securities. In the case of publicly-traded securities, this should be a public disclosure. 

III.5.a. Standard setters and authorities should review whether any references to CRA ratings 
in  standards,  laws  and  regulations  relating  to  disclosure  requirements  are  providing 
unintended  incentives  for  investors  to  rely  excessively  on  CRA  ratings  and,  if  appropriate, 
remove or amend these requirements. 

Next steps 

Standard setters and regulators should incentivise a transition to a reduced reliance on CRA 
ratings  over  a  reasonable  timeframe  extending  into  the  medium  term.  It  should  take  into 
account the need for market participants to build up their own risk management capabilities to 
replace reliance on CRA ratings. The milestones should be clearly visible. 

3 – Basel Committee on Banking Supervision 

Basel Committee on Banking Supervision 

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The  Basel  Committee  on  Banking  Supervision  is  an  institution  created  by  the  central  bank 
Governors of the Group of Ten nations. It was created in 1974 and meets regularly four times 
a year. 

The Committee's members come from Argentina, Australia, Belgium, Brazil, Canada, China, 
France,  Germany,  Hong  Kong  SAR,  India,  Indonesia,  Italy,  Japan,  Korea,  Luxembourg, 
Mexico,  the  Netherlands,  Russia,  Saudi  Arabia,  Singapore,  South  Africa,  Spain,  Sweden, 
Switzerland,  Turkey,  the  United  Kingdom  and  the  United  States.  The  Committee  usually 
meets  at  the  Bank  for  International  Settlements  (BIS)  in  Basel,  Switzerland,  where  its  12 
member  permanent  Secretariat  is  located.  The  Committee  is  often  referred  to  as  the  BIS 
Committee after its meeting location. However, the BIS and the Basel Committee remain two 
distinct entities.148 

The  Basel  Committee  formulates  broad  supervisory  standards  and  guidelines  and 
recommends statements of best practice in banking supervision (see bank regulation or Basel 
II  Accord,  for  example)  in  the  expectation  that  member  authorities  and  other  nations' 
authorities will take steps to implement them through their own national systems, whether in 
statutory form or otherwise. 

The purpose of the committee is to encourage convergence toward common approaches and 
standards. Dieter Kerwer reports that "the BCBS is not a classical multilateral organization. It 
has no founding treaty, and it does not issue binding regulation. Rather, its main function is to 
act as an informal forum to find policy solutions and to promulgate standards."149 

At present the IMF is collaborating with the Committee to improve bank regulation. 

The  Basel  committee  along  with  its  sister  organizations,  the  International  Organization  of 
Securities Commissions and International Association of Insurance Supervisors together make 
up the Joint Forum of international financial regulators. 

Basel II 

Basel II is an international initiative that requires financial services companies to have a more 
risk sensitive framework for the assessment of regulatory capital.  

The  Basel  Capital  Accord  sets  international  capital  adequacy  standards.  In  1988,  the  Basel 
Committee  on  Banking  Supervision  established  a  method  of  relating  capital  assets,  using  a 
simple system of risk weights and a minimum capital ratio of 8%. 

The planned implementation date for Basel II is December 2006 with parallel running from 
January  2006.  Banks,  academics  and  politicians,  particularly  in  the  USA  are  demanding 
changes to the draft rules, which they believe are too complex, overly prescriptive and costly. 
These changes may in turn cause delays to the implementation of the final Accord. 

Basel II is based on the concept of 3 Pillars: 

1. Minimum capital requirements 

2. Supervisory Committee 

3. Market Discipline    

148  

149  

Marrison, Chris (2002). The Fundamentals of Risk Measurement. New York, New York: McGraw Hill. 
pp. 340–342. 
Kerwer, Dieter (October 2005). "Rules that many use: standards and global regulation". Governance 18 
(4): 611–632. 

88/193 

 
 
 
                                                 
Basel  II  not  only  affects  traditional  finance  companies,  but  they  also  influence  other  areas 
such as the cost of project finance for Infrastructure Projects. 

Basel III 

The Toronto G20 statement on 26-27 June 2010 called on the FSB to reduce the reliance on 
credit rating agency (CRA) ratings, and on the Basel Committee to address adverse incentives 
arising from the use of CRA ratings in the regulatory capital framework. 

In  response  to  this  request,  the  Committee  established  a  working  group  (the  Ratings  and 
Securitisation working group) to review the Basel framework’s reliance on ratings and made 
several recommendations to the Basel Committee, most of which were ultimately included in 
the Basel III rules text. 

Basel III work on ratings and securitisation is planned to be finalised by the end of 2011. 

4  –  IOSCO  disclosure  principles  for  public  offerings  and  listings  of  asset-backed 
securities 

In April 2010, the International Organisation of Securities Commissions (IOSCO) published 
its Final Report on Disclosure Principles for Public Offerings and  Listings of  Asset-Backed 
Securities.  150    IOSCO  had  previously  decided  that  its  previously  published  disclosure 
requirements  did  not  fully  capture  all  the  information  needed  by  ABS  investors.    The 
principles are designed to be taken into account by securities regulators in the scope of their 
disclosure requirement regimes. The principles were developed within the remit of IOSCO's 
work  following  its  2008  Final  Report  on  the  Subprime  Crisis. 151 Poor  disclosure  and  poor 
investor  understanding  and  oversight  of  underlying  assets  in  ABS  were  significant 

150  

151  

The  full  report  can  be  viewed  at:  http://www.iosco.org/library/pubdocs/pdf/IOSCOPD318.pdf  and  a 
summary of the main points at: http://www.iosco.org/news/pdf/IOSCONEWS180.pdf. 
The full report can be viewed at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD273.pdf.  

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contributing factors to the Crisis.  The main areas of disclosure proposed by IOSCO for ABS 
are as follows: 

1. Parties Responsible for the Document;  

2. Identity of Parties Involved In the Transaction;  

3.  Functions  and  Responsibilities  of  Significant  Parties  Involved  In  the  Securitization 
Transaction;  

4. Static Pool Information;  

5. Pool Assets;  

6. Significant Obligors of Pool Assets;  

7. Description of the Asset Backed Securities;  

8. Structure of the Transaction;  

9. Credit Enhancement and Other Support, Excluding Certain Derivative Instruments;  

10. Certain Derivative Instruments;  

11. Risk Factors;  

12. Markets;  

13. Information about the Public Offering;  

14. Taxation;  

15. Legal Proceedings;  

16. Reports;  

17. Affiliations and Certain Relationships and Related Transactions;  

18. Interests of Experts and Counsel; and  

19. Additional Information.  

The guidance does not cover ABS where the asset pool is actively managed by the issuer. 

In the EU, the Prospectus Directive contains an Annex regarding the issuance of ABS. 

5 – Comparison of the existing regulatory frameworks for CRAs in EU and US 

Registration, supervision, enforcement power 

Requirement 

EU 

US 

Mandatory 
registration 

is 

required.  Activity 

This 
of 
unregistered  CRAs  and  use  of  their 
ratings 
is 
prohibited. (Art. 4(1), 14).  

regulatory  purposes 

for 

Not at this stage. However, the ratings 
of  a  non-registered  CRA  cannot  be 
used  for  regulatory  purposes.  The 
scope  of  use  of  credit  ratings  for 
regulatory  purposes  is  much  broader 
than in the EU therefore there is a big 
incentive to acquire NRSRO status. 

A  proposal  to  amend  the  registration 
requirements  is  included  in  the  Wall 
Street  Reform 
and  Consumer 
protection act of 2009. 

90/193 

 
 
 
Legal / physical 
presence 
requirement 

As  a  rule,  CRAs  need  to  be  legal 
persons established in the EU.  There is 
a  specific  regime  for  certified  CRAs, 
which  may  be  exempt 
the 
requirement  of  physical  presence.  
Endorsement  of  ratings  produced  by 
overseas  CRAs  is  possible.  (Art.  4,  5, 
14(1)). 

from 

No.  CRAs  to  promptly  furnish  the 
SEC  with 
legible,  complete,  and 
current  copies,  and,  if  specifically 
requested,  English 
translations  of 
records.  

Supervision by a 
public authority 

As of March 2010 competent authorities 
of  the  Member  States  with  CESR  co-
ordination. (Art. 22). 

The  SEC  has  statutory  authority  to 
oversee CRAs (NRSROs) as of 2007.  

ESMA  now  supervises  CRAs:  they 
must  register  with  ESMA  which  has 
including 
powers 
supervisory 
to 
requests, 
information 
personnel  and  inspection  powers  and 
the  CRAs  must  pay  fees  in  respect  of 
this supervision. 

access 

Yes. (Art. 36). 

Yes. 

Supervisory 
authority 
empowered to 
impose sanctions 

Organisational, corporate requirements 

Requirement 

EU 

US 

Rating policy 
review function 

Compliance 
function 

Independent 
members of the 
administrative or 
supervisory board  

There  is  a  requirement  for  an  internal 
function  to  review  the  methodologies, 
models  and  significant  changes 
to 
  This 
methodologies  and  models. 
function  should  be  independent  of  the 
business 
the 
independent  members  of  the  board. 
(Annex I.A.9). 

lines  and 

report 

to 

A  permanent  and  effective  compliance 
function operating independently of the 
business lines is required. This function 
must 
senior 
report 
to 
independent 
management 
members of the board. (Annex I.A.5-6). 

regularly 
the 

and 

least  1/3  but  not 

At 
than  2 
independent  members  required.  They 
have the specific task of monitoring the 
development  of  the  rating  policy  and 

less 

91/193 

Not envisaged.  

Bill  of  Restoring  American  Financial 
Stability  Act  proposed  by  Senate  in 
March 2010 proposes that SEC would 
be directed to issue rules under which 
registered  CRAs  have 
to  adopt 
procedures  for  the  development  and 
oversight of rating methodologies. 

Under  Dodd-Frank,  NRSROs  are 
required  to  establish  and  maintain 
internal  controls  over  methodologies, 
and produce a report on this.  

A  registered  CRA  should  designate  a 
compliance officer.  

Not  envisaged,  but  a  designated 
compliance  officer  is  responsible  for 
specific  monitoring  tasks  that  the  EU 
Regulation  attributes  to  independent 

 
 
 
internal 

methodologies,  effectiveness  of 
the 
systems, 
rating 
effectiveness of procedures dealing with 
conflicts  of  interest,  compliance  and 
governance processes. (Annex I.A.2). 

quality 

members. 

Wall  Street  Reform  Act  of  2009 
proposes  to  introduce  requirements 
for 
directors  with 
independent 
specific monitoring tasks. 

Conflicts of interest 

Requirement 

EU 

US 

General policy 

CRAs  are  to  ensure  that  conflicts  of 
interest will not affect ratings.  Actual 
or  potential  conflicts  of  interest  to  be 
(i) 
(ii.1) 
and 
eliminated  or  (ii.2)  properly  managed 
and in any case disclosed. 

identified 

either 

Conflicts of interest to be  

identified 

(i) 
(ii.1) 
and 
eliminated or (ii.2) properly managed 
and disclosed. 

either 

Some 
prohibited by law.  

conflicts  of 

(Annex I.B.1). 

interest 

are 

Some  conflicts  of  interest  prohibited 
by law.  

Prohibited conflicts 
of interest  

Ratings  not  to  be  issued  and  existing, 
potentially compromised ratings are to 
be immediately flagged as such when:  

A CRA is prohibited from having the 
following  conflicts  of  interest,  where 
it issues or maintains a rating: 

1)  CRA,  an  analyst  or  person 
approving ratings has direct or indirect 
entity 
ownership 
the 
schemes 
investment 
(collective 
excluded); 

rated 

in 

2) the rated entity is linked by control 
to CRA; 

3)  an  analyst  or  person  approving 
ratings  is  a member  of  supervisory or 
management board of the rated entity; 

4) an analyst, or person approving the 
ratings has had a relationship with the 
that  may  produce 
entity, 
rated 
conflicts of interest.  

(Annex I.B.3) 

1)  CRA  receives  10%  or  more  of  its 
net revenue from one entity;  

2) analyst or person approving ratings 
has  securities  or  any  other  direct 
ownership 
entity 
rated 
the 
in 
(sovereign issuers excluded); 

3) analyst or person approving ratings 
is  an  officer  or  director  of  the  rated 
entity; 

4)  CRA  associated  with  the  rated 
entity; 

CRA 

5) 
recommendations 
structure, 
activities  of 
securities; 

assets, 
the 

has 
on 

provided 
legal 
or 
the 

the 
liabilities 
issuer  of 

or 

6)  analyst  or  person  approving  the 
rating 
developing 
person 
methodologies for determining ratings 
has  negotiated  fees  with  the  rated 
entity; 

92/193 

 
 
 
 
 
 
 
 
 
7)  analyst  or  person  approving  the 
rating  receives  gifts  valued  at  above 
25$ in total.  

 In addition specific unfair coercive or 
abusive  practices  are  prohibited  (e.g. 
conditioning the issuance of rating on 
the purchase of another service by the 
CRA). 

Provision of 
consulting/advisory 
services   

It  is  prohibited  to  provide  consulting 
or advisory services to the rated entity 
or its related third party.  

Not prohibited but conflict of interest 
has  to  be  disclosed  and  properly 
managed.  

Provision of 
ancillary services   

(Annex I.B.4). 

(market 

provided 

Only  specific  ancillary  services  may 
be 
forecasts, 
estimates  of  economic  trends,  pricing 
analysis  and  other  general  data 
analysis as well as related distribution 
services).  The  CRA  is  to  ensure  that 
ancillary  services  do  not  present  a 
conflict  of  interest  with  the  rating 
activity  and  to  disclose  in  the  final 
rating  any  ancillary  services  provided 
to the rated entity. (Annex I.B.4). 

'Wall  Street  reform  act  proposes  to 
include  advisory  services  among 
prohibited activities. 

Provision  of  ancillary  services  to  the 
rated entities is qualified as a potential 
  CRAs  are 
interest. 
conflict  of 
required  to  disclose  in  form  NRSRO 
the  types  of  ancillary  services  they 
provide.    The  SEC  may  verify  if 
potential or actual conflicts of interest 
in this area are properly addressed.  

Rating staff 

Requirement 

EU 

US 

Compensation and 
performance 
evaluation of 
analysts 

Compensation 
performance 
and 
evaluation  of  analysts  is  not  to  be 
contingent  on  the  amount  of  revenue 
generated. (Art. 7(5)). 

Not envisaged but covered by general 
provision  to  disclose  and  manage 
conflicts of interest. 

Rating staff 
engagement in fee 
negotiations 

Rules on conduct 
of the staff 
engaged in the 
rating process 

Prohibited. (Art. 7(2)). 

Prohibited 
prohibited conflicts of interest). 

(included 

among 

is  prohibited  for 

-  It 
the  rating 
analysts  and  person  approving  the 
ratings  to  engage  in  any  transactions 
in  instruments  related  to  the  rated 
entity; 

-  It  is  prohibited  to  accept  money, 
gifts or favours from anyone the CRA 
does business with; 

The  following  are  not  allowed  as  a 
prohibited conflict of interest:  

2) analyst or person approving ratings 
has  securities  or  any  other  direct 
entity 
rated 
the 
in 
ownership 
(sovereign issuers excluded); 

7)  analyst  or  person  approving  the 
rating  receives  gifts  valued  at  above 
25$ in total; 

-  Handling  confidential  information 

93/193 

 
 
 
 
 
 
(incl. unpublished ratings); 

-  Look-back  reviews  of  ratings  when 
an  analyst  has  left  the  CRA  to  work 
for an entity it rates. 

(Annex I.C.1, 3, 4, 6) 

Rules excluding 
employees from 
the rating process  

and 

analysts 

Rating 
persons 
approving ratings are prohibited from 
being  engaged  in  rating  an  entity 
where  there  are  conflicts  of  interest 
arising 
financial 
instruments, 
employment, 
business or other relationships.  

owning 

recent 

from 

(Annex I.C.2) 

-  CRAs  expected  to  establish  and 
enforce  written 
and 
procedures  to  prevent  the  misuse  of 
material non-public information;   

policies 

- Look back reviews envisaged under 
the Wall Street Reform act in case an 
employee  of 
entity  was 
rated 
employed by CRA and participated in 
rating  activity  for  that  entity,  and 
there are disclosure requirements. 

The  following  are  not  allowed  as  a 
prohibited conflict of interest:  

2) analyst or person approving ratings 
has  securities  or  any  other  direct 
ownership 
entity 
rated 
the 
in 
(sovereign issuers excluded); 

3) analyst or person approving ratings 
is  an  officer  or  director  of  the  rated 
entity; 

7)  analyst  or  person  approving  the 
rating  receives  gifts  valued  at  above 
25$ in total. 

Rotation 

Rotation of rating staff is mandatory: 

Not envisaged. 

-  lead  rating  analyst  –  not  to  provide 
services  to  a  client  for  more  than  4 
years; 

- other rating analysts – not to provide 
services  to  a  client  for  more  than  5 
years; 

-  persons  approving  the  ratings  –  not 
to  provide  services  to  a  client  for 
more than 7 years. 

(Art. 7(4), Annex I.C.7). 

However,  there  is  a  general  rule  to 
prevent,  disclose  and  or  manage 
conflicts  of  interest.  The  procedure 
for managing conflicts of interest may 
include rotation mechanism. 

The Wall Street Reform Act proposes 
to direct SEC to undertake a study on 
rotation 
a 
mechanism. 

possible  mandatory 

Quality of ratings 

Requirement 

EU 

US 

CRAs' 
independence in 
determining their 
methodologies and 
the content of their 

Ensured.  Public  authorities  are  not  to 
interfere  in  the  methodologies  and 
content of ratings. (Art. 23(1)). 

94/193 

from 

Ensured.  SEC  and  state  authorities 
prohibited 
the 
substance  of  credit  ratings  or  the 
procedures  and  methodologies  for 
developing them. 

regulating 

 
 
 
 
 
 
 
ratings 

Monitoring activity:   Monitoring  of  ratings  required  on  an 
on-going  basis  (as  well  as  at  least  an 
annual review). (Art. 8(5)). 

Impact of 
methodology 
changes on existing 
ratings  

When  a  methodology,  model  or  key 
rating assumption is changed, a CRA 
is expected to: 

(a) 
immediately,  using  the  same 
means  of  communication  as  used  for 
the  distribution  of  the  affected  credit 
ratings,  disclose  the  likely  scope  of 
credit ratings to be affected; 

review 

(b) 
the  affected  credit 
ratings  as  soon  as  possible  and  no 
later than six months after the change, 
in the meantime placing those ratings 
under observation; and 

re-rate  all  credit  ratings  that 
(c) 
have 
those 
been 
based 
methodologies,  models  or  key  rating 
assumptions  if,  following  the  review, 
the  overall  combined  effect  of  the 
changes affects those credit ratings. 

on 

(Art. 8(6)). 

NRSROs  will  be  required  to  ensure 
that  methodologies  used  for  ratings 
are  approved  by  the  Board  (Section 
15(E)(r)(1).   

CRAs  are 
to  disclose 
required 
procedures  for  monitoring,  reviewing 
and  updating  the  ratings  including 
how frequently ratings are reviewed. 

NRSRO Boards required under Dodd-
Frank  to  ensure  that  the  internal 
control system, including with respect 
to  policies  and  procedures 
for 
determining  credit  ratings.  (Section 
15(E)(t)(3).  

CRAs  are  required  to  disclose  if 
changes  made  to  models  and  criteria 
for  determining  initial  ratings  are 
existing 
applied 
ratings. 

retroactively 

to 

New  legislation  (Wall  Street  Act, 
Restoring  the  Financial  Stability  act) 
contains 
that  material 
changes  to  methodology  have  to  be 
applied in a consistent manner (CESR 
advice paragraph 627). 

proposal 

NRSROs  will  be  required  to  apply 
such  changes  to  all  relevant  ratings 
within  a  reasonable  time  determined 
by the SEC (Section 15E(r)(2)(A) and 
(B).    In  line  with  this  requirement, 
NRSROs  will  have  to  immediately 
disclose  the  likely  scope  of  ratings 
affected 
to 
such 
methodology  by  the  same  means  as 
the ratings were distributed, including 
disclosure  of  errors  that  have  been 
discovered. 

changes 

by 

Quality of data used   A  CRA  is  expected  state  clearly  and 
prominently  when  disclosing  any 
credit  rating  whether 
it  considers 
satisfactory the quality of information 
available  on  the  rated  entity  and  to 

CRAs  required  to  give  a  description 
of  the  public  and  non-public  sources 
of  information  used  in  determining 
credit  ratings,  including  information 
and  analysis  provided  by  third-party 

95/193 

 
 
 
 
 
 
 
what extent it has verified information 
provided to it by the rated entity or its 
related third party.  

it 
the 

For  structured  finance  instruments,  a 
CRA is expected to state what level of 
performed 
assessment 
concerning 
diligence 
processes  carried  out  at  the  level  of 
underlying  financial  instruments  or 
other  assets  of  structured  finance 
instruments.  

has 
due 

(Annex I.D.I.4, I.D.II.2). 

vendors;  whether  and,  if  so,  how 
verification 
about 
information 
performed  on  assets  underlying  or 
referenced  by  a  security  or  money 
market  instrument  issued  by  an  asset 
pool or as part of any asset-backed or 
mortgage-backed 
securities 
transaction is relied on in determining 
credit ratings.  

Wall  Street  Reform  Act  proposes  to 
introduce requirement to disclose on a 
rating  by  rating  basis  information  on 
the reliability, accuracy and quality of 
the data relied on in the determination 
of the rating (CESR advice para 650).  
Under  Dodd-Frank,  NRSROs  will  be 
required  to  assess  the  quality  of  the 
information relied on, and publish this 
information  alongside  any  ratings 
issued (Section 15E(s). 

NRSROs  will  also  be  obliged  to 
consider  information  from  sources 
other  than  issuers  and  underwriters 
where 
(Section 
15(E)(v). 

is  credible 

this 

In  addition,  the  SEC  is  required  to 
adopt rules including requiring CRAs 
to  publish  a  statement  including  the 
extent  to  which  essential  data  was 
available  (which  may  be  especially 
relevant  in  unsolicited  ratings)  and 
limits on historical data. 

Not envisaged. (653). 

Limits to rating 
activity 

CRAs  shall  refrain  from  issuing  a 
rating  or  withdraw  an  existing  rating 
when there is a (i) lack of robust data; 
(ii) complexity of a structure of a new 
instrument; (iii) unsatisfactory quality 
serious 
of 
questions  as  to  whether  a  credible 
rating  can  be  produced. 
(Annex 
I.D.I.4). 

information  or 

that 

Transparency and disclosures 

Requirement 

EU 

US 

Disclosure of rating 
actions 

If ratings are intended for distribution 
channels  or  for  the  public,  any  rating 

 A CRA is required to disclose credit 
ratings  on  the  internet  or  through 

96/193 

 
 
 
 
 
 
 
decision  should  be  disclosed  on  a 
non-selective  basis  and  in  a  timely 
manner. 
the 
(also  applicable 
subscriber-pays model) 

to 

other  accessible  means  in  order  to 
meet the statutory definition of "credit 
rating agency" (736 ff). 

(Art. 10(1)). 

Not envisaged.  

Disclosure of full 
ratings history 

 From June 2010 CRAs must publicly 
disclose  on  their  website  the  rating 
history  information  for  all  ratings 
determined  by  the  CRA  after  June 
2007 ("100% requirement") (795 ff). 

Differentiation of 
structured finance 
ratings  

to 

structured 

When a CRA issues credit ratings for 
structured finance instruments, it shall 
ensure  that  rating  categories  that  are 
attributed 
finance 
instruments  are  clearly  differentiated 
using  an  additional  symbol  which 
distinguishes 
rating 
them 
categories used for any other entities, 
financial 
instruments  or 
financial 
obligations. (Art. 10(3)). 

from 

Currently  there  is  no  differentiation 
required.    This  proposal  has  been 
deferred  in  Nov  2009.  Now  the  SEC 
is  investigating  alternative  measures 
to differentiate SF from other ratings, 
e.g. 
of 
information  (see  CESR  advice  854 
ff). 

disclosure 

enhanced 

Dodd-Frank  provisions  capture  most 
structured  finance  ratings  through  a 
definition  of  'asset  backed  securities', 
with required actions including use of 
symbols  to  differentiate  structured 
finance  ratings  from  others  (Section 
of 
15E(s)(1)(B)), 
on 
assumptions 
volatility 
(Section 
15E(s)(3). 

disclosure 
and  warnings 

ratings 

of 

Disclosure of 
methodologies, 
models and key 
assumptions in use 

CRAs  are  required  to  disclose  on  an 
on-going  basis 
the  methodologies, 
and  descriptions  of  models  and  key 
rating 
as 
such 
correlation 
mathematical 
assumptions  used  in  its  credit  rating 
activities  as  well  as  their  material 
changes. (Art. 8(1), Annex I.E.I.5). 

assumptions 
or 

CRA  must  also  indicate  the  principle 
in 
methodology 
determining a specific rating (Annex I 
D I 2 b). 

that  was  used 

97/193 

the 

with 

credit 

the  CRA 

for  which 

A  general  description  is  required  of 
the  procedures  and  methodologies 
used  by  the  CRA  to  determine  credit 
ratings,  including  unsolicited  credit 
ratings  within  the  classes  of  credit 
ratings 
is 
registered.  The  description  must  be 
sufficiently  detailed  to  provide  users 
an 
ratings 
of 
understanding 
processes 
of 
employed by the CRA in determining 
credit  ratings,  including  in  particular 
descriptions  of    (…)  the  quantitative 
and  qualitative  models  and  metrics 
used 
to  determine  credit  ratings, 
including  whether  and,  if  so,  how 
assessments  of 
the  quality  of 
originators  of  assets  underlying  or 
referenced  by  a  security  or  money 
market  instrument  issued  by  an  asset 
pool or as part of any asset-backed or 
securities 
mortgage-backed 
the 
transaction 

factor 

into 

 
 
 
 
determination  of  credit  ratings;  the 
methodologies by which credit ratings 
of  other  credit  rating  agencies  are 
treated to determine credit ratings for 
securities 
or  money  market 
instruments issued by an asset pool or 
as  part  of  any  asset-backed  or 
mortgaged-backed 
securities 
transaction.  

Further  disclosure  requirements  on  a 
rating  by  rating  basis  proposed  in 
Wall  Street  Reform 
(e.g. 
disclosure on the sensitivity of ratings 
to assumptions made by CRA, (733)). 

act 

Envisaged  as  disclosure  on  website. 
(1,  3,  10  year  horizon  required  for 
each  rating  category).  Methods  used 
for 
to  be  publicly 
calculation 
explained. (790). 

Proposed  amendments  under  Wall 
Street  Reform  act  will  direct  SEC  to 
to  disclose 
each  CRA 
require 
information 
historical 
on 
performance of each rating (799 ff). 

the 

Historical 
performance data 
(default and 
transition studies)   

CRAs  are  to  make  available  in  a 
repository  established  by 
central 
CESR  historical  performance  data 
ratings 
including 
transition 
the 
frequency  and 
information  about 
credit ratings issued in the past and on 
their  changes.  Data  on  the  historical 
default rates of its rating categories to 
be  provided  every 
six  months. 
A credit  rating  agency  shall  provide 
information  to  that  repository  on  a 
standard  form  as  provided  for  by 
CESR.  CESR 
that 
information  accessible  to  the  public 
summary 
publish 
and 
shall 
information 
main 
on 
developments  observed  on  an  annual 
basis. (Art. 11(2), Annex I.E.II.1). 

shall  make 

the 

Standards on 
presentation of 
rating reports 

Envisaged. (Annex I.D.I). 

Envisaged. 

Record keeping obligations 

Requirement 

EU 

US 

Internal records 
retention period 

Internal  records  must  be  kept  for  at 
least 5 years (Annex I.A.8). 

Internal  records  must  be  kept  for  3 
years. 

Other issues 

Requirement 

EU 

US 

Notching practice 
(discriminatory 
treatment of ratings 
issued by other 
CRAs in situations 
where they could be 
used in the CRA's 

CRAs are prohibited to refuse to issue 
a  rating  of  an  entity  or  a  financial 
instrument  because  a  portion  of  the 
entity  or  the  financial  instrument  had 
been  previously  rated  by  another 
CRA. All instances of downgrades of 
structured 
underlying 

assets 

or 

following 

The 
is  prohibited  as 
anticompetitive  behaviour:  Issuing  or 
threatening  to  issue  a  lower  credit 
rating,  lowering  or  threatening  to 
lower  an  existing  credit 
rating, 
refusing  to  issue  a  credit  rating,  or 
to 
withdrawing 

threatening 

or 

98/193 

 
 
 
 
 
rating process)  

finance  instruments  shall  be  recorded 
and justified. (Art. 8(4)). 

Shopping for ratings   CRAs  are 

to  disclose  publicly 
information  about  structured  finance 
instruments  for  which  preliminary 
ratings  where 
(Annex 
I.D.II.4). 

requested. 

withdraw a credit rating, with respect 
securities  or  money  market 
to 
instruments issued by an asset pool or 
as  part  of  any  asset-backed  or 
mortgage-backed 
securities 
transaction,  unless  all  or  a  portion  of 
the assets within such pool or part of 
such  transaction  also  are  rated  by  the 
CRA, where such practice is engaged 
in by the CRA for an anticompetitive 
purpose. 

Under  agreement  between  the  New 
York Attorney General and the CRAs 
of  2008,  the  latter  would  charge  fees 
even  if  the  client  did  not  request  a 
rating after a "test rating". Under U.S. 
Treasury  proposal,  an  issuer  will  be 
required 
the 
preliminary  ratings  it  had  received 
from different credit rating agencies. 

to  disclose  all  of 

6 – Regulatory Changes in the US vs. EU new initiatives on credit rating agencies 

The  Dodd-Frank  Wall  Street  Reform  and  Consumer  Protection  Act  (Dodd)  devotes  a 
subsection  to  the  improvement  of  Nationally  Recognised  Statistical  Rating  Organisations 
(NRSRO)  regulation.  The  act  will  require  changes  in  the  way  the  SEC  regulates  NRSRO 
internal  control  and  procedures,  conflicts  of  interest,  rating  methodologies  and  their 
transparency  and  performance,  rating  analyst  training,  rating  symbols  and  disclosure  when 
issuing ratings of ABS. 

Many aspects of the reform are not decided in the regulation itself, but rule-making details are 
delegated to the Security and Exchange Commission (SEC). On 18 May the SEC published a 
consultation  paper  on  the  proposed  implementing  rules  for  a  2  months  consultation  period. 
The final SEC rules are expected to enter into force by end of 2011. 

A new Office of Credit Ratings is being established at the SEC which will register them and 
can fine or de-register them. It will also carry out annual examinations of NRSROs and write 
reports about the results, as well as conduct studies on NRSROs regarding their independence, 
possible conflicts of interest and the standardising of ratings terminology.  

US legislation vs. EU new initiatives on CRAs  

Problem 
area 

1. Reducing 
overreliance 
on external 
ratings 

US legislation 

EU new initiatives 

Removing  many  of  the  statutory  /  mandatory 
requirements  for  ratings  (from  Federal  Deposit 
Investment  Company  Act, 
Insurance  Act, 
Security  Exchange  Act,  et  al.)  or  replace  them 
with alternative “ standards of credit worthiness” 
as defined by the appropriate regulator.  

• 

Alternative standards of creditworthiness: 

 Internal  risk  credit  management 

• 
will be enhanced 

institutions, 

Credit 
investment  firms, 
insurance  and  reinsurance  undertakings, 
asset  managers  and  investment  funds' 
investment decisions must not rely solely 
ratings  but 
and  mechanistically  on 

152  

Report on Review of Reliance on Credit Ratings, July 2011, SEC staff. 

99/193 

 
 
 
 
 
 
 
                                                 
Problem 
area 

US legislation 

EU new initiatives 

always  form  their  own  internal  credit 
opinion on every exposure. (instruments: 
CRD  IV  –  July  2011;  Solvency  II  –  Q1 
2012; UCITS and AIFMD – Q2 -2012)  

Internal 

• 
based 
approaches  will  be  used  to  calculate 
capital requirements 

ratings 

Institutions  with  a  material  number  of 
exposures in a given asset class will need 
to develop internal models. (instruments: 
CRD  IV  –  July  2011;  Solvency  II  –  Q1 
2012) 

External  ratings  will  be  verified 

• 
internally 

Even  if  institutions  do  not  use  internal 
ratings they will be required to compare 
their  internal  credit  opinion  with  the 
capital  requirement  resulting  from  an 
external rating.  (instruments: CRD IV – 
July 2011; Solvency II – Q1 2012) 

on the national level, US federal banking agencies 
issued an advance notice of proposed rulemaking 
(ANPR) regarding alternatives to the use of credit 
ratings  in  regulatory  capital guidelines  in August 
2010,  in  response  to  section  939A  of  the  Dodd-
Frank  Act.  The  Act  requires  federal  agencies  to 
assess  regulations  and  substitute  references  to  or 
requirements  for  credit  ratings  with  alternative 
standards  of  creditworthiness,  that  are  uniform 
where  feasible.  The  federal  agencies  (including 
SEC) also conducted a roundtable to promote the 
the  development  of 
exchange  of 
alternative 
in 
standards 
November 2010. 

creditworthiness 

ideas  on 

• 
Investment  managers  and  institutional 
investors: in March 2011, the SEC proposed rules 
that would no longer require a CRA rating for the 
determination of which securities are permissible 
investments for a money market fund, and instead 
would  rely  on  the  determination  by  the  fund’s 
board  that  the  security  presents  minimal  credit 
risks. 

• 
Residential  and  commercial  mortgage 
backed  securities  in  functional  regulation:  US 
state  insurance  regulators  no  longer  use  CRA 
ratings  for  residential  and  commercial  mortgage 
backed securities in functional regulation. Rather, 
independent  third  parties  have  been  engaged  by 
the  National  Association 
Insurance 
Commissioners  to  model  potential  losses  on 
regulated 
insurance  companies’  RMBS  and 
CMBS portfolios. 

of 

Further  measures  to  reduce  reliance  have  been 
highlighter  in  the  Report  on  Review  of  Reliance 
on Ratings152: 

• 
Permission  to  register  primary  offerings 
of non-convertible securities by eligible issuers in 
forms forms S-3 and F-3 under the Securities Act: 
reference  to  NRSRO  is  proposed  to  be  replaced 
by the criterion that "the issuer has issued at least 
$1  billion  of  non-convertible 
securities". 
Equivalent changes or just deletions of references 
were made in forms S-4 and F-4; F-9; Rule 134, 
138, 139 and 168; schedule 14A. 

in 

Changes 

rules  and 

• 
forms  under 
Investment Company Act of 1940. References to 
credit ratings assigned by a single NRSRO in the 
presentation  of  portfolio  holdings 
the 
shareholder reports (forms N-1a, N-2 nd N-3) are 
proposed  to  be  replaced  by  funds  that  choose  to 
use credit quality categorizations. 

in 

• 

Changes 

in 

rules  and 

forms  under 

100/193 

 
 
 
 
Problem 
area 

US legislation 

EU new initiatives 

Exchange  Act.  In  the  prescription  of  minimum 
net  capital  requirements  for  broker-dealers  (Rule 
15c3-1, referred to as the "Net Capital Rule"), all 
references  to  credit  ratings  are  substituted  by  a 
standard  of  credit-worthiness:  a  broker-dealer 
take a 15% haircut on its proprietary positions in 
certain 
the  broker-dealer 
establishes,  maintains  and  enforces  written 
policies 
to 
and  procedures,  which 
determination  that  the  investment  has  only  a 
"minimal amount of credit risk".  

securities,  unless 

lead 

It  is  also  proposed  in  the  Appendix  to  the  Net 
Capital  Rule  to  delete  references  to  NRSRO 
ratings 
term  "major  market  foreign 
in 
currency".  

the 

In  Appendixes  E,  G  and  F,  which  deal  with 
alternative  approaches  to  computing  net  capital, 
SEC  proposed  to  replace  references  to  NRSRO 
ratings  by  risk  weight  (20%,  50%,  etc.)  Also,  an 
OTC  derivatives  dealer  would  be  required  to 
request  SEC  approval  to  determine  credit  ratings 
using  internal  ratings  rather  than  ratings  by 
NRSROs. 

Regarding  integrity  of  the  securities  trading 
market,  rules  101  and  102  of  Regulation  M  are 
proposed  to  be  changed.  References  to  credit 
ratings  in  these  rules  are  replaced  with  new 
standards relating to the trading characteristics of 
covered  securities.  Specifically,  the  Commission 
proposed to except nonconvertible debt securities, 
nonconvertible  preferred  securities,  and  asset-
backed securities from Rules 101 and 102 if they: 
(1) are liquid relative to the market for that asset 
class;  (2)  trade  in  relation  to  general  market 
interest  rates  and  yield  spreads;  and  (3)  are 
relatively  fungible  with  securities  of  similar 
characteristics and interest rate yield spreads. The 
proposal  would  require  a  determination  to  be 
made  using  reasonable  factors  of  evaluation  and 
the  determination  must  be  subsequently  verified 
by an independent third party. 

Further  removal  of  references  to  NRSROs  were 
made in rules 15c3-3 and rule 10b-10. 

• 
Further  considerations  are  made  by  SEC 
on the following rules: form S-3 under Securities 
Act,  Rule  3a-7  under  Investment  Company  Act 
and Rule 206(3)-3T under the Advisers Act 

2. Sovereign 
debt ratings 

specific 

action.  However, 

No 
on 
methodologies  and  process  of  issuing  ratings  to 
be strengthened (independent of rating class). E.g. 
CRA will be required to publish the reasons for a 
methodology change and have to inform investors 

rules 

ECB or ESM 

The ECB or ESM will be encouraged to 
establish independent credit assessments, 
particularly for European sovereigns and 

101/193 

 
 
 
 
Problem 
area 

3. Enhancing 
competition 

4. Civil 
liability 

5. Conflicts 
of interest 

US legislation 

EU new initiatives 

about 
methodologies. 

any 

significant 

errors 

in 

rating 

systemic credit institutions. (Instruments: 
EFSF Regulation) 

A  modification  to  rule  17g-5  of  the  Securities 
Exchange  Act  of  1934  expressly  addresses 
competition where an issuer or arranger pays for a 
rating for structured finance product.  The aims to 
increase  ratings  issued  for  structured  finance 
products and to increase unsolicited ratings.  The 
rule will require the issuer, sponsor or underwriter 
of  structured  finance  products  to  maintain  a 
information 
constantly  updated  website  of 
relevant to the rating or monitoring of the rating.  
This website will be accessible to other NRSROs 
not hired to issue the rating, so that they can issue 
unsolicited ratings.  Other NRSROs accessing the 
information will be obliged to issue and maintain 
ratings  for  10%  of  the  products  for  which  they 
access information. 

Increasing liability of NRSROs if they recklessly 
or  knowingly  failed  to  conduct  a  reasonable 
investigation 
its 
methodology  or  verify  them  if  obtain  from  other 
parties. 

facts  used  by 

into 

the 

Provisions  are  included  to  reduce  conflicts  of 
interests among employees of NRSROs. The SEC 
is 
the 
tasked  with  conducting  a  study  on 
appropriate  methods  of  paying  fees  to  NRSROs 
and  the  resulting  conflicts  of  interest  by  mid-
2012, and on that basis, deciding on a rule of how 
to  select  a  NRSRO  for  an  initial  rating  of 
structured finance product. 

Concerning  the  "issuer-pays"  model,  the  SEC  is 
exploring  the  option  of  creating  a  Credit  Ratings 
Board  to  designate  credit  rating  agencies  to  rate 
structured finance instruments. 

102/193 

A  network  of  European  small  and 
medium size rating agencies 

the 

A  network  of  European  small  and 
medium  size  rating  agencies  would  be 
promoted under a European Programme. 
This  could  consist  of 
future 
Competitiveness and SME programme to 
be  established  (as  successor    of  the  CIP 
the  Enterprise  and 
programme)  by 
Industry  Directorate  General  or  by  the 
"Horizon 
for 
innovation  related  actions  managed  by 
the 
DG  Research; 
financing  would  be  possible  as  of  2014 
at  the  earliest.  This  network  would 
enable  participating  small  and  medium 
to  share  data,  best 
rating  agencies 
practice  on  rating  methodologies  and 
resources. 

in  both  cases, 

programme 

2020" 

The  right  of  redress  will  be  ensured  to 
investors (Instrument: CRA3) 

Rotation of CRAs. 

An  issuer's  own  credit  worthiness  could 
not be rated by the same CRA for more 
than 3 consecutive years.  Another CRA 
would 
the 
outgoing  CRA  and  the  issuer  would 
make  available  all  information  accessed 
in the rating process. (CRA3) 

thereafter  and 

take  over 

A  CRA  would  not  be  able  to  rate  more 
than  5  consecutive  issues  of  any  asset 
class by the same issuer, or if fewer than 
5 issues are made, it would not be able to 
rate the issues of one issuer over a period 
exceeding 3 years.   

to 

in 

relation 

requirements  will 

Additional 
be 
introduced  on  CRAs'  independence  and 
objectivity 
their 
shareholders.  ESMA  would  be  required 
to ensure that: (1) shareholders could not 
either  individually  or  in  voting  blocs 
accrue  potentially  controlling  stakes  in 
more  than  one  CRA,  (2)  that  CRAs 
could  not  issue  ratings  for  any  firm  that 
holds shares in that CRA, even indirectly 
(3) any person that directly or indirectly 
controls a CRA would not be allowed to 
invest  in  products  and  entities  rated  by 
to  provide  advisory 
the  CRA  and 

 
 
 
 
 
 
 
 
 
Problem 
area 

US legislation 

EU new initiatives 

services  to  the  entity  which  or  whose 
products were rated. 

103/193 

 
 
 
ANNEX IV. OVERVIEW OF CRA MARKET 

1 – CRAs in the EU  

Pursuant  to  Regulation  1060/2009,  all  CRAs  operating  in  Europe  will  have  to  register  with 
ESMA. Therefore, while there are eight CRAs that have currently completed the registration 
process,  there  were  23  applications  made  between  7  June  2010  and  7  September  2010,  in 
respect  of  45  legal  entities,  so  the  number  of  registered  CRAs  is  expected  to  rise  as  the 
applications are processed.153 

List of registered or certified CRAs 

153  

CESR Annual report according to article 21 of Regulation (EC) 1060/2009 on Credit Rating Agencies, 
CESR/10-1424, 6 December 2010.  

104/193 

 
 
 
 
                                                 
Source:  List  of  Credit  Rating  Agencies  registered  in  accordance  with  Regulation  1060/2009, 
accessible at http://www.esma.europa.eu/popup2.php?id=8035. Last update: 31.10.2011 

CRAs that currently provide sovereign debt ratings154 

Standard & Poor’s with subsidiaries in: FR, DE, IT, ES, SE, UK 

Moody’s with subsidiaries in: CY, CZ, FR, DE, IT, ES, UK 

Fitch with subsidiaries in: FR, DE, IT, PL, ES, UK 

DBRS  

Capital Intelligence Limited (CY) 

Japan Credit Rating Agency Ltd. (JP) 
External Credit Assessment Institutions (ECAI)155's approved by the competent authorities156  

154  

155  

156  

This  list  lists  EU  based  CRAs  which  are  currently  providing  sovereign  debt  ratings.  It  may  not  be 
complete and also other CRAs may start rating sovereign debt ratings.  
As defined in article 81 of 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 business of credit institutions (recast). 
ECB response to the public consultation on CRAs: NCBs’ contributions as of 13 July 2010. 

105/193 

 
 
 
 
                                                 
Table below lists the approved ECAIs by Euro area national banking supervisors (data as of 
July 2010). It should be noted that the number of approved ECAIs by supervisors exceed that 
of  the  Eurosystem  in  the  Eurosystem  credit  assessment  framework  (ECAF).157 Within  this 
framework, the Eurosystem accepts four ECAIs (S&P, Moody’s, Fitch and DBRS), National 
Central Banks in-house credit assessment system source (ICASs)158 and rating tools such as 
Lince, ICAP159 and Coface. Various national banking supervisors have approved at a national 
level other ECAIs (i.e. Japan Credit Rating Agency, Banque de  France, Coface,  and  Rating 
and  Investment  Information  (R&I)).  During  2009,  no  new  ECAI  was  approved  by  national 
supervisory authorities. 

Source: ECB response to the public consultation on CRAs: NCBs’ contributions as of 13 July 2010. 

2 – Market Concentration within the Rating Industry 

Market share of outstanding ratings by rating agencies in the US for industrial corporations 
and financial institutions end 2009 was the following: 

157  

158  

159  

The  Eurosystem  credit  assessment  framework  (ECAF)  defines  the  procedures,  rules  and  techniques 
which ensure that the Eurosystem requirement of high credit standards for all eligible assets is met. In 
the  assessment  of  the  credit  standard  of  eligible  assets,  the  Eurosystem  takes  into  account  credit 
assessment  information  from  credit  assessment  systems  belonging  to  one  of  four  sources,  namely 
external  credit  assessment  institutions  (ECAIs),  NCBs’  in-house  credit  assessment  systems  (ICASs), 
counterparties’  internal  ratings-based  (IRB)  systems,  or  third-party  providers’  rating  tools  (RTs). 
Additionally,  in  the  assessment  of  the  credit  standard  the  Eurosystem  takes  into  account  institutional 
criteria and features guaranteeing similar protection for the instrument holder such as guarantees.  More 
information can be found on: www.ecb.europa.eu.  
Currently  Banco  de  España,  the  Banque  de  France,  the  Central  Bank  of  Ireland,  the  Deutsche 
Bundesbank, and the Oesterreichische Nationalbank have set up a ICAS facility. 
Lince is recognised as an ECAI for Capital Requirements purposes by Banca d’Italia and is recognised 
as  a  Rating  Tool  for  ECAF  purposes.  ICAP  is  recognised  as  an  ECAI  for  Capital  Requirements 
purposes by Bank of Greece and is recognised as a Rating Tool for ECAF purposes. 

106/193 

 
 
 
 
                                                 
Industrial corporations Financial institutions

Standard & Poor's
Moody's
Fitch
TOP 3 rating agencies
others

43,2%
32,3%
13,1%
88,6%
11,4%

24,0%
35,1%
33,0%
92,1%
7,9%

Source:  Lynn  Bai,  The  performance  Disclosures  of  Credit  Rating 
Agencies:  are  they  effective  reputational  sanctions,  New  York 
University Journal of Law & Business, 2010, p.32. 

This data shows that the three largest CRAs had a share of respectively 88,6% and 92,1% of 
ratings  for  respectively  industrial  corporations  and  financial  institutions  end  2009.  Similar 
market shares can be expected for other rating segments and territories, and applies also for 
credit ratings within the EU. 

The table below presents a non-exhaustive list of acquisition by three largest CRAs. 

Source: Norbert Gaillard (2007): “les méthodologies de notation souveraine”, thèse de 
doctorat en économie, Institut d’études politiques de Paris 

3 – Overview of the "big three" CRAs  

Organisation and financial performance 

107/193 

 
 
 
 
 
 
These  entities  of  Standard  and  Poor's  Moody's  and  Fitch  have  their  head  offices  and  main 
management, administrative and supervisory bodies in the US (although Fitch Ratings is dual 
headquartered  in  New  York  and  London).  They  operate  in  the  EU  through  subsidiaries 
established in several countries.160 Their activity does not have a territorial character.  

Moody's Investor Services is owned by Moody's Corporation (listed on the New York Stock 
Exchange  -  NYSE).  Standard  &  Poor's  is  owned  by  the  American  publisher  Mc  Graw-Hill 
(which is a listed entity on the NYSE). Fitch is a subsidiary of the French financial company 
Fimalac (listed on Euronext Paris).161  

Standards and Poor's 

Standard and Poor's Ratings Services is a division of Standard and Poor's (S&P), a division of 
The McGraw-Hill Companies, Inc. ("McGraw-Hill"), a U.S. listed publishing and information 
services group. 

In  the  E.U,  S&P  operates  in  France,  Germany,  Italy,  Spain,  Sweden  and  the  UK  via  local 
subsidiaries, branches or divisions of McGraw-Hill: 

•  Standard & Poor's España, S.A. (Spain) 

•  McGraw Hill International (U.K.) Limited (UK) 

•  Standard & Poor's AB (Sweden) 

•  The McGraw-Hill Companies GmbH (Germany) 

•  The McGraw-Hill Companies, SA (France) 

•  The McGraw Hill Companies, SRL (Italy) 

As  S&P's  ratings  are  issued  from  an  entity  that  also  conducts  other  business  (for  example, 
maintaining financial indices) making it difficult to locate financial information referring only 
to the ratings business. 

In  2010,  Standard  &  Poor's  (including  non-ratings  activity),  increased  profits  in  absolute 
terms, but fell slightly in terms of operating margin.  The operating margin was nonetheless 
significant at 45%: 

Revenue ($ million) 

2010

2009

2008 

Transaction 

Non-transaction 

Total revenue 

Operating profit 

662.5

549.8

554.9 

1032.9

987.5

1028.1 

1695.4

1537.3

1583 

762.4

712.2

749.3 

% Operating margin 

45.0

46.3

47.3 

Source: McGraw Hill 2010 Annual Report, p. 24, accessible at: 
http://www.mcgraw-hill.com/about/annual_report/ar2010.pdf.  

Some estimates have placed the operating margin for the ratings section of the business on its 
own at 50% in recent years.162 

160 

161 

162  

Standard  &Poor's  has  subsidiaries  in  France,  Germany,  Italy,  Spain,  Sweden  and  UK;  Moody's  has 
subsidiaries  in  Bulgaria,  Cyprus,  Czech  Republic,  France,  Germany,  Italy,  Spain  and  UK.  Fitch  has 
subsidiaries in UK ("Fitch Europe"), France, Germany, Italy, Poland and Spain. 
Fitch  merged  in  1997  with  the  British  IBCA  rating  company,  which  is  specialised  in  rating  banks. 
Fitch-IBCA then bought the fourth-largest American rating agency, Duff & Phelps, in June 2000 and, in 
December 2000, Thomson BankWatch, another agency specialised in rating banks. 
The Credit Rating Industry: Competition and Regulation, Fabian Dittrich, p. 20. Available from: 
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=991821. 

108/193 

 
 
 
                                                 
S&P published 870,000163 new and revised ratings in 2009.  Ratings are issued for a number 
of different sectors, such as structured finance, sovereign and corporate.  Although S&P does 
not appear to publish a detailed distribution of the ratings and revenue by region and sector, 
S&P does note that a fall in the issuance of ABS and RMBS declined in the US and Europe in 
2010,  resulting  in  lower  structured  finance  revenues. 164  S&P  rates  126  sovereign 
governments.165 

In the absence of S&P revenues by geographich region, the table below shows McGraw Hill 
revenues 

2010  

Revenue ($ million) 
US 
European Region 
Asia 
Rest of the world 
Total 
Source: McGraw Hill 2010 Annual Report, p. 64, accessible at: http://www.mcgraw-
hill.com/about/annual_report/ar2010.pdf.  

4226.4
963.7
467.8
293.9
5951.8  

4367.4
987.2
499.4
314.3
6168.3  

71.0% 
16.2% 
7.9% 
4.9% 

70.8%
16.0%
8.1%
5.1%

2009  

2008 
4579.4 
1020.5 
438.8 
316.4 
6355.1 

72.1%
16.1%
6.9%
5.0%

Moody’s Investors Service  

Moody's  Corporation,  based  in  the  U.S.,  has  a  number  of  subsidiaries  in  various 
jurisdictions.166 Its ratings business is primarily associated with Moody's Investors Service Inc 
("MIS"),  based  in  Delaware,  U.S.  MIS  claims  to  rate  or  analyse  debt  in  more  than  110 
countries,  25,000  public  finance  issuers,  12,000  corporate  issuers  and  106,000  structured 
finance obligations, employing 2,700 staff, including 1,200 analysts.  640 of the total staff are 
employed in the EU by MIS EU subsidiaries and one branch. 167 
MIS has the following seven EU subsidiaries168: 

•  Moody’s Investors Service Ltd, (UK) (includes its Czech branch, Moody’s Investors 

Service Ltd, organizační složka), 

•  Moody’s EMEA Ltd, 

•  Moody’s Deutschland GmbH, 

•  Moody’s France SAS, 

•  Moody’s Investors Service España S.A., 

163  

164  

165  

166  

167  

168  

Standard and Poor's website, About Standard and Poor's. Available from: 
http://www.standardandpoors.com/about-sp/main/en/eu.  
McGraw Hill 2010 Annual Report p 24 – 25. Available from: http://www.mcgraw-
hill.com/about/annual_report/ar2010.pdf. 
Standard and Poor's request for comment on Sovereign Government Rating Methodology And 
Assumptions, p 7, available from: 
http://www.interest.co.nz/sites/default/files/S&P%20Sovereign%20Government%20Rating%20Method
ology%20And%20Assumptions%20RFC.pdf. 
For a complete list of subsidiaries, see Moody's Corporation Form 10-K (Annual Report) filed with the 
SEC, available from: 
http://www.sec.gov/Archives/edgar/data/1059556/000119312511047974/d10k.htm, and Exhibit 21 of 
this filing, available from: 
http://www.sec.gov/Archives/edgar/data/1059556/000119312511047974/dex21.htm.  
European Union Transparency Report issued in respect of the year ended 31 December 2010, published 
March 2011, p 2, available from: 
http://www.moodys.com/PublishingImages/MCO/EU%20Transparency%20Report%202010.pdf. 
European Union Transparency Report issued in respect of the year ended 31 December 2010, published 
March 2011, p 8, available at: 
http://www.moodys.com/PublishingImages/MCO/EU%20Transparency%20Report%202010.pdf.  

109/193 

 
 
 
 
 
                                                 
•  Moody’s Investors Service Cyprus Ltd, and 

•  Moody’s Italia S.r.l. 

Moody's Corporation also includes details of revenue by sector and geographic jurisdiction in 
its Annual Reports. MIS issues ratings in the corporate finance, structured finance, financial 
institutions and public sector areas.  The following table gives a breakdown of MIS revenue in 
these four sectors: 

Revenue ($ million) 
Corporate finance 
Structured finance 
Financial institutions 
Public, project, infrastructure 
Other 
Total 
Source: Moody's Corporation Form 10-K (Annual Report 2011), p 99, filed with the SEC, available at: 
http://www.sec.gov/Archives/edgar/data/1059556/000119312511047974/d10k.htm.  

2009  
408.2
304.9
258.5
246.1
60.0
1277.7  

2010  
563.9
290.8
278.7
271.6
61.3
1466.3  

2008 
307.0 
404.7 
263.0 
230.0 
63.6 
1268.3 

31.9% 
23.9% 
20.2% 
19.3% 
4.7% 

38.5%
19.8%
19.0%
18.5%
4.2%

24.2%
31.9%
20.7%
18.1%
5.0%

These data show the declining role of structured finance in generating revenues falling from 
31.9% in 2008 to 19.8% in 2010, which is in line with an expected fall in structured finance 
product issuance since the crisis.   

In the absence of a geographic breakdown of revenue for Moody's Investors Service, the table 
below  shows  that  over  half  of  the  Corporation's  consolidated  revenue  derives  from  the  US, 
and a still significant proportion derives from the EMEA area. In 2009, 71% of Corporation's 
consolidated revenue is derived from Moody's Investors Service: 

2010  

Revenue ($ million) 
US 
EMEA 
Other 
Total 
Source: Moody's Corporation Form 10-K (Annual Report 2011), p 99, filed with the SEC, available at: 
http://www.sec.gov/Archives/edgar/data/1059556/000119312511047974/d10k.htm.  

2009  
920.8
624.7
251.7
1797.2  

1089.5
627.4
315.1
2032.0  

2008 
910.1 
603.1 
242.2 
1755.4 

51.2% 
34.8% 
14.0% 

53.6%
30.9%
15.5%

51.8%
34.4%
13.8%

These data show that revenues from the EMEA area continue to provide over 30% of revenue 
for the Corporation (these figures include businesses other than MIS).  Although separate EU 
data are not published in these filings, it is reasonable to assume based on the office locations 
of MIS that a large proportion of MIS's EMEA revenue is derived from the EU. 

Fitch Ratings 

Fitch operates through subsidiaries in the EU. The subsidiaries outside the UK are owned by 
Fitch Ratings Ltd. of the UK, itself owned by Fitch, Inc. of the US. These are the subsidiaries 
of Fitch Ratings in the EU: 

• 

• 

• 

• 

• 

• 

• 

Fitch Ratings Limited (UK) 

Fitch Ratings CIS Limited (UK) 

Fitch Ratings España S.A.U (Spain) 

Fitch Ratings Deutschland GMBH (Germany) 

Fitch France (France) 

Fitch Italia S.P.A. (Italy) 

Fitch Polska S.A. (Poland) 

110/193 

 
 
 
 
 
 
 
Fitch  Ratings  generated  revenues  of  $657.2  million  during  the  2010  fiscal  year,  a  7.8% 
increase from $609.8 million for the prior year. After translation into euros, its contribution to 
consolidated revenue came to €487.5 million versus €450.2 million for the previous period, an 
increase of 8.3% on  a  reported basis and 6.3% like-for-like169. The table below the  revenue 
distribution by geographic region. 

2010 

Revenue (in %) 
United States 
36.1%
United Kingdom 
11.5%
Other European Union countries 
21.6%
Other countries 
30.8%
Source: 2010 Fimalac Annual Report, p 15: http://www.fimalac.com/annual-reports.html.  

37.9%
10.0%
23.6%
28.5%

2009 

Ultimately  controlled  in  Europe  (unlike  the  other  two  large  CRAs),  by  the  French  parent 
company Fimalac, Fitch Ratings generates a large share of its revenue from the U.S., at nearly 
36% in 2010, but with a comparable 33% from EU countries. 

Though revenues at Fitch Ratings are significantly lower than at S&P and MIS, Fitch claims 
that  its  market  share  of  global  debt  issuance,  measured  in  terms  of  dollar  issuance  volume, 
stood  at  an  estimated  68%. 170 The  table  below  lists  global  market  share  for  the  individual 
sectors where Fitch is an active player. 

Non-Financial Corporates  
Financial Institutions  
Structured Finance  
US Public Finance  
Sovereigns  
Total 
Source: 2010 Fimalac Annual Report, p 18: http://www.fimalac.com/annual-reports.html.  

57% 
86% 
48% 
60% 
91% 
68% 

Fitch Ratings currently maintains coverage of approximately 6,000 financial institutions, 
including over 3,500 banks and 1,400 insurance companies. Finance & leasing companies, 
broker-dealers, asset managers, managed funds, and covered bonds make up the remainder of 
its financial institution coverage universe. Additionally, the agency currently rates more than 
2,000 corporate issuers, 100 sovereigns, 200 subsovereigns, 300 global infrastructure ratings, 
and 46,000 US municipal transactions. It also maintains surveillance on over 6,500 US, 1,300 
European and 800 Asian structured finance transactions.171

Profitability of three largest CRAs 

Over the years, there have been shifts in the revenue structure of the leading CRAs. Until the 
mid-1990s,  CRAs  specialised  in  and  derived  most  of  their  revenues  from  the  rating  of 
corporate  or  sovereign  debt.  However,  with  the  growth  of  structured  markets  they 
increasingly  engaged  in  the  highly  lucrative  activity  of  rating  then  new  structured  finance 
transactions. As a consequence, CRAs earned up to approximately 50% of their revenue from 
structured  finance  ratings. 172    According  to  the  SEC,  between  2002  and  2006,  revenues 
derived  from  rating  structured  products  increased  dramatically:  "revenues  derived  from 

169  
170  
171  
172 

2010 Fimalac Annual Report, p 17. Available from: http://www.fimalac.com/annual-reports.html. 
Ibid, p. 15. 
Ibid. 
In accordance with a Report on rating agencies published by the French Autorité des Marchés 
Financiers for 2006 the ratings income of the agencies in Europe represented in 2006 between 16% and 
30% of worldwide income, with transactions in the United States representing more than half of the 
income of the agencies. Structured finance business represented between 35% and 45% of European 
earnings. See AMF 2006 Report on rating agencies, Part I, Credit rating of corporate issuers and 
structured finance, 26.01.2007, p. 11. Available from: http://www.amf-
france.org/documents/general/7640_1.pdf.    

111/193 

 
 
 
  
                                                 
RMBS ratings increased between 2002 and 2006 by a percentage that varied among the three 
largest  NRSROs  from  approximately  100%  for  the  firm  which  had  the  lowest  percentage 
growth in revenues to over 200% for the firm which had the highest percentage growth. For 
CDOs,  during  the  same  period,  ratings  revenue  increased  by  a  percentage  that  varied  from 
approximately 200% for the firm which had the lowest percentage growth to over 800% for 
the firm which had the highest percentage growth."173   

The tables below give a comparison of the relatively high profit margins of the major CRAs. 

S&P

2010

2009

2008

($ million)
Total revenue
Operating profit

Moody's Investor Services

Fitch Ratings

($ million)
Total revenue
Operating profit

(€ million)
Total revenue
Operating profit

1.695,4
762,4
45,0%

1.537,3
712,2
46,3%

1.583,0
749,3
47,3%

1.466,3
649,4
44,3%

1.277,7
557,2
43,6%

1.268,3
600,6
47,4%

%

%

N/A
N/A

%

N/A

450,4
178,0
39,5%

486,8
159,0
32,7%  

45% 44%

46%

44%

47%

47%

40%

33%

50%

45%

40%

35%

30%

25%

20%

15%

10%

5%

0%

2010

2009

2008

S&P

Moody's Investor Services

Fitch

Figure 1. Profit margins of three largest CRAs 

Shareholding structure 

Figures  2  and  3  below  detail  a  group  of  shareholders  who  collectively  own  simultaneously 
37.9%  of  shares  in  The  McGraw-Hill  Companies  (which  wholly  owns  S&P)  and  53.0%  of 
shares in Moody's.  

173  

2011 Annual Report on Nationally Recognised Statistical Ratings Organisations, SEC, p22. 

112/193 

 
 
 
 
                                                 
N°

Current situation

Group of Shareholders

The group, aligned by shareholdings in the two largest CRAs, is composed of large financial 
services  companies 
such  as  Northern 
Trust  Corporation, 
Street 
State 
Corporation,  Black 
Rock  Inc,  Bank  of 
New  York.    Other 
firms  that  do  not 
hold  shares  in  one 
or the other of these 
also  have 
CRAs 
significant holdings, 
which 
also 
are 
indicated. 

1 Northem Trust Corp
2 Capital Group Companies
3 Vanguard Group Inc.
4 State Street Corp.
5 T. Rowe Price Associates
6 Fidelity Investments
7 Black Rock Inc.
8 Bank of New York
9 Massachuset. Financial Services

1,32%
21,98%
3,97%
3,91%
3,98%
8,15%
6,89%
2,25%
0,62%

1,75%
16,15%
4,44%
4,41%
3,90%
1,27%
4,59%
1,23%
0,21%

Moody's

S&P's

38%

53%

Figure 2.  Group of shareholders who collectively own S&P's and Moody's 

4 

shows 
by 
companies 

Sources: Roland Berger Strategy Consultants, research from Bloomberg, 
websites of investors and the CRAs, May 2011.

Figure 
shareholdings 
the 
aligned by shareholdings in S&P and Moody's, or with significant holdings in one or the other 
of  these  CRAs.    Companies'  (on  the  left)  holdings  in  the  other  companies  in  the  group 
(including  in  their  own  shares)  can  be  read  across  the  matrix.  For  example,  Northern  Trust 
holds 6.55% of its own shares, 4.01% of CRG's shares, and so on. 

The final row at the bottom of the matrix shows the total holdings of the group in each of the 
companies  listed  across  the  top  of  the  matrix.    For  example,  the  group  holds  collectively 
21.67% of State Street and 16.72% of Black Rock Inc. 

The data in this table are not necessarily complete – there may be further cross shareholdings 
not yet indicated.  

113/193 

 
 
 
 
 
 
 
 
 
 
 
Figure 3 Shareholder structure of S&P and Moody's  
Sources: Roland Berger Strategy Consultants, research from Bloomberg, websites of investors and 
the CRAs, May 2011. 

114/193 

 
 
 
           
 
 
 
 
 
 
 
 
 
 
Figure 4. Cross shareholdings of Moody's and S&P shareholders 
Sources:  Roland  Berger  Strategy  Consultants,  research  from  Bloomberg,  websites  of  investors  and 
the CRAs, May 2011. 

115/193 

 
 
 
         
 
 
 
 
 
 
 
ANNEX V. OVERVIEW OF RECENT VOLUNTARY INITIATIVES UNDERTAKEN BY MAJOR CRAS 
TO ENHANCE RATINGS QUALITY 

Standards and Poor's (S&P)  

Since  announcing  an  initiative  on  7  February  2008,  focusing  on  enhancing  various  areas 
comprising  governance,  analytics,  transparency  of  information  and  addressing  education 
issues,  S&P  has  put  a  number  of  implementing  actions  in  place.  The  following  actions  are 
mentioned in the most recent update relating to this programme: 

•  In  February  2009  the  firm's  appointed  Ombudsman  began  work,  after  appointment  in 

January by the McGraw Hill Audit Committee.   

•  Further  steps  have  been  taken  to  ensure  the  independence  of  ratings  analysts,  as 
introducing  separation  between  analysts  and  other  areas  including  policy  governance, 
criteria management and development and quality assurance. 

•  There  have  been  a  number  of  organisational  changes,  intended  to  increase  the 
independence of various groups and ultimately ensure the independence of ratings issued 
by S&P174. 

•  In the area of activity of the analysts, S&P has introduced a separate group charged with 
model  validation  and  increased  its  ongoing  education  requirements  for  analysts.    New 
measures relating to CDS, bond and loan spreads are now highlighted in analysis. 

•  In  the  area  of  transparency,  S&P  will  cease  providing  ratings  for  some  products  whose 
sponsors or issuers do not agree to the publication of certain information.  S&P has also 
developed earl warning indicators in relation to structured finance products. 

After  launching  a  consultation  paper  in  November  2010,  S&P  updated  their  sovereign  debt 
rating methodology.175 (see figure 1.). 

174  
175  

See Standard and Poor's "Standard and Poo'r commitment: Quality and Independence" on 4.8.2009 
Sovereign Government Rating Methodology and Assumptions, Standard & Poor's, June 30 2011  

116/193 

 
 
 
                                                 
Figure 1.  S&P's Sovereign Rating Framework 

The update is intended to provide additional clarity by introducing a finer calibration of the 
five major rating factors that form the foundation of a sovereign analysis and by articulating 
how these factors combine to derive a sovereign's credit ratings  

Standard  &  Poor's  analysis  of  a  sovereign's  creditworthiness  starts  with  its  assessment  and 
scoring  of  five  key  rating  factors.  Each  factor  receives  a  score,  using  a  six-point  numerical 
scale  from  '1'  (the  strongest)  to  '6'  (the  weakest).  A  series  of  quantitative  factors  and 
qualitative considerations form the basis for assigning the scores.  The criteria then combine 
those  five  scores  to  form  a  sovereign's  "political  and  economic  profile,"  and  its  "flexibility 
and performance profile".  

•  The political and economic profile reflects the view of the Agency of the resilience of a 
country's  economy,  the  strength  and  stability  of  the  government's  institutions,  and  the 
effectiveness  of  its  policy-making.  It  is  the  average  of  the  political  score  and  the 
economic score. 

•  The flexibility and performance profile reflects the Agency's view of the sustainability of 
a government's fiscal balance and debt burden, in light of the country's external position, 
as  well  as  the  government's  fiscal  and  monetary  flexibility.  It  is  the  average  of  the 
external score, the fiscal score, and the monetary score. 

Those two profiles are then used in figure 2. to determine an indicative rating level. 

The  sovereign  (foreign-currency)  rating  would  in  most  cases  fall  within  one  notch  of  the 
indicative rating level, based on the sovereign's positioning relative to peers. For example, for 
a sovereign having a "moderately strong" political and economic profile and a "very strong" 
flexibility and performance profile, the Agency would most likely assign a rating within one 
notch of 'AA-'. 

117/193 

 
 
 
 
Figure 2. Indicative Rating level from the combination of the two profiles 

A sovereign (foreign-currency) rating might differ by more than one notch compared with the 
indicative  rating  level  if  it  meets  one  or  more  of  the  following  exceptional  characteristics 
below:  

•  Extremely weak external liquidity. 

•  Extremely weak fiscal situation 

•  Exceptionally large net general government asset position 

•  Very high political risk and high debt burden 

•  Rescheduling risk 

•  High security risk 

•  Severe natural catastrophes 

If a sovereign combines several of the exceptional factors, its foreign-currency rating would 
be adjusted by the cumulative effect of those adjustments. Those exceptional adjustments are 
based on a forward-looking analysis.  

The  analysis  of  each  of  the  key  five  factors  mentioned  above  embodies  a  combination  of 
quantitative  and  qualitative  elements.  Some  factors,  such  as  the  robustness  of  political 
institutions,  are  primarily  qualitative,  while  others,  such  as  the  economy,  debt,  and  external 
liquidity use mostly quantitative indicators. 

Moody's  

Starting  in  August  2008,  Moody's  has  began  to  issue  a  series  of  '  Special  Comment' 
documents  in  relation  to  its  global  credit  policy,  detailing  measures  taken  to  strengthen  the 

118/193 

 
 
 
 
quality, transparency and independence of ratings.176 Updates provided in December 2008 and 
August 2009 indicated progress on these measures.177 The latter report outlines progress in the 
six broad areas that Moody's is targeting in these initiatives:  

•  Strengthening Analytical Integrity of Ratings 

•  Enhancing Consistency Across Rating Groups 

• 

• 

Improving Transparency of Ratings and the Ratings Process 

Increasing Resources in Key Areas 

•  Bolstering Measures to Manage Conflicts of Interest 

•  Pursuing Industry and Market-Wide Initiatives 

In addition, in September 2008, Moody's Global Sovereign published its rating methodology 
for sovereign debt.  The paper aims at increasing transparency by further clarifying the areas 
that Moody's takes into account when issuing its sovereign ratings so that market participants 
are better informed.178 

The document stresses the importance of interpreting quantitative factors through qualitative 
perspectives  and  without  relying  on  any  measure  mechanistically. 179   Moody's  sovereign 
ratings  take  into  account  four  main  areas:  economic  strength;  institutional  strength; 
government  financial  strength;  susceptibility  to  event  risk.    These  areas  are  further  divided 
and have different interactions in order to form a basis on which the final rating judgement is 
made (see figure 3 below) 

176  

177  

178  

179  

European Union Transparency Report issued in respect of the year ended 31 December 2010, published 
March 2011, pp 2 – 3, available from: 
http://www.moodys.com/PublishingImages/MCO/EU%20Transparency%20Report%202010.pdf. 
See Strengthening Analytical Quality and Transparency, An Update on Initiatives Implemented by 
Moody’s in the Past Twelve Months, August 2008 (Document No. 110613), Strengthening Analytical 
Quality and Transparency, An Update on Initiatives Implemented by Moody’s in the Past Eighteen 
Months, December 2008 (Document No. 113751), available from: 
http://v2.moodys.com/cust/content/content.ashx?source=StaticContent/Free%20Pages/Products%20and
%20Services/Downloadable%20Files/Strengthening%20Analytical%20Quality%20and%20Transparen
cy.pdf, and Strengthening Analytical Quality and Transparency, An Update on Initiatives Implemented 
by Moody’s Over the Past Two Years, August 2009 (Document No. 119843), available from: 
http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_119843. 
Rating  Methodology,  Sovereign  Bond  Ratings,  Moody's  Investors  Service,  September  2008,  p  1, 
available at: http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_109490. 
Ibid. 

119/193 

 
 
 
 
                                                 
Figure 3. Moody's Sovereign Rating Mechanics: example of country A 

The first step consists in determining the shock-absorption capacity of the country, based on 
the combination of two key factors:  

•  The  country’s  economic  strength,  captured  in  particular  by  the  GDP  per  capita  –  the 

single best indicator of economic robustness and, in turn, shock-absorption capacity.  

•  The institutional strength of the country, the key question being whether or not the quality 
of a country’s institutional framework and governance – such as the respect of property 
right, transparency, the efficiency and predictability of government action, the degree of 
consensus on the key goals of political action – is conducive to the respect of contracts.  

Combining  these  two  indicators  helps  determine  the  degree  of  resiliency,  and  position  the 
country in the rating scale: very high, high, moderate, low or very low.  

The second step focuses directly on debt matters, and especially the combination of two other 
factors:  

• 
The financial strength of the government. The question is to determine what must be 
repaid  (and  how  “tolerable”  the  debt  is)  and  the  ability  of  the  government  to  mobilize 
resources: raise taxes, cut spending, sell assets, obtain foreign currency  

120/193 

 
 
 
 
• 
The  susceptibility  to  event  risk  –  that  is  the  risk  of  a  direct  and  immediate  threat  to 
debt repayment, and, for countries higher in the rating scale, the risk of a sudden multi-notch 
downgrade. The issue is to determine whether the debt situation may be (further) endangered 
by the occurrence of adverse economic, financial or political events.  

Combining these two indicators helps determine degrees of financial robustness and refine the 
positioning of the country on the rating scale.  

The  third  stage  consists  in  adjusting  the  degree  of  resiliency  to  the  degree  of  financial 
robustness. This results in the identification of a rating range (see figure V.4).  

Figure 4. Sovereign rating Road Map 

The final determination of the sovereign bond rating is based on the output of the "rating road 
map" (see below), combined with all additional information that a rating committee will deem 
relevant to assess the creditworthiness of a government. The determination of the exact rating 
is done on the basis of a peer comparison, and weighting additional factors that may not have 
been adequately captured earlier.  

Fitch, Inc. 

After separating in 2008 its non-rating business into a separate division, Fitch Solutions, 
which focuses on risk, analytical and data tools, including distribution of ratings issued by 
Fitch Ratings, and a number of other initiatives intended to enhance the quality of ratings, 
Fitch Ratings, like the other two large rating agencies, has also issued its sovereign rating 
methodology. 180 

180  

Master Criteria: Sovereign Rating Methodology, issued on 16 October 2009, and updated on 16 August 
2010, available from http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=547765.  

121/193 

 
 
 
 
                                                 
The recently updated methodology of Fitch Rating, similarly to what happens for the other 
two large rating agencies, is based upon the interplay of qualitative as well as quantitative 
inputs into the ratings process181.    

Fitch's  approach  to  sovereign  risk  analysis  is  presented  as  a  synthesis  of  quantitative  and 
qualitative  judgements  that  try  to  capture  the  willingness  as  well  as  the  capacity  of  the 
Country to meet its debt obligations.  

The  sovereign  rating  analysis  incorporates  a  wider  range  of  factors  than  only  the  financial 
strength of the sovereign and includes an assessment of the following (see detail in figure 5. 
below):  

•  macroeconomic performance and prospects;  

•  structural  features  of  the  economy  that  render  it  more  or  less  vulnerable  to  “shocks”, 
including the risks to macroeconomic stability and public finances posed by the financial 
sector, as well as “political risk” and governance factors;  

•  public finances, including the structure and sustainability of public debt as well as fiscal 

financing; and  

•  external  finances,  with  a  particular  focus  on  the  sustainability  of  international  trade 
balances, current account funding and capital flows, as well as the level and structure of 
external debt (public and private).  

Figure 5. Sovereign Rating Model – Key variables 

Fitch has developed a proprietary Sovereign Rating Model (SRM) that generates on the basis 
of  the  variables  described  in  the  above  figure  a  score  calibrated  to  the  Long-Term  Foreign-

A number of other 'Master Criteria' documents were also issued in August 2010, available from: 
http://www.businesswire.com/news/home/20100813005704/en/Fitch-Publishes-Updates-Global-
Master-Criteria. 
See Fitch Ratings, Sovereign Rating Methodology. Master Criteria, 15 August 2011, available from: 
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=648978.  

181  

122/193 

 
 
 
 
                                                                                                                                                         
Currency  IDR.  However,  the  outcome  of  the  SRM  is  treated  as  only  one  of  a  range  of 
qualitative and quantitative inputs into the rating process. The actual rating determined by the 
sovereign rating committee can and does differ from that implied by the rating model. 

123/193 

 
 
 
 
ANNEX VI. PROBLEM DEFINITION – BACKGROUND AND TECHNICAL DETAILS 

1 – Background on the Financial Crisis  

Since August 2007 financial markets worldwide are suffering from a major confidence crisis. 
The  crisis  originated  in  the  US  residential  subprime  mortgage  market  and  subsequently 
developed into other sectors of the financial markets.  

This subprime turmoil hit Europe through three different channels. Firstly, some EU financial 
institutions  faced  losses  because  they  were  exposed  to  the  US  sub-prime  market.  Secondly, 
the  US  sub-prime  problems  have  considerably  slowed  down  US  growth  prospects.  Given 
global trade inter-linkages this affects the EU economic growth as well. Thirdly, the general 
market uncertainty eroded equity market prices also in Europe as well as reduced consumer 
and business confidence.  

CRAs were close to the origin of the problems that have arisen with subprime markets: they 
were giving favourable opinions on instruments that were financially engineered to give high 
confidence to investors. The investors – relying on CRAs' expertise – very often took little or 
no interest in the risks characteristics of these instruments, performance of underlying assets 
and general market outlook.  

CRAs failed to reflect early enough in their ratings the worsening of market conditions. The 
explanation for this poor performance by CRAs could be found in the unsatisfactory way the 
agencies manage their conflicts of interest, the lack of quality of the ratings they issued, the 
need  for  improved  transparency  of  the  agencies  and  the  inappropriate  internal  governance. 
The  subprime  debacle  demonstrated  that  the  existing  framework  for  the  operation  of  CRAs 
needs to be significantly reinforced. 

124/193 

 
 
 
 
 
Figure  1.  Cumulative  changes  in  average  five-years  sovereign  CDS  premia  for  euro  area  countries 
and iTraxx financial index182 (15 September 2008- 25 March 2009; bps) 

The  analysis  of  the  announcements  and  downgrades  from  3  large  rating  agencies  (S&P, 
Moody's and Fitch) in the period from October 2006 until August 2010 covers the financial 
crisis  and  the  consequent  Euro  debt  crisis.  In  this  period,  46  rating  announcement  of  EU 
Member  States  have  been  observed,  of  which  there  were  30  rating  changes  (of  which  29 
downgrades and 1 upgrade), 13 outlook revisions, and one review for future downgrade. 

Concurrent with the announcement of bank rescue packages in Euro-area countries, pressure 
on the financial sector eased while the opposite occurred at the general government level. This 
was  felt  though  a  sharp  increase  in  sovereign  credit  default  swap  premiums  for  most  EU 
countries,  whereas  the  credit  default  swap  premiums  for  European  financial  corporations 
reversed their upward trend and started to decline. Figure VI.1 illustrates these developments. 

Appetite  for  risk  on  markets  rapidly  decreasing,  markets  for  sovereign  bonds  started 
penalising  more  heavily  the  lack  of  absolute  solidity  in  public  finances  of  individual  Euro-
zone  countries,  as  well  as  they  started  penalising  other  macroeconomic  imbalances,  in 
particular with respect to Germany.183 

In  this  context,  CRA  intervened  with  some  negative  rating  changes  that  surprised  market, 
especially for the scale of the change.  

182  

183  

iTraxx (Bloomberg code 'ITRX') is the brand name for the family of credit default swap index products 
covering  regions  of  Europe,  Australia,  Japan  and  non-Japan  Asia.  They  form  a  large  sector  of  the 
overall  credit  derivative  market.  The  indices  are  constructed  on  a  set  of  rules  with  the  overriding 
criterion  being  that  of  liquidity  of  the  underlying  Credit  Default  Swaps  (CDS).  The  iTraxx  suite  of 
indices are owned, managed, compiled and published by International Index Company (IIC), who also 
license market makers. 
Attinasi M.G., Chcherita C., Nickel C. (2009), What explains the surge in Eurozone sovereign spreads 
during  the  financial  crisis  of  2007-09?,  ECB  Working  Paper  no.  1131/2009  and  Archyrou  M.G., 
Kontonikas  A.  (2011),  The  EMU  sovereign-debt  crisis:  fundamentals,  expectations  and  contagion, 
Economic Paper no. 436, European Commission. 

125/193 

 
 
 
 
                                                 
Date
23/10/2006
11/07/2008
11/07/2008
12/08/2008
27/10/2008
30/10/2008
17/11/2008
13/01/2009
14/01/2009
19/01/2009
21/01/2009
07/02/2009
24/02/2009
24/02/2009
24/02/2009
25/02/2009
21/03/2009
27/03/2009
30/03/2009
11/04/2009
23/04/2009
23/04/2009
04/08/2009
06/08/2009
12/08/2009
01/09/2009
03/09/2009
12/09/2009
29/10/2009
01/12/2009
16/12/2009
22/12/2009
21/01/2010
24/03/2010
31/03/2010
31/03/2010
31/03/2010
22/04/2010
27/04/2010
27/04/2010
28/04/2010
05/05/2010
04/08/2010
04/08/2010

Country
Lithuania

Czech

Greece

Action
Upgrade
Latvia Downgrade
Hungary Downgrade
Outlook
Romania Downgrade
Bulgaria Downgrade
Hungary Downgrade
Portugal
Outlook
Greece Downgrade
Spain Downgrade
Portugal Downgrade
Ireland Downgrade
Estonia Downgrade
Latvia Downgrade
Lithuania Downgrade
Outlook
Hungary Downgrade
Outlook
Slovakia
Hungary Downgrade
Ireland Downgrade
Latvia Downgrade
Lithuania Downgrade
Estonia Downgrade
Ireland Downgrade
Greece Downgrade
Outlook
Ireland
Maintain
Spanish
Outlook
Spain
Outlook
Portugal
Outlook
Spain
Greece Downgrade
Greece Downgrade
Bulgaria
Outlook
Portugal Downgrade
Outlook
Lithuania
Outlook
Latvia
Estonia
Outlook
Greece Downgrade
Greece Downgrade
Portugal Downgrade
Spain Downgrade
Review
Latvia Downgrade
Lithuania Downgrade

Portugal

CRA

Fitch
Moody's
Moody's
Moody's
S&P
S&P
S&P
S&P
S&P
S&P
S&P
Moody's
S&P
S&P
S&P
Moody's
Moody's
Moody's
S&P
Fitch
Moody's
Moody's
Fitch
S&P
Fitch
S&P
Moody's
S&P
Moody's
S&P
S&P
Moody's
Moody's
Fitch
Moody's
Moody's
Moody's
Moody's
S&P
S&P
S&P
Moody's
Fitch
Fitch  

Figure 2. Overview of sovereign rating announcements of EU Member States184 

2008:Q 1 2008:Q 2 2008:Q 3 2008:Q 4 2009:Q 12009:Q 2 2009:Q 3 2009:Q 4 2010:Q 12010:Q 22010:Q 3 2010:Q 4

0
0
0

0
0
0

0
1
-2

EU Up
0
EU No chang e
3
-9
EU Dow n
Figure  3.  Upgrades/Downgrades  for  Sovereign  Debt  ratings  of  EU  Member  States  by  the  3  largest 
credit rating agencies185 
According to the IMF186, while downgrades were somehow expected by markets, their extent 
- as they sometimes involved several notches at the same time - surprised markets.  

0
0
-3

0
4
-1

0
0
-1

0
1
-4

0
0
-3

0
3
-3

0
2
-2

0
0
0

In most cases rating changes arrived after already substantial movement in government bond 
spreads.  Very  few  announcements  were  in  fact  before  the  third  quarter  of  2008.  It  appears 
therefore that the 3 main rating agencies have not sufficiently anticipated the macroeconomic 

184  

185  

186  

IMF  working  paper,  Sovereign  Rating  News  and  Financial  Markets  Spillovers:  Evidence  from  the 
European Debt Crisis. Rabah Arzeki, Bertrand Candelon and Amandou N.R.Sy, IMF Working Paper, 
Sovereign  Rating  News  and  Financial  Markets  Spillovers:  Evidence  from  the  European  Debt  Crisis, 
March 2011, WP/11/68. 
European Commission, analysis based on data from IMF working paper, Sovereign Rating News and 
Financial Markets Spillovers: Evidence from the European Debt Crisis? 
IMF,  Global  Financial  Stability  Report,  Chapter  3,  The  uses  and  abuses  of  Sovereign  Debt  Ratings, 
October 2010, p. 88. 

126/193 

 
 
 
 
 
 
                                                 
weaknesses of European economies consecutive to the financial crisis 187 and, that they have 
been slow in reacting to the changing economic situations in some Member States. A shown 
in Figure 4, the pick of negative announcements was reached in the first Quarter of 2009. The 
number of negative rating announcements afterwards decreased but continued and reached a 
further  "peak"  of  downgrades  the  second  quarter  of  2010  when  the  European  Financial 
Stability Facility (EFSF) was adopted. 

10

8

6

4

2

0

-2

-4

-6

-8

-10

2008:Q1

2008:Q2

2008:Q3

2008:Q4

2009:Q1

2009:Q2

2009:Q3

2009:Q4

2010:Q1

2010:Q2

2010:Q3

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EU Up

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EU No change

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Figure  4.  Sovereign  Debt  Ratings  -  Upgrades/Downgrades  of  EU  Member  States  by  the  3  largest 
credit rating agencies 

This  Euro-zone  debt  crisis  was  not  the  first  time  that  CRA  seemed  to  react  to  events  rather 
than  anticipating  them.  It  was  already  the  case  during  the  Mexican  Crisis  of  1994-95,  and 
during  the  Asian  Crisis  of  1997.  Also  in  those  cases  CRA  were  accused  of  both  being  too 
slow  initially  in  downgrades,  and  subsequently  of  downgrading  more  than  the  worsening 
fundamentals justified.188 
As ratings actually influence markets189, their inaccuracy and/or ill timing creates concerns for 
financial stability.  

187  

188  

189  

Rabah Arzeki, Bertrand Candelon and Amandou N.R.Sy, IMF Working Paper, Sovereign Rating News 
and Financial Markets Spillovers: Evidence from the European Debt Crisis, March 2011, WP/11/68. 
See  IMF  (1999),  International  Capital  Markets,  and  Ferri  G.,  Liu  L.,  and  Stiglitz  J.  (1999),  the 
Procyclical role of Rating Agencies: Evidence from the East Asia Crisis, Economic Notes, 28-3. 
See Arezki  R.,  Candelon  B., Sy,  A. (2011),  Sovereign rating News  and Financial  markets  Spillovers: 
Evidence from the European Debt Crisis, IMF Working Paper 11/68 

127/193 

 
 
 
 
                                                 
Figure 5. Ireland's observed and predicted ratings according to Regression (I)190 

Regarding  ill-timing,  if  sovereign  ratings  lag  rather  than  lead  financial  markets,  improving 
ratings tend to reinforce euphoric expectations and stimulate excessive speculation during the 
booming  periods,  while  during  the  bust,  downgrading  can  spread  panic  among  investors, 
driving money excessively out of markets.191 A good example of this lagging behaviour from 
CRA  can  be  resumed  from  recent  academic  works.192 Figure  5  shows  for  example  how,  for 
the case of Ireland, ratings seems to have been changed in the beginning too late compared to 
macro-economic fundamentals, and then too much once again compared to what justifiable on 
the basis of macroeconomic variables. 

Regarding  inaccuracy,  first  of  all  CRA  cannot  easily  acquire  superior  information  on 
sovereigns. Second,  there  are  reasons  to consider that cardinal accuracy of ratings, i.e. their 
relationship with reference probability of defaults, important. However, it should be noted that 
while  banks  are  subject  to  rigorous  calibration  tests  of  their  internal  ratings,  CRAs  are 
normally  not  even  transparent  about  they  calibrate  and  about  how  they  validate  ratings  to 
default risk metrics. 193 

190  
191  
192  

193  

A regression line known as a "line of best fit". 
Reisen H., von Maltzan J. (1999), Boom and Bust and Sovereign Ratings, International Finance, 2(2). 
Gärtner M., Griesbach B., Jung F. (2011), PIGS or Lambs? The European Sovereign Debt Crisis and 
the Role of rating Agencies, University of St. Gallen, Discussion Paper 2011-06.  
On  how  ratings  cardinal  accuracy  can  be  validated  on  the  basis  of  statistical  text,  see  Coppens  F., 
Gonzalez  F.,  Winkler  G.  (2007),  The  performance  of  credit  rating  systems  in  the  assessment  of 
collateral used in Eurosystem Monetary Policy operations, ECB Occasional Paper n. 65, and De Lisa R., 
Marchesi  M.,  Zedda  S.  (2009),  Thresholds  for  Ratings'  Forecast  Default  Probabilities:  Some 
Quantitative Evidences in “New Frontiers in insurance and risk management”, McGraw-Hill, Milano.  

128/193 

 
 
 
 
                                                 
Figure 6. Positive and negative announcements over time (from 09/2006 to 01/2010) 

Figure 7. CDS Spreads for Selected European Countries and Greece Credit Ratings (from 01/2008 to 
01/2010) 

129/193 

 
 
 
 
 
Figure 8. Comparison of European sovereign spreads (bp) (from 01/2006 to 04/2011)194 

The recent financial and economic crisis had put a heavy burden on public finances in euro 
area countries and other EU Member States. 195 It resulted a heavy burden on taxpayers that 
may have to come to the rescue of a failing systemic relevant institutions. 

The main factors that have contributed are (1) In some countries large fiscal costs are related 
to capital injections for financial institutions; (2) The economic downturn had an immediate 
impact  on  tax  receipts  and  unemployment-related  spending;  (3)  The  discretionary  measures 
adopted to compensate for declining private demand in the economy had an adverse impact 
on fiscal positions.  
The  ECB  has  reported 196 that  over  the  last  three  years,  governments  have  taken  various 
measures  to  strengthen  the  financial  system  and  reduce  the  systemic  risks  in  the  financial 
sector  which  emerged  in  the  context  of  the  global  financial  crisis.  The  direct  costs  are 
recorded in government debt (e.g. capital injections for banks for which the government had 
to borrow in the market) and the recovery of these costs will depend on the future value of the 
acquired bank assets.  

194  
195  

196  

Source Bloomberg. 
For  an  overview,  see  van  Riet,  A.  (ed.),  “Euro  area  fiscal  policies  and  the  crisis”,  Occasional  Paper 
Series, No 109, ECB, Frankfurt am Main, April 2010. 
Monthly Bulletin April 2011, European Central Bank, Eurosystem, p. 69.  

130/193 

 
 
 
 
 
 
                                                 
Figure 9. Cumulated financial sector stabilisation operations and their impact on government debt and 
contingent liabilities (2008-10)197 

Figure  10.  Deficit,  borrowing  requirement 198  and  change  in  debt  (four-quarter  moving  sum  as  a 
percentage of GDP)199 

2 – Description and Analysis of Problem Drivers and Problems 

2.1 References to ratings in EU Financial Regulation  

Banking 
The  Capital  Requirements  Directive  (CRD)200 requires  credit  institutions  to  have  their  own 
sound  credit  granting  criteria  and  credit  decision  processes  in  place. 201  This  applies 

197  
198  
199  

200 

Monthly Bulletin April 2011, European Central Bank, Eurosystem, p. 70. 
Borrowing requirement (general government): net incurrence of debt by the general government. 
Sources: ECB calculations based on Eurostat and national data. For an overview, see Monthly Bulletin 
April 2011, European Central Bank, Eurosystem, p. 151.  
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 business of credit institutions (recast) (OJ L 177/1, 30.6.2006). 

131/193 

 
 
 
 
 
 
 
                                                 
irrespective  of  whether  institutions  grant  loans  to  customers  or  whether  they  incur 
securitisation  exposures.  Basing  credit  decisions  solely  on  external  credit  rating  agency 
ratings does not fulfil this requirement under EU-banking legislation. 

For  the  specific  purposes  of  calculating  regulatory  bank  capital  requirements,  rating  agency 
assessments are, in certain instances, applied as a basis for differentiating capital requirements 
according to risks202, and not for determining the minimum required quantum of capital itself. 
The CRD framework as a whole provides banks with an incentive to use internal rather than 
external  credit  ratings  even  for  purposes  of  calculating  regulatory  capital  requirements.203 In 
the specific case of securitisation exposures and due to a lack of sufficiently objective internal 
methodologies  within  banks,  most  of  them  would  be  expected  to  calculate  their  regulatory 
capital requirements by reference to external ratings.204 

Insurance and reinsurance 

The existing  directives on the supervision of insurance and reinsurance undertakings do not 
contain  any  provisions  which  place  reliance  on  credit  rating  agencies.  There  is  actually  no 
credit  risk  charge  for  the  solvency  margin  in  the  existing  framework  of  insurance  and 
reinsurance directives ("Solvency I").205  However, "Solvency I" is a minimum harmonisation 
and  a  number  of  Member  States'  national  laws  implementing  the  investment  and  capital 
requirement rules of the current "Solvency I" Directives206 do refer to ratings.207  

The  "Solvency  II"  Framework  Directive 208 ,  which  introduces  risk-oriented  solvency 
requirements for insurance and reinsurance undertakings, addresses credit risk but it does not 
contain  any  provisions  referring  to  or  placing  reliance  on  credit  rating  agencies.  Capital 
requirements are calculated using a standard formula or, subject to supervisory approval, by 
the  undertaking's  internal  model. 209  The  precise  design  of  the  standard  formula  capital 
requirements, including the market risk210 and counterparty default risk capital charge, will be 
set out in the future level 2 implementing measures which are currently being developed. In 
the  fifth  Quantitative  Impact  Study  (QIS5)211,  which  is  currently  being  carried  out,  credit 

201  
202  

203  
204  
205  

206  
207    

208  

209  
210  

211  

Annex V point 3 of Directive 2006/48/EC. 
This concerns the "Standardized Approach" ( Art. 78 ff Directive 2006/48/EC ) and Securitizations (Art. 
94, 96 Directive 2006/48/EC). 
Articles 78 and 84 in connection with Annex VII of Directive 2006/48/EC. 
Articles 94, 96 Directive 2006/48/EC. 
See  provisions  on  the  solvency  margin:  Articles  27  to  31  of  Directive  2002/83/EC,  Article  1  of 
Directive  2002/13/EC  of  5  March  2002,  OJ  L  77,  20.3.2002,  and  Articles  37  to  39  of  Directive 
2005/68/EC of 16 November 2005, OJ L 232, 9.12.2005.  
Articles 22 to 26 of Directive 2002/83/EC and Articles 20 to 23 of Directive 92/49/EEC. 
For  example,  in  the  Netherlands,  De  Nederlandsche  Bank  publishes  credit  spreads  that  (smaller) 
pension  funds  can  use  when  they  cannot  obtain  market  data  to  determine  buffers  to  cover  against 
reinsurance defaults. In the United Kingdom, the Insurance Prudential Sourcebook 1.6 provides a table 
with  “listed  rating  agencies”  Credit  ratings  from  these  firms  are  used  in  determining  assumed  spread 
stresses.  Ratings  are  also used  in  the  German  insurance  sector  for  asset  identification as  one  possible 
criterion to determine the safety of the asset. 
Directive  2009/138/EC  of  the  European  Parliament  and  of  the  Council  of  25  November  2009  on  the 
taking-up  and  pursuit  of  the  business  of  Insurance  and  Reinsurance  (Solvency  II)  ,  OJ  L  335, 
17.12.2009. 
Articles 100 to 127 of Directive 2009/138/EC. 
Market risk is caused by the day to day fluctuation in assets or securities prices which could be resulted 
in loss or profit. This risk is common to an entire class of assets and liabilities. Since this risk is caused 
by market itself it can not be diversified away. For instance changes in exchange rate, interest rate fall 
under this risk. Also a natural disaster which can have great impact on the prices of assets and securities 
are  known  as  market  risk.  For  the  banking  sector  Basel  II  has  proposed  two  main  approaches  to 
calculate this risk: standardized approach and model approach. 
In  order  to  assess  its  impact  the  development  of  "Solvency  II"  is  accompanied  by  five  Quantitative 
Impact  Studies.  In  these  studies  insurance  and  reinsurance  undertakings  as  well  as  insurance  groups 

132/193 

 
 
 
                                                                                                                                                         
ratings are used in the calculation of the standard formula, but QIS5 technical specifications 
do not prejudge any final decision as regards the standard formula. 

Pensions 
The  Institutions  for  occupational  retirement  provision  (IORP)  Directive212 does  not  contain 
any provisions referring or placing reliance on credit rating agencies.  A few Members States' 
rules and supervisory practices regarding IORPs  do make use of credit  ratings, for example 
with respect to investment rules and determination of an appropriate discount rate.  

Investment funds (UCITS) 

There  is  no  reference  to  credit  ratings  in  the  UCITS  directive  2009/65/EC.213 It  does  not 
provide for an obligation to take into account external credit ratings in the investment decision 
making process. 

Money market funds  

There  are  no  references  to  external  ratings  in  the  UCITS  directive  with  respect  to  money 
market funds. However, the CESR Guidelines on money market funds214 contains references 
to external ratings. According to this guideline, when assessing the quality of a money market 
instrument,  a management company must consider the credit quality of that  instrument. For 
this purpose a money market instrument is not considered to be of high quality unless it has 
been  awarded  one  of  the  two  highest  available  short-term  credit  ratings  by  each  recognised 
CRA that has rated the instrument or, if the instrument is not rated, it is of equivalent quality 
as determined by the management company's internal rating process. However, the guideline 
clarifies that the responsibility for the assessment of the quality of a money market instrument 
lies with the management company. In making such assessment it should take into account a 
range  of  factors  and  should  not  place  undue  weight  on  the  credit  rating  of  the  instrument. 
Money market funds may hold sovereign issuances of at least investment grade as awarded by 
one or more recognised CRAs.  

Investment firms 

For  the  purposes  of  defining  high  quality  money  market  instruments  that  must  be  held  by 
qualifying money market funds (which are allowed – at par with credit institutions and other 
eligible  entities  –  to  receive  on  a  temporary  basis  clients  funds  from  an  investment  firm), 
Article 18 of Directive 2006/73/EC (the MiFID Implementing Directive)215 makes reference 
to ratings of these instruments issued by competent CRAs.216 It requires that these instruments 
should have been awarded the highest available credit rating by each competent rating agency 

212 

213  

214  

215 

216 

under the scope of "Solvency II" determine their eligible own funds and capital requirements according 
to preliminary specifications of the new rules. 
Directive 2003/41/EC of the European Parliament and of the Council of 3 June 2003 on the activities 
and supervision of institutions for occupational retirement provision, OJ L 235/10, 23.9.2003. 
Directive    2009/65/EC  of  the  European  Parliament  and  of  the  Council  of  13  July  2009  on  the 
coordination  of  laws,  regulations  and  administrative  provisions  relating  to  undertakings  for  collective 
investment in transferable securities (UCITS), OJ L 302/32, 17.11.2009. 
CESR's  guidelines  on  a  common  definition  of  European  money  market  funds  of  19  May  2010, 
CESR/10-049.  These  guidelines  are  not  legally  binding  but  national  regulators  will  be  expected  to 
implement them. 
Commission  Directive  2006/73/EC  of  10  August  2006  implementing  Directive  2004/39/EC  of  the 
European  Parliament  and  of  the  Council  as  regards  organisational  requirements  and  operating 
conditions  for  investment  firms  and  defined  terms  for  the  purposes  of  that  Directive,  OJ  L  241/26, 
2.9.2006). 
According  to  the  same  article,  a  rating  agency  shall  be  considered  to  be  competent  if  it  issues  credit 
ratings  in  respect  of  money  market  funds  regularly  and  on  a  professional  basis  and  is  an  eligible 
external  credit  assessment  institution  (ECAI)  within  the  meaning  of  Article  81(1)  of  Directive 
2006/48/EC. 

133/193 

 
 
 
 
                                                                                                                                                         
which  has  rated  that  instrument.  An  instrument  that  is  not  rated  by  any  competent  rating 
agency shall not be considered to be of high quality. 

Disclosure requirements for securities 

When  securities  are  offered  to  the  public  or  admitted  to  trading  on  a  regulated  market 
according  to  the  Prospectus  Directive217 a  prospectus  needs  to  be  published.  On  debt  issues 
for  instance  Annex  V  paragraph  7.5  of  the  Prospectus  Implementing  Regulation218 requires 
that the prospectus must contain information on credit ratings – if available – assigned to an 
issuer  or  its  debt  securities  at  the  request  or  with  the  cooperation  of  the  issuer  in  the  rating 
process including a brief explanation of the meaning of the ratings if this has previously been 
published by the rating agency.  

ECB Regulation 

The  Eurosystem  credit  assessment  framework  (ECAF)  defines  the  procedures,  rules  and 
techniques  which  ensure  that  the  Eurosystem  requirement  of  high  credit  standards  for  all 
eligible assets is met.219 

In the assessment of the credit standard of eligible assets, the Eurosystem takes into account 
credit  assessment  information  from  credit  assessment  systems  belonging  to  one  of  four 
sources, namely:  

•  external credit assessment institutions (ECAIs),  

•  NCBs’ in-house credit assessment systems (ICASs),  

•  counterparties’ internal ratings-based (IRB) systems, or  

• 

third-party providers’ rating tools (RTs).  

Additionally,  in  the  assessment  of  the  credit  standard  the  Eurosystem  takes  into  account 
institutional  criteria  and  features  guaranteeing  similar  protection  for  the  instrument  holder 
such as guarantees.  

The  Eurosystem's  normal  benchmark  for  establishing  its  minimum  requirements  for  credit 
quality  threshold  is  defined  in  terms  of  a  "single  A"  credit  assessment—corresponding  to  a 
probably of default (PD) over a one-year horizon of up to 0.10 percent. In October 2008, the 
credit  quality  threshold  was  temporarily  relaxed  and  allowed  to  admit  up  to  triple-B 
collateral—with a PD equal to 0.40 percent. In April 2010 the Governing Council of the ECB 
decided to prolong the use of that category of assets beyond the end of 2010. The new eligible 
instruments need to be monitored against the credit quality thresholds. 

European Financial Stability Facility Framework Agreement  
The  establishment  of  the  European  Financial  Stability  Facility  (EFSF) 220  framework 
agreement 221 of 7 June 2010 between the EFSF and the "euro-area Member States" or "EFSF 
Shareholders"  sets  out  detailed  operating  conditions  of  the  EFSF  that  contain  references  to 

217  

218  
219  

220  
221   

Directive  2003/71/EC  on  the  prospectus  to  be  published  when  securities  are  offered  to  the  public  or 
admitted to trading and amending Directive 2001/34/EC (OJ L 345/64, 31.3.2003). 
Regulation (EC) No 809/2004 implementing Directive 2003/71/EC (OJ L 215/3, 16.6.2004). 
The general documentation on the ECAF is in Section 6.3 of the General Documentation, Section 6.3, 
as well as the amendments set out in Guideline ECB/2009/01, available from: 
http://www.ecb.int/paym/coll/elisss/html/index.en.html.  
The EFSF is a "société anonyme" incorporated in Luxembourg. 
European Financial Stability Facility (EFSF) framework agreement available from: 
http://www.efsf.europa.eu/attachments/efsf_framework_agreement_en.pdf.  

134/193 

 
 
 
                                                 
external  ratings222.  The  European  Financial  Stability  Mechanism  will  be  replaced  by  a  new 
instrument  as  of  2013,  the  European  Stability  Mechanism  (ESM).  The  treaty  establishing223 
the ESM does not contain any direct references to external ratings.  

State Aid 

Credit  ratings  are  currently  used  by  the  Commission  in  assessing  measures  adopted  by 
Member States under the State aid Rules in different contexts.  

First, the Communication from the Commission on the revision of the method for setting the 
reference and discount rates and the Commission Notice on the application of Articles 87 and 
88 of the EC Treaty to State aid in the form of guarantees224 uses an entity's credit rating (but 
not  limited  to  external  rating)  to  establish  whether  state  guarantees  or  loans  constitute  State 
aid.225 

Second, in the context of the pricing of state guarantees for banks, since July 2010, a step-up 
fee (in addition to the level recommended by the ECB) is applied and depends on the bank's 
credit rating. 

Third,  in  assessing  whether  state  guarantees  are  being  appropriately  priced  pursuant  to  the 
Communication  from  the  Commission  on  the  Application  of  State  Aid  Rules  to  Measures 
Taken  in  Relation  to  Financial  Institutions  in  the  Context  of  the  Current  Global  Financial 
Crisis226, the Commission will use a bank's credit rating as a measure of its creditworthiness. 

Fourth, the current rating and the outlook of a financial institution is one of the four criteria 
set  out  in  Annex  I  of  the  Commission  Communication  on  Recapitalisation  of  Financial 
Institutions of 5 December 2008227 for evaluating whether a bank can be classified as sound or 
distressed.  However,  this  Communication  is  currently  being  revised  and  as  such,  this 
requirement may be removed from the rules applicable from January 2011 onwards. 

Finally, the Communication from the Commission on the Treatment of Impaired Assets in the 
Community  Banking  Sector  of  25  February  2009228 requires  banks  to  disclose  the  current 
rating (when available) for each basket of activities they hold, such as structured products and 
securitised positions. This information is used as complementary source of information to the 
assessment of the impaired assets which are to be transferred to or guaranteed by a Member 
State,  but  is  not  the  primary  benchmark  for  the  valuation  of  such  impaired  assets.  In  this 
respect, a detailed and independent look-through analysis is performed to calculate expected 
losses and when relevant, confronted with the results deriving from external credit ratings. 

2.2 – Sovereign Debt Ratings 

Definition of Sovereign Ratings and Sovereign Default 

Sovereign credit ratings can be defined as a condensed assessment by credit rating agencies of 
a  government’s  ability  and  willingness  to  repay  its  public  debt  both  in  principal  and  in 

222  

223  

224  

225  
226  
227  
228  

More particularly, point 2 (3) regarding issues of guarantees states that the EFSF may also request the 
Guarantors to issue Guarantees under this Agreement for other purposes which are closely-linked to an 
issue  of  Funding  Instruments  and  which  facilitates  the  obtaining  and  maintenance  of  a  high  quality 
rating for Funding Instruments issued by EFSF and efficient funding by EFSF 
Treaty establishing the European Stability Mechanism (ESM) signed on 11 July 2011, currently under 
ratification by the Eurozone Member States. http://www.efsf.europa.eu/attachments/esm_treaty_en.pdf 
OJ C 155, 20.6.2008, p. 10–22. With effect from 1 December 2009, Articles 87 and 88 of the EC Treaty 
have  become  respectively  Articles  107  and  108  of  the  TFEU.  The  two  sets  of  provisions  are  in 
substance identical. 
OJ C 14, 19.1.2008, p. 6–9. 
OJ C 270, 25.10.2008, p.8. 
OJ C 10, 15.1.2009, p. 2-10. 
OJ C 72, 26.03.2009, pages 1-22. 

135/193 

 
 
 
                                                 
interests on time. In this, context, they are considered forward-looking qualitative measures of 
the probability of default put forward by rating agencies.229  

A sovereign defaults when it fails to make timely payment of principal or interest on its debt, 
or  if  it  offers  a  distressed  exchange  for  the  original  debt230.  According  to  the  IMF,  default 
events do not usually include the failure to repay debt owed to other governments and official 
creditors, including the IMF and World Bank.  

However,  definition  of  default  risk  varies  among  the  main  rating  agencies.  S&P  measures 
default risk  in terms of default probability whereas  Moody’s ratings measure expected loss. 
Fitch rates issuers on a default probability basis and instruments on an expected loss basis. As 
a  result,  at  least  in  theory,  Moody’s  ratings  should  diverge  from  Fitch’s  and  S&P’s  on  the 
same issuer according to variations in loss severity. According to the IMF, in practice, little 
divergence is observed, particularly among investment-grade ratings.231 
CRAs typically signal in advance their intention to consider rating changes232. For example, 
Fitch, Moody’s, and S&P all use negative “review” or “watch” notifications to indicate that a 
downgrade  is  likely  within  the  next  90  days.  They  use  a  negative  “outlook”  notification  to 
indicate  the  potential  for  a  downgrade  within  the  next  two  years  (one  year  in  the  case  of 
speculative-grade credits).  

Importance of Sovereign Debt Ratings 

Sovereign  credit  ratings  are  considered  important  for  at  least  three  reasons.  First,  sovereign 
ratings are a key determinant of a country’s borrowing costs in international capital markets. 
In this context sovereign ratings affect countries access and the terms of that access to capital 
markets,  with  the  threshold  between  investment-grade  and  speculative-grade  ratings  having 
important market implications.233 

Second,  according  to  a  recent  study,  the  sovereign  rating  generally  sets  a  ceiling  for  the 
ratings assigned to domestic banks and companies234, and therefore affects private financing 
costs. Therefore, sovereign ratings affects not only financing costs for the sovereign but also 
corporates and credit institutions with international capital market access are constrained by 
the sovereign ratings. In this context, it should be noted that there exists a direct link between 
sovereign  ratings  and  ratings  of  financial  institutions  located  within  the  territory  of  the 
sovereign.  

Third,  some  institutional  investors  have  lower  bounds  for  the  risk  they  can  assume  in  their 
investments  and  will  choose  their  portfolio  composition  taking  into  account  the  credit  risk 
signalled  by  the  rating  notations.  Therefore,  according  to  a  recent  study,  sovereign  ratings" 
also  expands  the  pool  of  potential  buyers  of  a  country’s  bond  issuances  to  institutional 
investors235.  

Sovereign debt –Sources of spillover effects 

229  

230  
231  
232  
233   

234  
235  

Afonso,  A.,  P.  Gomes,  and  P.  Rother  (2007),  What  ‘Hides’  Behind  Sovereign  credit  Ratings?  ECB 
Working Paper No. 711. 
IMF, Financial Stability Report, 2010, chapter 3: the uses and abuses of sovereign ratings. 
Ibid. 
Ibid. 
Jaramillo L., Determinants of Investment Grade Status in Emerging Markets, IMF working paper, 2010. 
reference WP/10/117.same comment as above –reduce the number of footnoes 
Ibid. 
Ibid. 

136/193 

 
 
 
                                                 
A  recent  study 236  has  demonstrated  that  sovereign  downgrades  have  statistically  and 
economically  significant  spillover  effects  both  across  countries  and  financial  markets. 
According  to  the  study,  there  are  many  potential  channels  through  which  sovereign  rating 
news may have spillover effect across countries and across financial markets. Another recent 
study 237  has  shown  that  there's  asymmetry  in  market  reactions  to  sovereign  debt  rating 
changes, i.e. while there is a significant reaction of sovereign yield spreads (and particularly 
CDS spreads) to negative events, the reaction to positive events is much more muted.  

In  this  context,  a  sovereign  rating  downgrade  in  a  given  country  is  likely  to  affect  the 
profitability of domestic banks of the country and of banks in other countries where banks are 
holding this debt. This is the case of Europe where banks hold at times substantial amount of 
sovereign debt in both their trading and banking books.238  

Sovereign  rating  news  may  spill  over  across  countries  and  markets  when  banks  across 
countries hold claims on banks in other countries and are thus exposed to one another. As this 
cross-holding  feature  is  an  important  element  of  the  European  financial  markets  sovereign 
credit rating announcements may spillover to other markets as a result of rating-based triggers 
such  as  those  in  banking  regulation,  ECB  collateral  rules,  CDS  contracts  or  investment 
mandates. 

According  to  the  study,  sovereign  rating  downgrades  have  statistically  and  economically 
significant  spillover  effects  both  across  countries  and  financial  markets  implying  that  rating 
agencies announcements could spur financial instability. Those spillover effects depend both 
on the type of rating announcements, on the source country experiencing the downgrade and 
the  rating  agency  from  which  the  announcements  originates  from.  Furthermore,  the  study 
found evidence that some rating announcements such as rating downgrades near speculative 
grade  (for  example,  the.  downgrade  of  Greece  to  BBB+  from  A-  by  Fitch  on  December  8, 
2009) have a systematic spillover effects across Euro zone countries under consideration (For 
example, it resulted in a 17 and 5 basis points increase respectively for Greek and Irish CDS 
spreads). Another example of spillover effects is the Austrian CDS spreads and stock market 
indices  moved  which  sharply  following  the  downgrades  of  Baltic  countries,  while  the 
Austrian credit rating remained unchanged. One possible channel of this spillover effect is the 
exposure of Austrian banks to the Baltic countries. 

Analysis of sector and cross-sector risks related to sovereign ratings 
According to the Cross-Sectoral Risk Task Force239 (hereafter referred to as the CSR TF) of 
the  three  European  Supervisory  Authorities  (ESAs),  there  has  been  a  visible  link  between 
sovereign and bank CDS spreads multiple countries , including GR, PT, IT as shown in chart 
1 below. However, in the insurance sectors, such a correlation is less evident (as shown in 2 
below). Contagion to other EU countries has been limited and mainly stems from cross-border 
holdings of government bonds and increased difficulty in issuing debt securities. So far, there 

236  

237  

238  

239  

Rabah Arzeki, Bertrand Candelon and Amandou N.R.Sy, IMF Working Paper, Sovereign Rating News 
and Financial Markets Spillovers: Evidence from the European Debt Crisis, March 2011, WP/11/68. 
See Afonso, Furceri, Gomes, ECB paper n. 1347, June 2011. according to the Authors the reaction of 
CDS spreads to negative rating events has increased considerably after the beginning of the crisis (i.e. 
the 15.9.2008 – day of Lemahn bankruptcy). 
Blundell-Wignall,  A.  and  P.  Slovik  (2010),  “The  EU  Stress  Test  and  Sovereign  Debt  Exposures”, 
OECD  Working  Papers  on  Finance,  Insurance  and  Private  Pensions,  No.  4,  OECD  Financial  Affairs 
Division. Available from: www.oecd.org/daf/fin.  
Cross-Sectoral  Risk  Task  Force  of  the  European  Supervisory  Authorities:  Cross-sectoral  risk 
assessment  report:  March  2011.  The  report  focuses  on  the  common  sources  of  risk  for  the  different 
sectors  of  financial  institutions  and  on  cross-sectoral  contagion  links.  The  assessment  of  the  risks  is 
provided on the basis of the information collected in January 2011. 

137/193 

 
 
 
                                                 
has  not  been  evidence  of  destabilising  speculation  or  market  manipulation  in  the  markets 
related to specific sovereign bonds.  
The threats for the EU financial system involve, according to the CSR TF240 , first, increased 
default risk premia for highly indebted countries propelling writedowns on all sovereign asset 
holdings that are marked-to-market. Second, the sovereign debt market unrest can spill-over 
to  other  markets  such  bank  funding  markets  (increasing  banks’  funding  costs)  or  equity 
markets as e.g. in May 2010, resulting in higher market risk levels for financial institutions. 
Third,  the  fiscal  austerity  measures,  possibly  aggravated  by  sovereign  and  bank  funding 
problems, can contain economic growth and increase private sector credit risk. 

Source: Internal study from BaFin, Germany 
Figure 11. Bank vs Sovereign CDS spreads by country and Insurance vs. Sovereign CDS spreads by 
country 

Sectorial risks due to Sovereign debt ratings 

According to the CSR TF, the higher default risk premium of the affected countries and their 
rating downgrades also negatively affect the banks domiciled in these countries. These banks 
face higher funding costs irrespective of their own performance as their spreads and ratings 
are linked to those of the sovereign. Banks also hold large quantities of their own government 
debt, which has caused significant losses on market-value terms, and their credit risk outlook 
depends  on  the  impact  of  the  austerity  measures  on  the  real  economy  and  asset  prices, 
especially real estate.  

Regarding the rest of the EU banking sector, according to the CSR TF, significant risk relates 
to the holdings of the sovereign debt of the affected countries. However, the most part of the 
exposure (on average around 80%) is held in the banking book. Banking book exposures are 
supposed to be held to maturity and are not marked-to-market.241 While significant, most of 
the largest cross-border banking groups have relatively contained exposures to sovereign debt 
of countries other than their own domicile. Nevertheless, market concerns may spill over to 
other assets from the affected countries, like covered bonds.242  

240  
241  

242  

Ibid. 
The EBA does not as yet have statistics regarding the proportion of assets allocated in the Available For 
Sale (AFS) portfolio of the banking book, for which market value losses are deducted from banks’ own 
funds, unless own funds are insulated from market value changes through the use of "prudential filters".  
EBA’s assessment of sovereign debt risk will be repeated in the forthcoming stress test.  

138/193 

 
 
 
 
 
 
 
                                                 
EU insurance undertakings and occupational pension funds manage a large government bond 
portfolio. For insurance undertakings the overall exposure towards government bonds of EEA 
countries  (plus  Japan,  Switzerland  and  the  U.S.)  is  roughly  1,300  bn  EUR  (24%  of  total 
assets)  according  to  the  data  collected  by  European  Insurance  and  Occupational  Pensions 
Authority  (EIOPA)243.  The  same  figure  for  occupational  pension  funds  is  estimated  around 
350 bn EUR (14% of total assets). The impacts on specific undertakings depend on the extent 
of asset diversification. Generally, the portfolios are well-diversified. 

In  insurance  and  occupational  pension  sector  there  is  no  evidence  of  fire  sales,  but  in  some 
cases  a  partial  shift  towards  more  secured  sovereign  debt  has  taken  place.    In  general,  de-
risking of the portfolios has taken place in the second and third quarters of 2010, according to 
the EIOPA survey.  

In some EU countries, investment patterns of asset managers may be characterised by above-
average exposures towards sovereign debt issued with “average plus” –yields, which could be 
an indication of the “search for yield” and greater risk taking.  

Cross-sectorial and contagion risks due to sovereign debt ratings 
According to the CSR TF, some banks followed by the European Banking Authority244 (EBA) 
have already suffered from consequences of the fiscal consolidation measures, as reductions 
in disposable income has lead to an increase in loan loss provisions. In particular, the quality 
of  the  consumer  loan  portfolio  has  experienced  a  severe  deterioration.  Fiscal  consolidation 
can reduce economic activity, leaving fewer growth and profit opportunities for all financial 
institutions,  although  it  might  also  have  longer-term  beneficial  effects,  for  example  through 
improved confidence and lower funding costs.   

According  to  the  CSR  TF,  all  EU  banks  could  suffer  from  contagion  effects  via  funding 
markets should the concerns related to sovereign risk persist. Also financial markets can more 
widely be affected by turmoil in sovereign debt markets, as was evidenced during 2010. The 
consequence can be hits in  the pricing  of  assets  and higher market volatility. This would in 
particular  affect  insurance  undertakings  and  pension  funds  that  have  large  investment 
portfolios. 

According to the CSR TF, there is also close interaction between the sovereign and municipal 
debt.  Municipal  financing  is  a  relatively  important  business  for  a  number  of  major  banks 
followed  by  the  EBA.  So  far  defaults  on  municipalities  are  rare,  but  the  market  pricing  of 
municipal default risk is closely linked to that of the sovereign. 

Risk description: Further negative developments in sovereign debt markets 

Sector affected 
Banking 

Impact 
High  

Insurance 
Financial conglomerates 

Medium to high  
Medium to high  

Details 
Heightened liquidity and funding risks 
Decreased quality in loan portfolios   
Market value losses on sovereign debt instruments 
Market value losses on sovereign debt instruments  

Asset management 
Pension funds 
Consumers 

Medium 
Low  
High  

Potential risks related to “search for yield” 
Market value losses on sovereign debt instruments 
Reduced public sector benefits and decreased 

243  

244  

EIOPA  is  one  of  the  three  supervisory  authorities  responsible  for  the  insurance  sector,  accessible  at: 
https://eiopa.europa.eu/.  
EBA is one of the three supervisory authorities responsible for the banking sector. More information is 
available at: https://eba.europa.eu/.  

139/193 

 
 
 
 
 
                                                 
Cross-sector contagion issues 

Geographic impacts 
Policy implications 

private consumption  

Risk of contagion to other financial markets (bank funding, equity, municipal debt) 
Reduced business activities due to fiscal consolidation 
Vary significantly per country - institutions in highly indebted countries most affected 
Supervisory attention towards institutions’ sound risk management and adequacy of 
diversification 
Incentives are created to hold sovereign debt as prudential regulation in banking or 
insurance does not take into account increased sovereign risk premia 

2.3. Competition in the Credit Rating Sector  

The  root  causes  of  the  limited  competition  within  the  rating  industry  can  be  explained  by 
market  characteristics  both  on  the  demand  side,  which  includes  issuers  and  investors  and 
supply side, which includes the credit rating agencies.  

On the demand side, there is little willingness from issuers to pay for low or medium range 
ratings  and  many  investors  concentrate  on  securities  rated  by  highly  reputable  agencies, 
channelling demand for ratings to a small number of CRAs.245 This is related to the signalling 
function of ratings for issuers and the perceived informational quality and value of ratings to 
investors.  Demand  is  also  driven  by  "network  effects",  as  ratings  provide  investors  with  a 
comparative risk evaluation.246 More specifically, an important aspect of the value of a rating 
is  its  comparability  to  other  ratings.  Therefore,  issuers  favour  ratings  from  leading  rating 
agencies  that  can  ensure  the  largest  comparability  of  ratings  for  investors  which  increases 
market concentration.247 

On the supply side, market concentration is reinforced by barriers to entry. Investors attribute 
considerable importance to reputation which is hard to acquire for new market entrants.248 In 
this context, it should be noted that for a small rating agency with a low absolute number of 
ratings, even a single badly perceived rating could have a statistically relevant impact on its 
performance and reputation. 

Furthermore, ratings from newly registered and authorised CRAs face restricted uptake by the 
market as they cannot always be used for regulatory capital purposes if they have not obtained 
the  External  Credit  Rating  Institute  (ECAI)  statute249.  As  shown  in  Annex  IV,  section  1, 
mainly 3 CRAs have obtained ECAI approval from the majority of national regulators while 
all  other  CRAs  have  obtained  ECAI  approval  in  only  a  very  limited  number  of  Member 
States,250 thus limiting the choice for issuers and investors of CRAs whose ratings can be used 
for  regulatory  purposes.251 Furthermore,  due  to  the  absence  of  a  standardized  rating  scale, 

245  

246  

247  

248  

249  

250  
251  

Fabian Dittrich, The Credit Rating Industry: Competition and Regulation, 2007, p59. Available from: 
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=991821.  
Financial instruments from diverse areas such as structured finance products or sovereign debt can be 
compared, whereas the "absolute risk" of the rating category can change over time, See BIS (Bank of 
International  Settlements,  Basel  Committee  on  banking  supervision,  2000:  "Credit  Rating  and 
Complementary sources of credit Quality Information", Working Papers No 3, August 2000. Available 
from: http://www.bis.org/publ/bcbs_wp3.pdf.  
Fabian Dittrich, The Credit Rating Industry: Competition and Regulation, 2007, p73-74 Available from:  
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=991821.  
OECD,  Organisation  for  Economic  Co-operation  and  Development,  Credit  Rating  Agencies: 
Competition related issues, June 2010, DAF/COMP(2010)20, p.11.  
Article  1  of  the  CRA  regulation  states  that  registration  is  only  a  precondition  to  obtain  ECAI  statute 
under Directive 2006/48/EC.of the European Parliament and the Council of 14 June 2006 relating to the 
taking up and pursuit of the business of credit institutions. A CRA needs to be ECAI to ensure that its 
ratings can be used for regulatory capital purpose as required in article 80-83 of Directive 2006/48/EC. 
Therefore, additional requirements provided for in Directive 2006/48/EC apply.  
All other CRAs have obtained ECAI approval in 6 or less Member States in July 2010. 
This is particularly relevant for issuers aiming to sell their debt instruments in an international context, 
requiring an ECAI statute in all Member States. 

140/193 

 
 
 
 
                                                 
small  CRAs'  ratings  are  not  always  readily  comparable.  A  further  barrier  to  entry  is  that 
issuers and investors are sometimes unaware that alternative players exist.252 

For  investors,  this  implies  that  there  is  a  strictly  limited  choice  of  ratings  and  limited 
alternatives available to compare ratings from a wide range of CRAs, while they have limited 
opportunity to assess rating quality. For issuers, market concentration implies limited choice 
and  alternatives  to  be  rated,  and  most  probably,  higher  prices  for  ratings  due  to  the 
oligopolistic  structure  of  the  market.253 In  addition,  some  segments  of  issuers,  particularly 
Small and Medium-sized Enterprises (SMEs) or small sovereigns, might experience difficulty 
obtaining  a  rating  as  not  all  market  segments  are  covered  by  rating  agencies.  For  these 
enterprises  ratings  from  existing  rating  agencies  might  be  too  expensive  or  these  markets 
might be considered too small for existing rating agencies. This could be an additional barrier 
for  Small  and  Medium-sized  issuers  to  access  capital  markets.  Furthermore,  new  entrants 
experience  difficulty  establishing  themselves  in  the  market  and  in  gaining  reputation. 
Evidence shows that those who are able to successfully establish themselves have often been 
taken over by existing rating agencies.254  

It  should  be  noted  that  the  CRA  regulation  partially  addresses  this  problem  through 
registration and official endorsement.255 Registration  and  official endorsement of new rating 
agencies  under  the  CRA  regulation  is  expected  to  improve  the  visibility  of  new  rating 
agencies establishing themselves on the EU market. Furthermore, the high standards for rating 
methodology  and  the  supervision  of  registered  rating  agencies  are  elements  which  could 
contribute to some extent to the reputation of newly established rating agencies among issuers 
and investors. Over a long period of time this could eventually contribute to diversity of rating 
agencies available on the EU market.  
Some  studies  have  argued  that  increased  competition  has  reduced  rating  quality.256 In  this 
context,  some  authors  believe  that  greater  competition  increases  the  risk  of  rating  shopping 
and decreases reputation costs for CRAs, leading to inflated, lower quality ratings.257 It should 
be  noted  that  "increased"  competition  occurred  in  the  market  segment  of  structured  finance 
products  for  which  only  a  limited  number  of  investment  banks  participated.  CRAs'  quality 
standards  decreased  as  they  raced  to  offer  "better  ratings"  in  order  to  retain  business.  This 
problem  is  addressed  by  the  CRA  Regulation,  requiring  high  quality  ratings  and 
methodologies subject to regulatory supervision by ESMA.  

2.4. Civil Liability 

Survey of Member States' civil legal orders in respect of provisions on which investors could 
base claims against CRAs having infringed the CRA Regulation 

The  Commission  services  asked  ESMA  to  survey  a  sample  of  Member  States  civil  legal 
orders  in  respect  of  provisions  on  which  investors  could  base  claims  against  CRAs  having 
infringed the CRA Regulation. 

252  

253  

254  

255  
256  

257  

European  Association  of  credit  rating  agencies  (ECRA),  contribution  to  the  public  consultation  of  7 
January 2011.  
Fabian Dittrich, The Credit Rating Industry: Competition and Regulation, 2007, p100. Available from:  
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=991821. 
E.g. Fitch has established itself by an aggressive acquisition strategy, see Dodd, Randall ad Gautam 
Setty, 2003, "Credit Rating Agencies: Their Impact on Capital Flows to Developing Countries". 
Financial Policy Forum, Special policy report 6, 2003, p.7. Available from:  
http://www.financialpolicy.org/FPFSPR6.pdf.  
As provided for in Article 14-20 of the CRA Regulation. 
Becker,  Milbourn,  How  did  increased  competition  affect  credit  ratings?  Harvard  Business  School, 
Working Paper 09-051, p.30. 
Camanho et al., 2010; Bolton et al., 2009; Skreta and Veldkamp, 2009. 

141/193 

 
 
 
                                                 
All respondents said that investors could at least in theory base claims against CRAs having 
infringed  the  Regulation.  The  Member  States  did  not  in  general  have  specific  provisions 
relating to civil liability of CRAs. Only France adopted in 2010 a specific law in relation to 
the  liability  of  CRAs  not  only  to  clients  but  also  to  third  parties  (including  investors  using 
ratings) "in case of delict and quasi-delict, for the harmful consequences of any negligence or 
breaches".   

Investors without a contractual relationship with a CRA (which is the normal situation under 
the prevalent issuer-pays model) must refer to liability in tort, while a party with a contractual 
relationship can refer to contractual liability.  

It seems that in many Member States it is not certain that an action based on liability in tort by 
an investor  would be successful.  In Sweden and Poland for example, it is rather unlikely that 
a  party  with  no  contractual  relationship  with  a  CRA  could  establish  an  indemnity  liability 
claim under tort law.  In other member states (UK, Netherlands) civil liability of a CRA vis-à-
vis investors depends on a range of criteria and courts take a flexible approach depending on 
the circumstances of the case. In Germany, civil liability vis-à-vis investors that do not have a 
contractual relationship with the CRA could theoretically be based on delict (Art. 823 (2) of 
Bürgerliches Gesetzbuch (German civil code), however this requires that courts consider that 
the  specific  provision  of  the  CRA  Regulation  that  has  been  infringed  intends  to  protect  the 
investors and it is not clear whether courts will actually make this assumption.  

Also  notable  was  the  various  degrees  to  which  civil  liability  could  be  excluded  or  limited 
under the different legal orders; again varying from state to state.  There was a common need 
to establish a causal link leading to the damages, and most Member States had a standard of 
fault of negligence and intention. 

The  following  summary  contains  assumptions  (for  example  where  there  is  no  existing  case 
law) and is intended as a general, non-exhaustive guide: 

Specific 
CRA civil 
liability 
regime? 
No 

Austria 

Belgium 

No 

Provisions 

Standard of 
Fault 

Exclusion of 
liability possible 

Intention, 
negligence or 
carelessness 

To a limited 
extent 

In some cases, but 
not for fraudulent 
misrepresentation, 
or where such an 
exclusion empties 
the obligations of 
their substance 

§§1293 ff ABGB(General 
Civil Code), (financial) 
damage (cf. §1293 s.1 
ABGB) due to an 
unlawful (cf. §1294 s.2 
ABGB) culpable (cf. 
§1295 par.1 ABGB) 
behavior esp. in breach of 
the CRA Regulation's 
(protection) requirements 
(cf. §1311 ABGB; called 
"Schutzgesetzverletzung")
Article 1382 and 1383 of 
the Belgian Civil Code 
related to general non-
contractual civil liability 

142/193 

 
 
 
 
 
 
Specific 
CRA civil 
liability 
regime? 
No 

Cyprus 

Czech 
Republic 

No 

France 

Yes 

Germany 

No 

Greece 

Latvia 

Lithuania 

Luxembourg 

Malta 

No 

No 

No 

No 

No 

Provisions 

Standard of 
Fault 

Exclusion of 
liability possible 

Various, 
including intent 

Yes 

Yes, except if 
caused by 
negligence or 
intention 
Under tort law, 
exclusion clauses 
generally 
considered null 
and void, 
however, claims 
under contract 
cannot rely on tort 
to void such 
exclusions 

Negligence 

Negligence, 
intent or 
omission 

Intention, 
negligence 

By law or 
contract 
No 

No specific 
standard of fault 

Fault or 
negligence 
Negligence, 
intent 

No 

Yes, in some 
cases, exclusion 
clauses must be 
consented to by 
all parties and not 
be illegal or 
contrary to public 
policy 

Civil Procedures Rules, 
Civil Wrongs Law, 
Contract Law, Law of 
Evidence 
Act No. 40/1964 Coll., 
Civil Code, as amended, 
section 420 

Law  2010-1249 on 
banking and financial 
regulation of October 
22nd 2010, article 10: 
codified into Monetary 
and Financial Code MFC 
(articles L. 544-4 to L. 
544-6 in chapter IV of 
title IV of book V), 
referring to article 1382 
and 1383 of Civil Code 
Bürgerliches Gesetzbuch 
(BGB), contract with 
CRA; § 611, § 433, § 459 
BGB, third party; § 823 
para 2 BGB, § 611, § 433, 
§ 459 BGB 
914 Civil Code 

Article 1 of the Civil 
Procedure Law 
General provisions of 
civil liability established 
in the Civil Code of the 
Republic of Lithuania 
Code civil, articles 1382 
and 1383 
Maltese Civil Code: Of 
Contracts: art. 993  

Maltese Civil Code: Of 
Torts and Quasi Torts: art. 
1031 – 1032, 1033, 1037, 
1038, 1044, 1045, 1047, 
1049 – 1051  

Maltese Civil Code: Of 
the Effects of Obligations: 
1125 – 1141  

143/193 

 
 
 
 
 
 
 
 
 
 
Specific 
CRA civil 
liability 
regime? 
No 

Netherlands 

Poland 

Slovenia 

No 

No 

Sweden 

No 

UK 

No 

Provisions 

Standard of 
Fault 

Exclusion of 
liability possible 

Dutch Civil Code (CC), 
6:162 CC (non-
contractual liability) 

Likely to be 
negligence 

Yes, but not for 
non-contractual 
liability, though it 
can be limited to 
a certain extent 

or 6:194 CC (misleading 
advertisement) (lex 
specialis of the above 
general tort provision) 
Article 415 of the Civil 
Code 
Code of Obligations (OZ, 
Official Gazette of the 
Republic of Slovenia, 
Nos. 83/2001… 97/2007), 
Articles 131-189 
Pursuant to the Swedish 
Tort Liability Act (SFS 
1972:207), Chapter 2 
Section 2 
General law of contract 
and tort. In tort, the most 
relevant cause of action is 
likely to be the tort of 
negligence. 

No specified 
standards 
Intent or 
negligence 

Not for tort 
liability 
No 

Contract, 
negligence 

Yes, but only 
enforceable as far 
as court assesses 
such a clause to 
be reasonable 

2.5. Conflicts of Interest due to remuneration models  

In  the  following  the  main  remuneration  models  for  credit  rating  agencies  are  presented 
followed by a description of potential conflicts of interest linked to the respective model. 

Issuer-pays model 

This model relates to the case where issuers solicit and pay for the ratings of their own debt 
instruments. The issuer-pays model is by far the dominant remuneration model currently used 
by  credit  rating  agencies.  On  average,  the  revenue  generated  by  the  issuer-pays  model 
represents more than two-third of total CRAs' revenues. 

The  issuer-pays  model  entails  conflicts  of  interest  by  its  nature.  The  inherent  conflict  of 
interest  in  this  model  is  that  rating  agencies  have  a  financial  interest  in  generating  business 
from  the  issuers  that  seek  the  rating,  which  could  lead  to  assigning  higher  ratings  than 
warranted in order to increase its revenues from the issuer. A low rating might affect future 
business.  If  reputational  concerns  or  regulation  are  not  strong  enough  to  discipline  credit 
rating agencies, the issuer-pays model can result in inflated ratings.  

Investor/subscriber-pays model 

Under this model, credit rating agencies would earn fees from users of the ratings. In the mid-
1970s, as credit ratings started to become more important because of the increasing reliance 
on  ratings  in  rules  and  regulations,  CRAs  stopped  selling  ratings  to  investors  and  instead 
began  charging  the  companies  that  issue  the  debt  they  rate.  Still,  in  the  US,  some  of  the 
smaller  CRAs,  such  as  Egan-Jones  Rating  Company  (which  focuses  on  corporates),  Lace 

144/193 

 
 
 
 
 
 
 
 
Financial  Corporation,  and  Realpoint,  LLC  (which  focuses  on  structured  finance),  use  the 
investor/subscriber-pays models. 

Even if the conflicts of interests related to the investor/subscriber-pays model are in general 
considered to be less strong than those attributed to the issuer-pays model, the investor-pays 
model  is  by  far  not  free  form  conflicts  of  interests:  A  large  investor  may  try  to  influence 
CRAs to provide lower initial ratings (which tend to provide higher yields), while institutions 
that can only invest in highly rated instruments due to regulatory requirements might pressure 
a CRA to assign an investment-grade rating on a particular security.  

It has also been shown that under the "investor-pays" model there is the risk of "free-riders" 
when an investor accesses the information paid by another investor, without having to support 
the cost of the information production258.   

Moreover,  some  experts  doubt  whether  the  investor-pays  model  would  provide  enough 
resources  for  credit  rating  agencies  to  deliver  high  quality  ratings  and  employ  a  sufficient 
number  of  analysts,  as  investors  are  not  always  able  or  willing  to  pay  for  rating  services. 
Ultimately  the  investor-pays  model  could  marginalise  ratings  for  smaller  issuers  and  less 
liquid issuances.  

The public utility/government model 

This model is currently not applied in practice. It would require transforming a credit rating 
agency into a public utility and funding it with government revenues. 

Also the public utility/government model is not free from conflicts of interest, especially with 
regard to sovereign debt ratings.  It involves taxpayers' money. 

258  

A  user/investor-pays-based  business  model  is  difficult  to  maintain  because  of  the  inability  to  restrict 
access  to  ratings  and  their  public  good  characteristic  of  aggregating  difficult-to-obtain  private 
information.  See  the  International  Monetary  Fund,  World  Economic  and  Financial  Surveys  Global 
Financial Stability Report, October 2010, p.14. 

145/193 

 
 
 
                                                 
ANNEX VII. DESCRIPTION OF OPTIONS 

Identified policy options regarding objective 1 - Diminish the impact of “cliff" effects on  
financial institutions and markets by reducing reliance on external credit ratings 

(Potential) 
Instrument  

All references 
to ratings in 
EU Financial  

CRDIV 
proposal as 
adopted on 20 
July 2011. 
Solvency II 
implementing 
measures259, 
UCITS260 and 
AIFMD261  

Policy option 

Description 

Option 1 (baseline) 

The baseline scenario applies. 

Option 2 

(Reduce reliance on external 

ratings by enhancing 
internal risk management 
and promoting the use of 
internal rating models for 
regulatory purposes) 

All explicit references to external credit ratings in regulatory 
capital  frameworks  for  financial  institutions  would  be 
reviewed.  This  would  include  the  guidelines  from  the 
European  Supervisory  Authorities.  A  specific  obligation 
should be included in EU legislation encouraging European 
Supervisory  Authorities  to  use  other  means  for  assessing 
creditworthiness rather than pure reliance on ratings. 

Option  2  would  require  financial  firms  (credit  institutions, 
investment  firms,  insurance  and  reinsurance  undertakings, 
pension funds, UCITS managers and in the future alternative 
investment  fund  managers)  to  assess  the  credit/market  risk 
using  their  own  methodology.  Financial  firms'  investment 
decisions  would  not  rely  solely  or  mechanistically  on 
external  ratings  but  would have  to  be  based  in  addition, on 
information  obtained  through  own  due  diligence,  external 
research or market based measures (such as CDS prices). 

Firms  with  material  and  complex  credit  risk  exposure 
(banks,  certain  investment  firms,  insurance  and  reinsurance 
undertakings)  will  be  required  to  develop  and  use  internal 
models  for  the  calculation  of  capital  requirements,  rather 
than  relying  on  external  ratings  under  a  standardized 
approach.  

Standardised  approach  would  remain  available  for  smaller 
institutions  for  which  the  development  of  internal  models 
would  be  disproportionate  or  for  those  institutions  whose 
exposure  to  credit  risk  is  less  material  or  less  complex. 
However,  also  those  firms  would  have  to  assess  if  the 
inherent  credit  risk  of  an  exposure  is  significantly  higher 
than  the  one  that  corresponds  to  the  capital  requirement 
assigned under the standardised approach based on external 
ratings, and to reflect the higher degree of credit risk in the 
evaluation of their overall capital adequacy. This measure is 
also recommended by FSB and thus would ensure coherence 
at the international level. 

It  should  also  be  made  sure  that  references  to  external 
ratings  will  be  avoided  to  the  extent  possible  in  any  future 
EU  legislation  including  technical  standards  and  guidelines 

259 
260 

261 

Implementing measures of Solvency II are expected in Q2 2012. 
Directive 2009/65/CE of the European Parliament and the Council of 13 July 2009 on the coordination 
of laws, regulations and administrative provisions relating to undertakings for collective investment in 
transferable securities (UCITS), OJ L 302, 17.11.2009. 
Alternative  Investment  Fund  Managers  (AIFM)  Directive  (“AIFMD”).  On  11  November  2010,  the 
European Parliament and the Council have reached a political agreement on the "Draft Directive" and 
the publication of the Directive in the Official Journal of the European Union is expected in Q1 2011. 

146/193 

 
 
 
 
 
                                                 
Policy option 

Description 

Option 3 

(Require credit institutions, 

investment firms, insurance 
and reinsurance 
undertakings to use more 
than one rating, if available) 

Option 4 

(Improve disclosure 

requirements for issuers of 
structured finance products 
on an ongoing basis) 

of the European Supervisory Authorities. 

This  option  would  require  credit  institutions,  investment 
firms, insurance and reinsurance undertakings to use at least 
two credit ratings issued by different credit rating agencies, 
where available. These ratings would be required to be used 
for  the  calculation  of  capital  requirements  under  the 
standardized approach.262  

Improve  disclosure  requirements  for  issuers  of  structured 
finance  products  on  an  ongoing  basis,  enabling 
the 
disclosure of the main elements of underlying asset pools for 
structured finance products necessary for investors to make 
their  own  credit  assessment  and  thus  not  rely  on  external 
ratings. Issuers could disclose this information by means of 
a website. 

(Potential) 
Instrument  

Solvency II 

Amendment 
of the CRA 
Regulation 

Identified policy options regarding objective 2 - mitigate risks of contagion effects linked 
to sovereign debt ratings 

Policy option 

Description 

1. No policy change 

The baseline scenario applies. 

2. Require CRAs to publish a 

full research report on 
sovereign debt ratings and 
allocation of staff 

Strengthen existing disclosure requirements for solicited 
and  unsolicited  sovereign  debt  ratings  by  requiring 
CRAs  to  disclose  free  of  charge  their  full  research 
reports  on  sovereign  debt  ratings  in  order  to  improve 
transparency  and  enhance  users'  understanding.  This 
option  could  also  include  the  publication  of  additional 
figures  on  the  allocation  of  staff  in  the  annual 
transparency report. 

(Potential) 
Instrument  

Amendment of 
CRA Regulation 
(CRA III) 

3. Require CRAs to publish 
sovereign ratings after 
closing of EU trading venues 

Require  CRAs  to  publish  sovereign  debt  ratings  only 
after  the  close  of  business  of  European  trading  venues 
ensuring  that  all  market  participants  can  obtain  a  full 
understanding of any change of a rating. 

Amendment of 
CRA 
Regulation 
(CRA III) 

4. Require CRAs to conduct the 

sovereign debt ratings 
process more frequently 

5. Extend powers of competent 

authorities (ESMA) to 
scrutinize rating 
methodologies 

Strengthen  the  current  review  requirement  for  credit 
ratings  by  requiring  CRAs  to  assess  sovereign  debt 
ratings more frequently. This could entail, for instance, 
the  reduction  of  the  maximum  time  period  after  which 
sovereign  debt  ratings  have  to  be  fully  assessed  to  six 
months from twelve as currently provided for in article 
8 (5) of the CRA regulation. 

Extend the powers of the ESMA by requiring registered 
CRAs  to  notify  it  in  advance  of  any  change  to  rating 
methodologies.  This  could  apply  for  methodologies  of 
sovereign  debt  ratings  and  also  for  other  asset  classes. 
ESMA  would 
changed 
scrutinize  whether 
methodology complies with the criteria in Art. 8 (3) of 

the 

Amendment of 
CRA Regulation 
(CRA III) 

Amendment of 
CRA Regulation 
(CRA III) 

262  

Basel II: under this approach banks are required to use ratings from External Credit Rating Agencies to 
quantify required capital for credit risk. 

147/193 

 
 
 
 
 
 
                                                 
Policy option 

Description 

(Potential) 
Instrument  

interfere  with 

the  content  of  credit 

the  CRA  Regulation  will  be  specified  in  the  future 
regulatory technical standard. In doing so, ESMA shall 
not 
rating 
methodologies  as  required  in  article  23.1  of  the  CRA 
regulation.  Only  after  a  positive  assessment  by  ESMA 
the  CRA  may  proceed  with  the  new  methodology. 
Furthermore, ESMA shall be empowered to restrict for 
a  limited  period  the  issuance  of  ratings  if  it  has 
sufficient  concern 
that  a  CRAs  methodology  or 
application of a methodology is in danger of infringing 
the Regulation.   

6. Require (EU) sovereigns to 
publish a standardized set 
data on economic 
performance to enable credit 
risk assessment 

7. Grant ESMA the power to 
restrict or ban temporarily 
sovereign debt ratings in 
situations defined by the 
Regulation 

8. Encourage an existing, 

independent EU structure or a 
brand new European Credit 
Rating Agency to issue credit 
ratings 

sovereigns 

to  disclose  a 

Require 
limited  and 
standardised  set  of  relevant  information  necessary  for 
investors to perform their own credit assessment which 
would be published on a centralised website, facilitating 
comparability of standardized information for investors.   

Define 
the  exceptional  conditions  under  which  a 
temporary  banning  or  restriction  of  sovereign  ratings 
could  be  imposed  in  the  Regulation.  These  exceptional 
situations  could  include  an  event  that  poses  a  threat  to 
financial 
excessive 
volatility  or  cases  where  there  are  ongoing  negotiations 
on  a  financial  assistance  programme  for  EU  Member 
State.  Detailed  criteria  for  determining  an  exceptional 
situation  would  be  determined  by  means  of  a  delegated 
act. 

stability,  market 

confidence, 

Encourage  an  existing  independent  EU  structure  (ECB) 
or promote a brand new European Credit Rating Agency 
to  issue  independent  credit  assessments,  particularly  for 
European sovereigns. These assessments could include a 
detailed  research  report  and  methodology  and  would  be 
published  and  remain  freely  available  for  investors, 
offering 
existing 
commercial credit ratings. Existing EU structures such as 
the ECB or ESM could be encouraged to provide such a 
service. 

independent 

alternative 

an 

to 

Amendment of 
CRA Regulation 
(CRA III) 

Amendment of 
CRA Regulation 
(CRA III) 

Amendment of 
ECB Regulation 

Or  

Council and 
Parliament 
Regulation 
(New Agency) 

9. Prohibit sovereign debt 

ratings 

Prohibit  registered  and  authorised  credit  rating  agencies 
from  issuing  sovereign  debt  ratings.  Investors  would  be 
required  to  perform  their  own  assessment  of  sovereign 
debt  products  based  on  all  relevant  publicly  available 
information.  

Amendment of 
CRA Regulation 
(CRA III) 

Identified policy options regarding objective 3 - improve credit rating market with a view 
to enhance competition and improve ratings quality 

Policy option 

Description 

Instrument 

1. No policy change 

The baseline scenario applies. 

2. Encourage the emergence of 

a network of small and 
medium size rating agencies 

A  network  of  European  small  and  medium  size  rating 
agencies  would  be  promoted  under  a  European 
Programme.  This  could  consist  of  a  specific  action 

The common 
strategic 
framework for 

148/193 

 
 
 
 
 
 
Policy option 

Description 

under  the  Competitiveness  and  Innovation  Programme 
(CIP) 263 of  the  Enterprise  and  Industry  Directorate 
General,  which  would 
financial 
perspectives  of  the  period  2012-2017.  This  network 
would  enable  participating  small  and  medium  rating 
agencies 
to  share  data,  best  practice  on  rating 
methodologies and resources. 

fall  under 

the 

3. Encourage the emergence of 

a new European rating 
agency 

The  emergence  of  a  fully  independent  European  rating 
agency in the structure of a private foundation or in the 
form  of  a  new  Public  Agency  (see  above  option  8  of 
previous  section).  To  support  the  private  foundation  an  
initial funding to cover start-up costs for the first three to 
a maximum of five years could be provided through the 
European  Investment  Bank  (EIB)    or  our  of  the  Union 
Budget 

4. Harmonise ratings scales to 
improve comparability of 
ratings between CRAs 

ESMA  would  be  empowered  to  prepare  draft  technical 
standards  on  a  harmonised  rating  scale  to  be  used  by 
registered  CRAs.  All  ratings  would  need  to  follow  the 
same rating scale standards, ensuring that ratings can be 
compared  more  easily  by  investors.  Furthermore,  this 
could include common definitions on sovereign default. 

Instrument 

research and 
innovation 
funding 
(Horizon 2020) 

or 

the new 
Competitiveness 
and SME 
programme for 
the continuation 
of the non-
innovative 
actions of the 
CIP 

Financing 
decision of the 
Commission 

+ 

Grant agreement 

(direct or 
following call 
for tenders) 

Amendment of 
CRA Regulation 
(CRA III) 

5. Establish a European Rating 

Index (EURIX) 

All  rating  agencies  would  be  required  to  communicate 
all ratings to ESMA, which would publish all available 
ratings on the market for a debt instrument in the form 
of  European  Rating  Index  (EURIX),  which  would  be 
freely available for investors.  

Amendment of 
CRA Regulation 
(CRA III) 

6. Require CRAs to issue joint 
ratings at the level of the 
rating committee 

Amendment of 
CRA Regulation 
(CRA III) 

Small  and  larger  CRAs  would  be  required  to  work 
together  in  order  to  issue  a  joint  credit  rating.  This 
option  will  thus  provide  opportunities  for  the  smaller 
agencies  to  gain  exposure,  demonstrate  capability  and 
build  reputation  over  time  so  that  they  become  real 
competitors to the current large CRAs, not only in terms 
of  size  and  expertise,  but  most  importantly  reputation. 
More  than  one  CRA  would  be  involved  in  issuing  a 
rating 
finance 
instruments  or  sovereign  debt  and  the  4  eyes  principle 
would only  apply  to  certain areas  of  the rating,  mainly 
the final decision at the rating committee level.  

for  corporate 

structured 

issuers, 

7. Ban large CRAs from 

The  larger  CRAs  would  be  prevented  from  acquiring  Amendment of 

263  

The  Competitiveness  and  Innovation  Framework  Programme  (CIP)  supports  innovation  activities, 
provides better access to finance and delivers business support services in the regions. The Enterprise 
and  Innovation  Programme  (EIP),  one  of  the  specific  programmes  under  the  CIP,  seeks  to  support 
innovation and small and medium sized enterprises (SMEs).  

149/193 

 
 
 
 
                                                 
Policy option 

acquiring small and 
medium-sized CRAs 

Description 

small and medium-sized CRAs. The main purpose is to 
ensure the active presence of a much higher number of 
CRAs  in  the  EU  market  once  other  measures  to 
facilitate the growth of smaller CRAs come into effect. 

8. Introduce temporary market 
share ceilings for CRAs  

No  CRA would be  allowed  to have  more  than  a  certain 
percentage, for example 20%, of total market share. The 
purpose  of 
the  current 
is 
oligopolistic market structure.   

this  measure 

to  alter 

Instrument 

CRA Regulation 
(CRA III) 

+ 

Amendment of 
the Merger 
Regulation 

Amendment of 
CRA Regulation 
(CRA III) 

requirement; 

The  process  would  have  three  phases:  (1)  transition 
period (for example, 5 years) under which CRAs would 
need  to  accommodate  their  rating  business  to  the 
ceiling's 
(for 
instance,  10  years)  under  which  the  smaller  CRAs  will 
have the possibility to expand their business and build up 
their  reputation  to  become  real  competitors  to  large 
CRAs;  (3)  the  end  of  the  temporary  restriction  period 
under  which  all  requirements  on  ceilings  would  be 
removed. 

(2)  monitoring  period 

9. Require CRAs to disclose 

pricing of ratings and ensure 
that prices are not 
discriminatory and based on 
costs  

Amendment of 
CRA Regulation 
(CRA III) 

CRAs  would  be  required  to  disclose  pricing  of  ratings 
and ensure that prices are not discriminatory and based 
on  costs,  in  an  aggregated  format,  so  that  issuers  have 
clarity  on  the  amount  of  fees  that  CRAs  charge.  The 
information  should  be  transparent  and  accurate  and 
cover  all  rated  asset  classes,  possibly  in  aggregated 
format  and  via  a  website.  Furthermore,  to  avoid 
potential  conflicts  of  interest  in  the  provision  of  rating 
and  ancillary  services,  CRAs  will  have  to  ensure  that 
the prices and fees they charge for their services are (a) 
not  discriminatory,  i.e.  fully  based  on  the  costs  and 
transparent pricing criteria  ; (b) not  based on  any  form 
of contingency. 

Identified policy options regarding objective 4 – ensure right of redress for investors 

Policy option 

Description 

Instrument 

1. No policy change 

The baseline scenario applies. 

2. Introduce civil liability of 
CRAs into EU legislation 

3. Ensure civil liability of 

CRAs towards users of credit 
before national courts 

Investors  could  directly  base  claims  against  CRAs  that 
have  infringed  the  CRA  Regulation  and  caused  damage 
to  the  investor  on  a  provision  in  the  CRA  Regulation 
which would specify  all conditions for civil liability of 
CRAs. Civil liability of CRAs would thus be regulated at 
the  Union  level  and  no  longer  in  Member  States'  own 
civil law orders. 

This option would ensure civil liability of CRAs towards 
investors before national courts in case a CRA infringes 
the  CRA  Regulation  thereby  causing  damage  to  an 
investor  having  relied  on  a  flawed  rating.  Common 
principles under  which  CRAs  should be  held  liable  (eg. 
standard of proof) would be defined. 

Amendment of 
CRA Regulation 
(CRA III) 

Amendment of 
CRA Regulation 
(CRA III) 

150/193 

 
 
 
 
 
 
Identified policy options regarding objective 5 - improve ratings quality by reinforcing 
independence of credit rating agencies and promoting sound credit rating processes and  
methodologies 

Policy option 

Description 

1. No policy change 

The baseline scenario applies. 

Potential 
Instrument 

The  issuer  would  remain  free  to  hire  its  own  rating  agency,  but  each 
institutional  investor  would  be  required  to  obtain  its  own  independent 
rating  before  investing  in  a  particular  financial  instrument  for  amounts 
above  certain  thresholds  (e.g.  for  clients  who  may  be  treated  as 
professionals and whose investment portfolio exceeds EUR 500,000264).  

Amendment 
of CRA 
Regulation 
(CRA III) 

2. Require 

institutional 
investors to obtain 
their own ratings 
before they can 
purchase a 
particular 
financial 
instrument 

3. Require trading 
venues to set up 
and ensure the 
administration of 
the "Trading 
venues pay" 
model 

Trading  venues  would  be  required  to  ensure  and  organise  the  rating  of 
listed  and  traded  companies  and  instruments.  As  the  bulk  of  global 
securities  is  traded  outside  traditional  trading  venues,  for  non-listed 
companies and instruments, the "Subscriber / Investor Pays" model could 
apply. The platform would be required to organise the rating of a pool of 
loans by one of CRAs. Selection of the CRA rating an instrument could 
be made on the basis of objective criteria.  

Amendment 
of MiFID 

4. Require CRA 
selection to be 
undertaken by an 
independent board 

An 
independent  "Credit  Rating  Agencies  Board"  composed  of 
supervisors,  representatives  of  issuers,  subscribers  and  investors  and 
credit  rating  agencies  would  be  empowered  to  select  a  CRA  either  at 
random or on the basis of objectively defined criteria to rate an issuer’s 
structured  finance  instruments.  The  issuer  would  remain  free  to  (1) 
secure no rating from selected CRA at all, or (2) hire additional CRAs if 
desired. 

Amendment 
of CRA 
Regulation 
(CRA III) 

5. Introduce rotation 
rules for the CRAs 
engaged by an 
issuer to rate its 
own products and 
to rate the issuer 
itself and in 
introduce 
mandatory 
separation 
between them 

An issuer's own credit worthiness could not be rated by the same CRA 
for  more  than  3  consecutive  years.    Another  CRA  would  take  over 
thereafter and the outgoing CRA and the issuer would make available all 
information accessed in the rating process, and hand over appropriately 
to the incoming CRA to enable it to perform ratings effectively. 

Amendment 
of CRA 
Regulation 
(CRA III) 

A CRA would not be able to rate more than 5 consecutive issues of any 
asset  class  by  the  same  issuer,  or  if  fewer  than  5  issues  are  made,  it 
would not be able to rate the issues of one issuer over a period exceeding 
3 years.  After a CRA has rated 5 consecutive issues for an issuer, that 
issuer must then solicit any ratings for at least its 5 following issues from 
a  different  CRA  or  CRAs  or  if  fewer  than  5  issues  are  made,  for  a 
maximum  period  of  three  years.    Then,  after  3  years  have  passed  or  5 
issues  have  been  made,  whichever  is  sooner,  the  issuer  could  solicit 
ratings from the first CRA again if desired. 

Furthermore,  mandatory  separation  between  the  rating  of  an  issuer  and 

264  

The  investment  portfolio  size  refers  to  professionals  in  all  investment  services  and  activities  and 
financial instruments as defined in Annex II, Professional Clients, II.1, "the size of the client's financial 
instrument  portfolio,  defined  as  including  cash  deposits  and  financial  instruments  exceeds  EUR 
500.000",  Directive  2004/39/EC  of  the  European  Parliament  and  of  the  Council  of  21  April  2004  on 
markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 
2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC, 
OJ L0039, 28.04.2006.  

151/193 

 
 
 
 
 
 
                                                 
Policy option 

Description 

Potential 
Instrument 

its  products  would  be  introduced,  so  that  a  CRA  would  not  be  able  to 
simultaneously rate an issuer and its products. 

This rule should ensure that a range of CRAs are selected by an issuer to 
rate  its  products.    CRAs  should  only  rate  products  for  which  it  has  the 
capacity to rate in compliance with the CRA Regulation. 

This rule would only apply to solicited ratings, as it primarily addresses 
conflicts relating to the issuer-pays model.  Unsolicited ratings could still 
be made at all times. 

6. Introduce specific 
requirements on 
CRAs' 
independence and 
objectivity in 
relation to their 
shareholders 

Introduce  specific requirements on CRAs' independence and objectivity 
in relation to their shareholders. ESMA would be required to ensure: (1) 
shareholders  could  not  either  individually  or  in  voting  blocs  accrue 
potentially controlling stakes in more than one CRA, (2) that CRAs could 
not  issue  ratings  for  any  firm  that  holds  shares  in  that  CRA,  even 
indirectly (3) any person that directly or indirectly controls a CRA would 
not be allowed to invest in products and entities rated by the CRA and to 
provide  advisory  services  to  the  entity  which  or  whose  products  were 
rated.265 

7. Strengthen rules 
on disclosure of 
rating 
methodologies 

Existing  rules  on  rating  methodologies  would  be  strengthened  by  (1) 
extending  the  requirement  to  disclose  methodologies  and  underlying 
assumptions behind ratings from structured finance products to all asset 
classes,  (2)  enhancing  the  requirement  to  disclose  material  changes  in 
the  publication  of  clear 
methodologies  by  additionally  requiring 
reasoning  and  justification  for  the  changes  and  (3)  enhancing  the 
requirement  to  disclose  errors  in  methodologies  or  their  application  by 
requiring  immediate  disclosure  directly  to  the  affected  parties  including 
investors, issuers and competent authorities. 

Amendment 
of CRA 
Regulation 
(CRA III) 

Amendment 
of CRA 
Regulation 
(CRA III) 

8. Require CRAs to 
inform issuers 
sufficiently in 
advance of the 
publication of a 
rating 

Exiting  disclosure  requirements266 for  solicited  and  unsolicited  ratings 
would  be  strengthened  by  requiring  CRAs  to  inform  issuers  for  which 
they are in the process of issuing a  rating sufficiently in advance of the 
publication of the rating, of the principle grounds on which the rating is 
based.  This  could  include  a  requirement  to  elaborate  on  the  main 
assumptions which justify the change of rating and would apply both to 
solicited and unsolicited ratings. 

Amendment 
of CRA 
Regulation 
(CRA III) 

265  
266  

This option is in line with existing company law and free movement of capital provisions. 
This  option  would  extend  the  current  requirement  of  12  hours,  provided  for  in  Annex  I  D  (3)  which 
does not reflect the working hours available to perform an assessment. 

152/193 

 
 
 
 
                                                 
ANNEX VIII. ANALYSIS OF THE IMPACT OF POLICY OPTIONS ON STAKEHOLDERS  

Policy options regarding objective 1 – reduce reliance on external ratings by enhancing 
internal risk management and promoting the use of internal rating models for regulatory 
purposes 

Option 1 (baseline) 

n.a. 

Impact on stakeholders 

Option 2 

(Reduce reliance on 
external ratings by 
enhancing internal risk 
management and 
promoting the use of 
internal rating models 
for regulatory purposes) 

Regarding the use of internal rating models: 

(++) individual investors reassured that management of  investment risk is restoring confidence   

(-)the relevant financial companies bear ongoing and higher compliance cost  

(+) financial institutions gain comfort that both enhanced credit risk management systems and external credit 
ratings would mitigate exposures, but would need to adapt compliance systems 

(0) issuers – no obvious costs or benefits 

(++) sovereigns/taxpayers – gain comfort that financial institutions less likely to be bailed out   

(+/-) CRAs incentivised to constantly improve rating quality. However, a shift to internal rating models will 
reduce the business activity of CRAs, which may affect the quality of the services delivered by CRAs 

(+)  supervisors  gain  comfort  that  financial  institutions  do  not  mechanistically  rely  on  external  ratings,  but 
need  to supervise 

Regarding the use of standardised approach: 
(++) individual investors obtain reassurance that risk of "cliff" effects on financial institutions would be 
mitigated 
(-) financial institutions bear on-going and higher compliance costs       
(0) issuers – no obvious costs or benefits  
(++) sovereigns/taxpayers gain confidence in sustainability of financial institutions 
(+) CRAs – the requirement for credit institutions to compare internal ratings with external ratings may 
incentivize CRAs to constantly improve their rating methodologies 

(-) supervisors would need  to ensure in supervisory processes that rules are applied 

(0) individual investors - investors could face some additional searching cost. 

(-) financial institutions bear higher compliance cost to search for ratings and apply 

(0) issuers - issuers will not bear additional cost as it is not an obligation to obtain 2 ratings.  

(0) sovereigns/taxpayers – will not bear additional cost as it is not an obligation to obtain 2 ratings.  

(+) CRAs would potentially increase the rating market sizeze 

(++) individual investors and financial firms would benefit from increased product information  

(--) issuers face compliance costs to disclose and they may reduce the information for external credit ratings 

(++) sovereigns/taxpayers benefit from possible reduced capital market volatility  

(++) CRAs incentivised to improve the rating quality and to provide unsolicited ratings   

(-) supervisors would need  to ensure in supervisory processes that rules are applied 

Option 3 

(Require credit 
institutions, investment 
firms, insurance and 
reinsurance 
undertakings to use 
more than one rating, if 
available) 

Option 4 

(Improve disclosure 
requirements for issuers 
of structured finance 
products on an ongoing 
basis) 

Policy options regarding objective 2 – mitigate risks of contagion effects linked to sovereign 
debt ratings 

Option 1 (baseline) 

n.a. 

Impact on stakeholders 

Option 2 

(++) improves transparency of sovereign debt ratings to investors including credit institutions 

(Require CRAs to publish a 
full research report on 
sovereign debt ratings and 
allocation of staff) 

Option 3 

(+) improves transparency on  sovereign ratings towards sovereigns 

(-) CRAs face opportunity costs as they could loose some revenue from selling research reports.   

(+) improves transparency of sovereign debt ratings to investors and ensures that all market participants 
have same information on ratings of sovereigns issuers 

153/193 

 
 
 
 
 
 
 
 
  
 
(Require CRAs to publish 
sovereign ratings after closing 
of EU trading venues; 
Introduce a requirement to 
CRAs to publish sovereign 
ratings after closing of EU 
trading venues) 

Option 4 

(Require CRAs to conduct the 
sovereign debt ratings process 
more frequently) 

Option 5  

(Extend powers of competent 
authorities (ESMA) to 
scrutinize rating 
methodologies for sovereign 
debt ratings (and any other 
ratings with financial stability 
implications)) 

Option 6 

(Introduce a requirement for 
(EU) sovereigns to publish a 
standardized set data on 
economic performance to 
enable credit risk assessment) 

Option 7 

(Grant ESMA the power to 
restrict or ban temporarily 
sovereign debt ratings in 
exceptional situations) 

Option 8 

(Encourage an existing, 
independent EU structure or a 
brand new European Credit 
Rating Agency  to issue credit 
ratings) 

Option 9 

(Prohibit sovereign debt 
ratings) 

Impact on stakeholders 

(+) ensures good communication on rating changes for sovereign issuers.  

(+) clear and transparent rules on timing of disclosures of ratings by CRAs. 

(+) improves transparency of sovereign debt ratings to investors, ensures all market participants have up 
to date information on ratings of sovereigns issuers 
(+) Sovereigns will benefit from improve transparency to investors 
(-) CRAs would need to conduct full rating process more frequently and could face therefore limited 
additional costs  

(+) increased power for competent authorities to scrutinize ratings 

(+) investors would benefit from improved quality and  scrutinized rating methodologies for sovereign 
ratings   

(-) limited risks that independence of CRAs with regard to rating methodologies  is undermined. CRAs 
would need to ensure that rating methodologies are sufficiently justified and explained.  

(+) easy access to investors to this information to ensure they can make own assessment.  

(-) additional disclosure for sovereigns of already available information 

(+) easy access for CRAs on already available information to perform ratings. 

(++) Investor, credit institutions and  sovereigns will benefit from reduced risks of further contagion 
effects in exceptional cases undermining market stability 
(-) Sovereigns subject to the ban could face risks that new issuances would have limited market interest 
due to absence of a rating due to the temporarily ban. 

(+) investors benefit from improved information through an additional independent and credible source 
of credit opinions.  
(+)sovereign issuers and systemic credit institutions benefit from additional credit opinions are available 
from an credible source 
(-) EU structure entails risks that independence could be questioned by investors. 
(-) CRAs would be subject to more competition from a stakeholder with important reputation 

(-) lack of existing alternatives for investors and limited knowledge to make own assessment 
(-) some credit institutions might face difficulties to further invest in sovereign debt instruments. 
(-) some sovereigns might experience problems to find sufficient investors when issuing sovereign debt 
due to lack of ratings 
(-) SMEs will need to set up their internal assessment for sovereigns 
(-) CRAs deprived from revenue source 

Policy options regarding objective 3 – improve credit rating market conditions with a view to 
improve ratings quality 

Option 1 (baseline) 

n.a. 

Impact on stakeholders 

Option 2 

of 

the 
 (Encourage 
emergence 
a 
network  of  small  and 
medium  size  rating 
agencies) 

(++)  investors  will  obtain  more  choice  of  ratings  and  rating  agencies  ensuring  they  can  better  compare  credit 
opinions and make their own decisions.  

(++) issuers would have more choice for rating agencies which could lead to lower prices 

(-) large CRAs would become subject to more competition in rating industry;  

154/193 

 
 
 
 
 
 
 
 
 
 
 
 
 
(+) small and medium SMEs would be stimulated to enter rating market at larger scale 

Impact on stakeholders 

Option 3 

(+) an additional source of credible and independent credit ratings would be available to investors 

(Encourage the 
emergence of a new 
European rating 
agency) 

Option 4  

(Harmonise ratings 
scales to improve 
comparability of 
ratings between 
CRAs) 

Option 5 

(Establish a 
European Rating 
Index (EURIX)) 

Option 6. 

(Require CRAs to 
issue joint ratings at 
the level of the rating 
committee) 

Option 7  

(Ban large CRAs 
from acquiring small 
and medium-sized 
CRAs) 

(-) new market entrants could face competition by a new EU CRA.  

(+) issuers will have more choice of sizeable rating agencies. 

(-) CRAs would be subject to more competition from a new agency with considerable size   

(+) improved understanding and comparison of ratings by investors  
(+) issuers might benefit from better prices due to more competition  
(+) small CRAs will benefit from better visibility on ratings 
(-)large CRAs would face more competition due to better comparability  

(+) investors benefit from improved transparency on ratings available from distinct CRAs ensuring they can better 
perform their own assessment 
(+) issuers might benefit from better prices due to more competition  
(+) small CRAs will benefit from better visibility on ratings 
(-) large CRAs would face more competition due to better comparability  

(-) The reputational advantage of Big Three CRAs versus smaller CRAs would decrease overtime 
(+) The reputational disadvantage  of smaller CRAs would decrease overtime  
(-) the increase of cost for issuers competition in the market 
(+) investors might  profit from higher rating quality and increased reliability of their ratings 

(-) bigger CRAs will be in banned from acquiring/ merging with smaller CRAs 
(+) smaller CRAs would be in a better position if the further expansion/ consolidation will be banned for bigger 
CRA. 
No substantial impact of this measure is foreseen on issuers or investors  

Option 8  

(Introduce temporary 
market share ceilings 
for CRAs) 

(-) CRAs whose market share exceeds the threshold will have to give up some clients). 
 (+) Smaller (or new market entrants ) CRAs will benefit from the growth opportunities  
(-/+) issuers might face higher prices in short run. In long-run however issuers will have more choice among 
CRA. 
(≈/+) during the phase-in period (first 5 years) investors will be more inclined to shop for unsolicited ratings. In 
long-run, investors will benefit from more choice in the market 

(+) issuers, investors, other purchasers of CRAs services will benefit for more transparency on the fees charged 
for CRAs services but also from strengthened independence stemming from restrictions on CRAs' abilities to 
negotiate fees individually with each client 
(+) smaller/growing CRAs will benefit from  more favourable market conditions due to price transparency and 
prohibition of price discrimination 
(-) large CRAs will face more competition due to increased transparency and limits of price discrimination.  

Option 9  

(Require CRAs to 
disclose pricing of 
ratings and ensure 
that prices are not 
discriminatory and 
based on costs ) 

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Policy options regarding objective 4 - ensure right of redress for investors 

Impact on stakeholders 

Option 1 (baseline) 

Option 2 

(Introduce  civil  liability 
of  CRAs 
into  EU 
legislation) 

n.a. 
(+) investors benefit from effective right of redress and from high quality ratings due to preventive effect on 
CRAs behaviour 
 (+/-) CRAs would be incentivised to produce high quality ratings but may face restricted business 
opportunities. In addition, CRAs could face civil liability claims from investors 
(+) issuers indirectly profit from higher rating quality and increased reliability of their ratings 
(+) positive impact on right to an effective remedy and a fair trial (Art. 47 Charter) 

Option 3 

(Ensure civil liability of 
CRAs towards users of 
credit ratings before 
national courts) 

(+) investors benefit from effective right of redress and from high quality ratings due to preventive effect on 
CRAs behaviour 
 (+/-) CRAs would be incentivised to produce high quality ratings but may face restricted business 
opportunities. In addition, CRAs would face civil liability claims from investors 
(+) issuers indirectly profit from higher rating quality increased reliability of their ratings 
(+) positive impact on right to an effective remedy and a fair trial (Art. 47 Charter) 

Policy options regarding objective 5 – Improve ratings quality by reinforcing independence of 
credit rating agencies and promoting sound credit rating processes and methodologies 

n.a. 

Impact on stakeholders 

(+/-) investors would have a greater number and variety of ratings at their disposal.. However, at the same time, this 
option  may  discourage  investors  from  conducting  their  own  due  diligence.  Investors    would  bear  most  of  the  
compliance costs 
 (-) issuers may face difficulties raising funding (it would become more expensive) 
(+) sovereigns/taxpayers gain comfort that alternative remuneration models would bring more transparency to the 
market and would therefore contribute to the stability of capital markets   
(+/-) CRAs gain a new investor pays rating market. However, it would reduce the issuer pays market  
(+/-) supervisors gain comfort that conflicts of interest due to the issuer pays model would be mitigated. However, 
the FSB principles may be violated as reliance on external credit ratings would increase 

(+) investors would be assured high quality ratings free of conflicts of interest  
(--)  issuers  may  have  difficulty  raising  funds.  They  would  bear  higher  on-going  costs.  It  may  also  reduce  market 
liquidity 
(+) sovereigns/taxpayers gain comfort that the stability capital markets would be improved    
(-) CRAs could lose  interest in constantly reviewing and improving the quality of ratings 
(+/-)  supervisors  obtain  full  independence  of  credit  ratings  on  listed  instruments,  but  may  face  further  difficulty 
regulating unlisted instruments 

(+) investors would be assured ratings exposed to lower potential risk of conflicts of interest  
(0) issuers – no obvious costs or benefits 
(-) CRAs could face more difficulty in developing business as it would not have complete control over the amount of 
business  it  takes  on.  Potential  market  entrants  could  face  difficulties  in  proving  accuracy  and  developing 
reputational capital. There could also be a reduced incentive for CRAs to compete on the basis of rating quality and 
streamline their operational performance 

(++) Ratings rotation would bring more liquidity into the rating market 
(++) investors could gain further comfort that issuers are not affecting ratings and that they are issued with reduced 
conflict 
(+/-) issuers could be concerned that agencies are less likely to compete on rating quality, and they could be forced 
to pay higher fees if a CRA was more certain to gain business from them 
(+) sovereigns/taxpayers could gain comfort that rating agencies could be  less subject to some conflicts of interest, 
and that sovereign ratings issued  
(-) CRAs with strong reputations  and successful ratings track records could face more competition from CRAs with 
lesser reputation and track records  
(+/-) supervisors should not incur significant additional burden 

Option 1 
(baseline) 

Option 2 

(Require 
institutional 
investors  to  obtain 
their  own  ratings 
they  can 
before 
purchase 
a 
particular financial 
instrument) 

Option 3 

(Require trading 
venues to set up 
and ensure the 
administration of 
the "Trading 
venues pay" 
model) 

Option 4 

(Require CRA 
selection to be 
undertaken by an 
independent 
board) 

Option 5 

(Introduce rotation 
rules for the CRAs 
engaged by an 
issuer to rate its 
own products and 
to rate the issuer 
itself and in 
introduce 
mandatory 
separation 
between them) 

156/193 

 
 
 
 
 
 
 
 
Impact on stakeholders 

Option 6  

(Introduce specific 
requirements on 
CRAs 
independence and 
objectivity in 
relation to their 
shareholders) 

Option 7 

(Strengthen rules 
on disclosure of 
rating 
methodologies) 

(++) investors could gain comfort that further potential conflicts of interest would be mitigated, giving them further 
confidence in ratings without being under additional obligations themselves 
(-) issuers may have to take further steps in identifying conflicts before approaching CRAs for ratings 
(+) sovereigns/taxpayers could gain comfort that there would be more transparency and a reduction in conflicts, 
leading to improve ratings 
(-) CRAs may have to take further steps in identifying conflicts before accepting certain issuers as clients 
 (+/-) supervisors might face resource burdens in analysing data in order to enforce these requirements.  They may, 
however, develop greater market oversight 

(++) investors could become better informed about rating methodologies and would gain further understanding of 
the rating process. They could also have quicker access to more detailed information on ratings 
 (++) issuers could gain greater clarity about the methodologies and about the effect of changes to them on their 
instruments' and their own ratings 
(+) sovereigns/taxpayers do not appear to incur any additional burden due to this option, sovereigns might have the 
chance to provide feedback on methodologies, and will also have greater clarity of the market 
(-) CRAs may have to delay updates to methodologies if obliged to consult.  Changes could mean greater cost of 
updated analysis and communications with stakeholders 
(++) supervisors do not appear to incur any additional burdens due to these changes, but would gain comfort that 
market participants were better and more quickly informed of developments in the market due to methodology 
changes, and could benefit from increased due diligence at supervised firms (who may be encouraged by easier 
access to methodologies) 

Option 8 

(Require CRAs to 
inform issuers 
sufficiently in 
advance of the 
publication of a 
rating) 

(+/-) investors could gain greater confidence on credit ratings, but the reliance on external ratings might increase  
(++) issuers could gain greater clarity about the methodologies and they would have an opportunity to draw 
attention of the credit rating agency to any factual errors before the rating publication 
(++) sovereigns could gain greater clarity about the methodologies and they would be able to check the ratings 
before the publication 
(-) CRAs may have to delay issuance and update of ratings. Delay could mean a risk of insider dealing and greater 
cost of analysis and communications with stakeholders 
(++) supervisors do not appear to incur any additional burdens due to these changes, but would gain comfort that 
market participants would have more reliable ratings, specifically on sovereign debt ratings 

157/193 

 
 
 
 
 
 
 
 
ANNEX  IX.  ENCOURAGING  AN  EXISTING,  INDEPENDENT  EU  STRUCTURE  OR  PROMOTE  A 
BRAND NEW EUROPEAN CREDIT RATING AGENCY TO ISSUE SOVEREIGN DEBT RATINGS 

Under this option an existing EU structure with adequate resources and capacity or a brand 
new  European  Credit  Rating  Agency  would  issue  credit  ratings  for  sovereign  issuers  to 
provide market participants with a greater variety of opinions on credit worthiness. As regards 
the use of an existing EU Institutions, only the option 'ECB/ESCB' is assessed since the other 
two  (Commission  and  EFSF/ESM)  would  be  less  efficient  and  effective  (see  analysis  in 
section. 6.3).  

Sub-options 

The implications of the following range of concrete models are considered: 

(cid:131)  EU ratings provide by the European Central Bank in cooperation with the ESCB 

(cid:131) 

Independent EU rating agency, fully financed by the Union budget (see Annex XI). 

a) EU ratings issued by the European Central Bank 

Under  this  sub-option  the  European  Central  Bank  would  determine  and  issue  independent 
credit  assessments,  particularly  for  European  sovereigns,  based  on  information  provided  by 
the Member States. These assessments, including a detailed research report and methodology 
would  be  published  on  their  respective  websites  and  remain  freely  available  or  investors, 
following the "government pays model" and offer an alternative to existing commercial credit 
ratings. 

To establish the credit assessments of European sovereigns, the institution could base itself on 
already reported information provided by the ESS (European Statistical System) coordinated 
by EUROSTAT. 

The ECB would remain free to modify these credit assessments at any moment in time and 
update the assessment at least periodically (for instance twice a year). 

The  staff  of  the  service  would  consist  of  approximately  150  up  to  250  independent  ECB 
Officials  necessary  to  perform  the  ongoing  credit  assessment  for  all  EU  sovereigns  and 
systemic  credit  institutions.  This  would  ensure  that  at  least  2  experts  per  sovereign  are 
available for small Member States and 3-5 experts are available for large sovereigns. These 
assumptions  were  made  based  on  input  received  from  industry  experts  within  the  rating 
market. 

Based on an annual cost of EUR 75.000 per full time equivalent, as this activity will require 
highly  skilled  economic  profiles,  and  including  overhead  costs  in  the  range  of  20%-30%  of 
headcount, this would result in an incremental annual cost of 13.5-24.4 Million to be covered 
by the EU budget.  

It should be noted that in its contribution to the public consultation, the ECB considered this 
policy  measure  beyond  is  task.  Furthermore,  other  responses  of  public  consultation  raised 
concerns regarding to credibility and independence of an public EU structures to issue credit 
ratings. 

158/193 

 
 
 
 
 
 
 
 
 
Table 1: Key elements of ratings by ECB 

Ratings by ECB 

Objective 

Concept 

and 

performs 

The  ECB 
publishes 
periodically  credit  ratings  of  sovereigns 
(EU-Member  States  or  EEA-Member 
States),  on  validated  information  provided 
by Member States 

EU regulation, Union ownership 

Legal  setup 
and 
ownership 

Funding 

Union Budget 

Payment 
model 

Government Pays model, Free usage for all 
investors 

Governance  European Central bank 

Staff 

EU officials  
incremental 150-250 FTE to perform credit 
assessment for EU sovereigns and EU 
systemic credit institutions 

(Full Time Equivalents) 

Type 
ratings 

of 

Sovereign ratings 

Budget/costs 

Staff: EUR 11.2.-18.7 Million per year 
Total: 13,5 -24.4 Million per year 

Offer investors an alternative for 
private ratings for sovereign 
ratings which entail the 
largest risks of spill-over 
effects 

Ensure validation and 

certification of data provided 
by Member States 

Ensure independency of credit 

assessment 

Ensure there is only indirect 

payment by issuer through 
the Union budget 

Ensure wide use and availability 

to investors 

Ensure all EU sovereigns  and 
systemic credit institutions 
are continuously rated 

Ensure independence from EU 
Member States and credit 
institutions 

Ensure independence from 

Member States and credit 
institutions rated 

Capitalise on existing expertise 
available within the ECB 
Ensure rating of entities with 

systemic and market stability 
implications which can be 
used for regulatory purpose 

Table 2: Detailed estimation of the costs implications under this option 

Summary 
Staff in  full time equivalents (FTE) 
Staff costs per FTE 
Total staff costs 
Overhead costs & IT 
Total overhead costs 
Total costs 

Minimum 
EUR 
150 
        75.000    
  11.250.000   
20% 
    2.250.000   
  13.500.000   

Maximum 
EUR 
250 
             75.000    
       18.750.000    
30% 
        5.625.000    
       24.375.000    

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ANNEX  X.  EUROPEAN  NETWORK  OF  SMALL  AND  MEDIUM-SIZED  CREDIT  RATING 
AGENCIES 

The idea of a European network of small and medium-sized Credit Rating Agencies received 
support from many small CRAs, Member States and regulators, including the ECB during the 
recent public consultation. Consequently, the feasibility of this idea is further explored below. 

Benefits of a network/association 
Integration  of  small  and  medium-sized  credit  rating  agencies  into  a  network  or  association 
would offer an opportunity to improve competitiveness of individual small and medium-sized 
credit rating agencies and allow them to expand into the rating of a wider range of entities or 
products,  which  in  long-run  would  help  to  provide  credible  European  alternatives  to  the 
services provided by the three major credit rating agencies. 

A network could significantly reduce the costs for individual members due to the economies 
of  scale  in  the  development  of  common  IT  systems  and  other  projects,  the  costs  of  which 
would be shared among the members. 

The  lower  barriers  to  access  the  CRA  market  would  increase  the  number  and  quality  of 
ratings. More and better ratings would enhance investors' information and thus contribute to 
financially sound decision making. 

The  small  and  medium-sized  credit  rating  agencies  forming  such  a  network  of  agencies 
should remain independent legal entities and would be subject to the current CRA Regulation. 
EU competition rules for co-operation between competitors should also be respected. 

Fields of cooperation 
CRAs  could  collaborate  to  create  a  common  rating  platform  by  sharing  best  practices  and 
resources,  building  expert  knowledge  and  enhancing  the  quality  of  ratings.  A  European 
network of small and medium-sized Credit Rating Agencies could help CRAs to e.g.: 

build up expert knowledge and capable human resources 
improve methodologies 
ensure quality of rating processes 
exchange data 
facilitate analysis of cross border companies 
ensure ratings comparability and consistency 
develop joint marketing and sales strategies 
disseminate rating results to wider public (joint website) 
develop rating indexes 
reinforce internal controls 

1. 
2. 
3. 
4. 
5. 
6. 
7. 
8. 
9. 
10. 
11.  educate investors 
12.  manage capacity problems 
13.  share or develop common IT systems 
14.  share legal, compliance and administrative functions 

The need for the pan-European financial support 
There  are  already  some  private  initiatives  to  create  a  network  of  European  CRAs,  which 
however develop quite slowly and do not have a pan-European reach.  
To speed up the creation of a true pan-European network of small and medium sized credit 
rating agencies it is therefore important that adequate financial incentives are established. 

160/193 

 
 
 
 
 
 
 
 
 
 
 
It is essential that EU financially contributes to the creation of such a structure to make it "up 
and running". Once the creation of a network is completed and the membership costs decrease 
substantially due to a sufficiently large number of members, the EU financial support in terms 
of co-financing the establishment and operations and projects of such a network from the EU-
budget would be gradually terminated. It is suggested that the duration of co-financing should 
be  limited  in  time  (5  years).  Afterwards,  the  network  would  become  fully  financed  by  the 
members of a network. 

Expected participation 
Based  on  the  recent  public  consultations  and  discussions  with  stakeholders,  15  European 
CRAs may participate in such a network in the medium term (5 years). 

Expected costs of the pan-European network 
Based  on  calculations  of  external  experts  and  depending  on  the  level  of  integration,  the 
indicative  annual  costs  could  for  the  establishment  and  operation  of  a  network  could  be  as 
shown in Table 1:  

•  Annual operation cost: 0.7-1.5 million EUR   (own staff between 10 and 20 in 5 years, 

mostly dedicated to IT development) 

•  overhead costs in the range of 20%-30% of headcount 

Table 1 : Detailed estimation of the costs implications under this option 

Summary 
Staff in  full time equivalents (FTE) 
Staff costs per FTE 
Total staff costs 
Overhead costs & IT 
Total overhead costs 
Total costs 

Minimum 
EUR 
10 
         75.000 
  750.000    

20% 
    150.000    
    900.000    

Maximum 
EUR 
20 
             75.000    
      1.500.000    
30% 

         450.000   
       1.950.000    

Available means for the EU support 

As discussed above, to make a pan-European network an attractive structure for a voluntary 
participation of CRAs, the initial costs of establishment and operation of a network should be 
supported.  

In that respect the network could be supported making recourse to one of the two instruments 
under  which  the  actions  of  the  existing  CIP  (competitiveness  and  Innovation  Framework 
Programme) will continue as from 2014 onwards267, i.e.: 

- the common strategic framework for research and innovation funding, called 'Horizon 2020"; 

-  the  new  Competitiveness  and  SME  programme  for  the  continuation  of  the  non-innovative 
actions of the CIP mentioned above. 

The  identification  of  the  programme  which  would  fit  the  best  the  funding  of  the  proposed 
network  will  be  done  at  a  later  stage  when  all  the details  of  the  two  instruments  mentioned 
will be known.   

267   

The multiannual financial framework 2014-2020 "A budget for Europe 2020" COM (2011) 500 final of 
29.6.2011. 

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Compliance with EU competition rules 
Any  network  of  small  and  medium-sized  rating  agencies  would  have  to  adhere  to  existing 
competition  rules  which  apply  to  all  companies  in  the  EU.  Information  exchange  between 
competitors  can  -depending  on  the  market  characteristics  and  the  characteristic  of  the 
information  exchange  -  be  in  contradiction  with  European  Competition  rules268.  Any  rules 
facilitating the cooperation between small and medium size rating agencies would thus have 
to be carefully drafted to ensure compliance with existing competition rules.  

Exchange  of  information  linked  to  rating  methodologies  and  of  statistics  on  aggregate  and 
historical  data  (defaults,  etc.)  should  normally  be  considered  as  consistent  with  EU 
competition rules, as they are unlikely to lead to a collusive outcome. 

On the contrary, information exchange on CRAs individualised intentions concerning future 
conduct  regarding  prices  and  quantities  (including  intended  future  sales,  market  shares, 
territories, and sales to particular groups of consumers) must not be facilitated as exchange of 
such  information  is  generally  considered  and  fined  as  cartels.  Furthermore,  exchange  of 
strategic data related to actual prices and quantities as well as other strategic information can 
have  an  appreciable  adverse  impact  on  one  of  the  parameters  of  competition  such  as  price, 
output, product quality, product variety or innovation. Such information exchange should be 
excluded.  

268  

Communication from the Commission, Guidelines on the applicability of Article 101 of the Treaty on 
the Functionning of the European Union to horizontal co-operation agreements, OJ C11/1, 14.01.2011, 
para 55 – 110. 

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ANNEX XI. EUROPEAN CREDIT RATING AGENCY 

Overall concept of a European Rating agency 
One  of  the  possibilities  to  increase  the  number  of  market  participant  in  the  rating  agency 
industry is the introduction of a European rating agency. Such a move was considered in the 
public  consultation  on  rating  agencies  and  the  European  Parliament  considered  in  its  "own 
initiative  report"  that  further  analysis  would  be  appropriate  with  regard  to  the  design  of  a 
European rating foundation.  

Proposal  of  the  European  Parliament  regarding  an  independent  European  Credit 
Rating Foundation (ECRaF) 

In  its  own  initiative  report  prepared  by  Wolf  Klinz, the European  Parliament calls  for  a the 
establishment  of  a  fully  independent  European  Credit  Rating  Foundation  (ECRaF)269 which 
would  expand  its  expertise  into  all  three  sectors  of  ratings  including  sovereign  ratings, 
corporates and structured finance product. To ensure its credibility the management, staff and 
governance structure of the new ECRaF would need to be fully autonomous with regard to the 
Member States or any other public bodies. Furthermore, the European parliament considered 
that after a start-up period, the new ECRaF should be fully self sufficient. In the report, the 
European  parliament  asked  the  Commission  to  conduct  a  detailed  impact  assessment  and 
feasibility  study  on  the  establishment  of  an  independent  ECRaF  and  to  come  forward  with 
legislative proposals. 

Sub-options 
The implications of the following range of concrete models of European credit rating agencies 
are considered: 

(cid:131) 

Independent EU rating agency, fully financed by the Union budget  

(cid:131)  Foundation, with public start-up financing  

a) EU Public Rating Agency, financed by Union Budget 

Under  this  option,  a  new  and  independent  EU  public  rating  agency  would  be  established, 
which  would  issue  independent  credit  assessments  for  EU  Sovereigns  and  systemic  credit 
institutions,  hereby  contributing  to  the  monitoring  of  market  stability.  These  independent 
credit risk assessments would be freely available for all investors and could be used by credit 
institutions or insurance entities for the purpose of determining regulatory capital. 

The agency would be headed by an independent management board appointed for a period of 
5  years  and  would  staffed  by  250-400  EU  officials  which  would  perform  the  credit  risk 
assessments.  This  would  entail  [1-2]  analysts  per  country  dedicated  for  sovereigns  small 
sovereigns  and  [2-5]  for  large  sovereigns  and  1  up  to  3  analysts  per  systemic  credit 
institution.270 

269  

270  

European Parliament resolution of 8 June 2011 on credit rating agencies: future perspectives (Reference: 
2010/2302 (INI), Rapporteur Wolf KLINZ, ADE, DE).  
It is considered that the same credit institutions which are subject to stress testing would obtain a credit 
assessment, which entails approximately 90 credit institutions. See communication from the European 
Banking Authority, press release 21 April 2011: www.eba.europa.eu.   

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Member  States  and  systemic  credit  institutions  would  be  required  to  provide  any  relevant 
information to the agency in order to perform the credit risk assessment. It should be noted 
that  the  majority  of  the  information,  particularly  for  sovereigns  is  already  reported  and 
processed  by  the  ESS  coordinated  by  EUROSTAT  which  would  be  re-used.  Furthermore, 
credit institutions would need to provide a similar set of data as they already perform today 
for the purpose of European Stress testing.  

The new EU public rating agency would entail an annual cost of EUR 24.4-39 million to be 
covered by the Union budget which includes headcount base on an annual cost of EUR75.000 
per FTE and overhead costs representing 20%-30% of headcount costs as shown in table 2.  

Table 1. key element of an independent EU rating agency 

EU rating service 

Objective 

Concept 

A  new  EU  agency  would  be  set  up  to 
perform  credit  ratings  for  EU  sovereigns 
and systemic EU credit institutions  

EU regulation, Union ownership 

Legal  setup 
and 
ownership 

Funding 

Union Budget 

Payment 
model 

Government Pays model, Free usage for all 
investors 

Governance  European Commission 

Staff 

EU officials  
incremental 250-400 FTE (full time 

equivalents)  

Type 
ratings 

of 

EU  Sovereigns  and  systemic  EU  credit 
institutions 

Budget/costs 

Staff: EUR 18.8-30 Million per year 
Total: EUR 22.5 -39 Million per year 

Offer investors an alternative for 

private ratings for asset 
classes with financial stability 
concerns 

Ensure independency of credit 

assessment 

Ensure independence  

Ensure wide use and availability 

to investors 

Ensure independence from EU 

Member States 

Ensure independence from 
Member States rated 
institutions 

Ensure that important  asset 

classes are rated 
Capitalise on existing 

information and expertise 
available at EU-level 

Table 2: Detailed estimation of cost implications of this option 

Summary 
Staff in  full time equivalents (FTE) 
Staff costs per FTE 
Total staff costs 
Overhead costs & IT 
Total overhead costs 

Minimum 
EUR 
250 
        75.000    
  18.750.000   
20% 
    3.750.000   

Maximum 
EUR 
400 
             75.000    
       30.000.000    
30% 
        9.000.000    

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Total costs 

  22.500.000   

       39.000.000    

b) EU Rating Foundation, start-up financed first -5 years by the Union Budget 

Under this option, a new and independent EU public rating agency would be established as a 
private  foundation  under  national  law  and  set  up by  private  investors,  including  issuers  and 
users  of  credit  ratings.  Furthermore,  to  ensure  the  agency  can  establish  itself  it  would  be 
financed the first 5 years with public funding. This could be undertaken through a public grant 
or  a  loan.  This  is  the  main  distinction  with  previous  option.  Also  under  this  option 
government would be attributed to an independent government board.  

The  independent  foundation  would  establish  credit  assessments  for  a  wide  range  of  asset 
classes  including  Sovereigns  and  corporations  (including  credit  institutions)  and  structured 
finance  products,  with  particularly  focus  of  debt  instruments  issued  within  the  EU. 
Furthermore, foundation is expected to start off with sovereign ratings and credit institution 
within  the  short  term,  after  which  it  would  extend  its  scope  to  other  corporations  and 
structured finance products.  

The  foundation  could  operate  according  to  the  "investor  pays"  model.  In  this  context, 
investors would need to pay a fee if the would want to obtain a rating. 

The foundation would consist of an independent government board and consist of a workforce 
of 400-1200 analysts to perform ratings. The workforce would evolve gradually over time in 
line with the extension of the product reach covered, starting of with a limited staff to ensure 
that sovereigns and credit institutions can be rated, gradually extending to other corporate and 
structured finance products for which would require an increase of staffing 

An EU rating foundation would entail an annual cost of EUR 39-97.5 million to be covered 
by  the  Union  budget  which  includes  headcount  base  on  an  annual  cost  of  EUR  75.000  per 
FTE and overhead costs representing 20%-30% of headcount costs as shown in Table 4.  

Under  this  option,  during  the  first  5  years  these  operational  costs  would  be  borne  by  the  
Union  budget.  This  financing  could  be  provided  through  a  loan  provided  by  the  European 
Investment  Bank.  After  the  initial  period  of  5  years,  which  should  enable  to  EU  rating 
foundation  to  establish  itself  on  the  market  and  reach  a  stable  an  sufficient  client  base,  the 
loan would need to be paid back based on the by revenue linked to rating services according 
to the investors pays model.  

Table 3. Key elements of an EU Rating Foundation, start-up financed first 5 years by the 
public sector 

EU rating service 

Objective 

Offer investors an alternative for 
private ratings for a wide 
range of asset classes  

Ensure independency of credit 

assessment 

Concept 

A  private  foundation  would  be  set  up  to 
perform  credit  ratings  for  a  wide  range  of 
asset 
include 
institutions, 
sovereigns 
corporates  and  could  over  time  cover 
structured finance products. 

classes.  This 
and 

credit 

could 

Public sector funding necessary to finance 
start-up phase 

165/193 

 
 
 
  
 
 
Legal  setup 
and 
ownership 

Private  foundation  with  public  financing 
for first 5 year. 

Funding 

Payment 
model 

Private/Public  sector.  Only  start-up  phase 
financed by public sector. 

Investors  pays  model  [alternatively  the 
existing "issuer pays" model could also be 
applied to this types of ratings] 

Allow for fast set-up 
Ensure stable financing to 

ensure agency can establish 
itself on market. 

Ensure independence from 
public sector while  

Turn away from issuers pays 

model to avoid key conflict 
of interest 

Governance  Private 

sector, 
transparency through disclosure 

maximisation 

of 

Prevent third-party influence, 
ensure independence  

Staff 

time 
Incremental  400-1000  FTE  (full 
equivalents) to perform of a wide range of 
asset classes 

Type 
ratings 

of 

EU Sovereigns , EU credit institutions, EU 
corporates  and  EU  structured  finance 
products  

Ensure a wide range of assets 
can be covered over time 

Step by step approach starting 

with sovereigns and 
extending to other asset 
classes. 

Budget/costs 

Staff: EUR 30 - 75 Million per year 
Total: EUR 39 -97.5 Million per year 

Public financing during first 5 years: EUR 
195-487.5  million  depending  on 
the 
number of asset classes covered. 

Table 4: estimation of annual costs under this option. 

Summary 
Staff in  full time equivalents (FTE) 
Staff costs per FTE 
Total staff costs 
Overhead costs & IT 
Total overhead costs 
Total costs 

Minimum 
EUR 
400 
        75.000    
  30.000.000   
20% 
    9.000.000   
  39.000.000   

Maximum 
EUR 
1000 
             75.000    
       75.000.000    
30% 
       22.500.000    
       97.500.000    

The public consultation outline strong opposition from a large majority of stakeholders with 
regard to a public European rating agency. The main concerns expressed regard the credibility 
and independence of a public agency. Furthermore, the costs in relation to such an initiative as 
as describe above cannot be underestimated.  

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ANNEX XII. ASSESSMENT OF ADMINISTRATIVE BURDEN AND COMPLIANCE COSTS  

This  annex  provides  an  assessment  of  compliance  costs,  including  administrative  burdens, 
resulting  from  individual  policy  options.  They  are  grouped  in  five  categories  according  to 
specific objectives (see section V). 

1 – Policy options to reduce overreliance on ratings 

Introduction 

This chapter identifies policy options that aim to reduce market overreliance on CRAs. The 
measures will impact the compliance costs and administrative burdens of CRAs, regulators or 
other stakeholders. In 2009 there were 25 CRAs271 established in 44 locations (see Annex IV.). 

Option 1 – No policy change 

Under  this  option  existing  rules  and  corresponding  administrative  burdens  or  compliance 
costs remain equal. 

Option 2 – Reduce reliance on external ratings by enhancing internal risk management and 
promoting the use of internal rating models for regulatory purposes 

The requirement to strengthen their internal risk management requirement would ensure that 
financial firms (credit institutions, investment firms, insurance and reinsurance undertakings, 
pension  funds,  UCITS  managers  and  in  the  future  alternative  investment  fund  managers)  to 
assess the credit/market risk by themselves, using their own methodology.  

However,  the  requirement  to  strengthen  internal  risk  management  could  lead  to  some 
compliance  costs.  This  measure  would  apply  to  all  types  of  financial  firms  including  credit 
institutions, insurance and re-insurance undertakings and investment firms.  

As  this  measure  does  not  entail  any  reporting  requirement  it  would  not  entail  any 
administrative  burden.  However,  to  conduct  own  internal  risk  managements,  entities  which 
currently do not provide for such function would need to set this up in their organisation. For 
others  which  already  perform  internal  risk  management  this  would  require  only  limited 
additional efforts or would remain business ass usual.  

Currently, while there is limited information on which institutions already perform such a risk 
management,  it  can  be  assumed  that  the  majority  of  institutions  already  apply  internal  risk 
management  to  some  extent.  However,  for  those  institutions  which  do  not  have  such  a 
function in place, the additional effort would be proportionate to the risks to which they are 
exposed.  Some  other  would  need  to  enhance  their  efforts  to  perform  the  internal  risk 
assessment. 

In  respect  to  the  use  of  internal  rating  models  for  the  calculation  of  regulatory  capital 
requirements,  a  distinction  is  made  between  (A)  financial  firms  with  material  and  complex 
risk  exposures  which  would  be  required  to  use  internal  models  for  the  calculation  of 
regulatory  capital,  and  (B)  financial  firms  which  will  be  allowed  to  continue  to  use  the 
"standardised approach" based on external ratings which would need to complement this with 
assessment of the inherent credit risk of an exposure and where appropriate reflect this in the 
capital requirement.  

271  

Impact  Assessment  Accompanying  document  to  the  Proposal  for  a  Regulation  of  the  European 
Parliament  and  of  the  Council  amending  Regulation  (EC)  No  1060/2009  on  credit  rating  agencies 
COM(2010) 289 final, dated 2.6.2010. 

167/193 

 
 
 
 
                                                 
A.  Financial  firms  with  material  and  complex272 credit  risk  exposure  would  be  required  to 
develop and use internal rating models rather than using the standard approach, which relies 
on external ratings.  

In  this  context,  the  key  variable  to  identify  compliance  costs  relates  to  the  identification  of 
material and complex credit risk exposures which would be defined on the basis of specific 
technical  guidelines.  Such  an  assessment  would  be  attributed  to  the  supervisory  authorities 
such  as  the  European  Banking  Authority  (EBA).  This  assessment  would  be  subject  to  a 
specific cost-benefit analysis.  

As  the  material  and  complex  credit  risk  exposures  has  not  yet  been  determined  by  the 
regulatory  authorities  through  a  technical  standard  the  number  of  the  amount  of  financial 
firms which would be subject to this requirement is currently uncertain. As a result, a detailed 
assessment of the compliance costs of administrative burdens would be premature.  

As  a  preliminary  qualitative  assessment,  one  could  consider  that  for  those  institutions 
impacted by this new rule, the additional effort would most likely be proportionate to the risks 
to which they are exposed. For those institutions which currently rely solely on ratings, they 
would need to design internal rating models. For some institutions, this could require to set up 
a new risk management department to determine these models and apply them for their risk 
exposures.  For  these  institutions,  the  additional  workload  would  be  material.  Other 
institutions  which  already  today  perform  partly  or  fully  such  assessments,  would  be  only 
minor  affected.  A  more  detailed  assessment  would  need  to  be  conducted  by  EBA  to  design 
the detailed technical standard.  

B. Those financial firms allowed to use the "standardised approach" based on external ratings 
for calculating their regulatory capital requirements would need to assess if the inherent credit 
risk  of  an  exposure  is  significantly  higher  than  the  one  that  corresponds  to  the  capital 
requirement assigned under the "standard approach" based on external ratings (or the absence 
thereof). They would be required to reflect if there would be a higher degree of credit risk in 
their evaluation of their overall capital adequacy. This requirement could lead to some further 
compliance  costs  for  institutions  which  currently  do  not  assess  the  credit  risk  of  their 
exposures.  

•  For  large  financial  institutions,  it  can  be  assume  they  perform  such  an  assessment  and 
therefore can be considered business as usual. It can be assumed that these entities would 
have the most material part of exposures.  

•  For  smaller  financial  firms  which  do  not  necessary  assess  the  credit  risk  of  an  exposure 
would  most  likely  need  to  introduce  this  activity.  The  magnitude  of  the  cost  related  to 
introducing this activity would most likely be proportionate to the size and magnitude of 
the  risk  exposures  themselves.  Small  firms  with  extensive  exposures  would  most  likely 
face material compliance costs proportionate to the risk of this activity. This could include 
setting  up  an  internal  service  to  perform  such  an  activity.  Small  financial  firms  without 
material credit exposures would face limited compliance costs or no costs at all.  

As  there  is  a  lack  of  date  on  risk  exposures  which  would  be  covered  under  this  option,  a 
quantitative assessment remains beyond the scope of this analysis.  

Option  3  -  Require  credit  institutions,  investment  firms,  insurance  and  reinsurance 
undertakings to use more than one rating (if available) 

272  

A good proxy for large or complex exposures is exposures of "large or sophisticated institutions" for a 
sectoral  legislation  where  entities  are  mainly  exposed  to  credit  risk  (e.g.  banking  sector).  This  would 
also  allow  applying  the  proportionality  principle  in  sectors  where  credit  risk  is  usually  not  the 
predominant  risk  of  large  or  sophisticated  entities  (e.g.  insurers).  Finally,  this  would  also  capture  the 
pending developments on complex exposures such as securitisation that are being discussed in Basel. 

168/193 

 
 
 
                                                 
This  option  would  require  credit  institutions,  investment  firms,  insurance  and  reinsurance 
undertakings  to  use  at  least  two  credit  ratings  issued  by  different  CRAs,  where  available. 
These ratings would be required to be used for the calculation of capital requirements under 
the standardized approach. 

As  this  option  would  require  financial  firms  using  the  standardized  approach  for  the 
calculation of capital requirements to identify if there is more then one rating available when 
calculating capital requirements.  

This option is not expected to generate any additional administrative burden as this does not 
entail any new reporting requirements for parties involved. This option could however result 
in some very limited compliance cost to check availability and use of alternative ratings when 
available. 

As ratings are published by CRAs under the issuers pays model, and are therefore mainly free 
of charge available to issuers this option are limited to additional searching cost to identify if 
there  are  more  then  one  rating  available.  Furthermore,  financial  firms  might  be  required  to 
adapt their process for calculating capital requirements to take into account a second rating. 
As search costs are limited and ratings freely available compliance costs are considered not 
material.   

Overall,  there  are  8,094  relevant  financial  institutions  in  total  of  which  6,458  Credit 
institutions and 1,636 insurance companies. Those institutions using "standardised approach" 
based on external ratings would need to research 2 ratings instead of 1 rating to determining 
their capital requirements. However as explained above, it can be assumed this is not a time-
consuming change in the process of determining capital requirements under the "standardized 
approach".  

Option 4 – Improve disclosure requirements for issuers of structured finance products on an 
ongoing basis 

Under this option, all issuers of structured finance products would be required on an ongoing 
basis  to  disclose  main  elements  of  underlying  asset  pools  for  structured  finance  products 
necessary for investors to make their own credit assessment and not rely on external ratings. 
Issuers could disclose this information by means of a website. 

Compliance cost and administrative burden: 

This option would entail some compliance cost to set up a system to disclose information and 
an  ongoing  cost  to  update  information  periodically.  It  can  be  plausibly  assumed  that  the 
information on structured finance products that needs to be disclosed is available at the issuer 
to  some  extent,  particularly  as  this  information  is  communicated  to  CRAs  for  obtaining  a 
credit rating.  

To set up a system to comply with disclosure requirements to issuers of a structured finance 
instruments  or  their  related  third  parties  would  face  a  one-off  cost.  These  costs  would  be 
related  to  the  information  disclosure  and  consist  of  a  one-off  investment  in  information 
systems  (website)  development and compliance procedures. In order to quantify the one-off 
costs for the relevant structured finance issuers, we made the following assumptions: 

(1) According  to  our  estimates  there  are  approximately  125  EU-wide  issuers  273  of 

structured finance instruments and related third parties. 

273  

Extraction made from Securitisation data on all securities issued worldwide backed by EU collateral for 
the year 2010, Association for Financial Market in Europe (AFME), Securities Industry and Financial 
Market Association (SIFMA) and European Securitisation Forum (ESF). 

169/193 

 
 
 
                                                 
(2) The  Commission  Services  estimated  that  it  would  take  an  issuer  approximately  300 
hours274 to develop a website, as well as procedures to disclose the information This 
would result in a total one-off hour burden of 37,500 hours for 125 EU-wide issuers. 

(3) The average hourly cost for a Compliance Manager is 53€ and the average hourly cost 
for  a  Programmer  Analyst  is  40€.  Therefore,  the  average  one-time  cost  to  an  issuer 
would be (150 hours × 53€) + (150 hours × 40€) = € 13,950. 

For these reasons, the Commission estimated that the average one-off administrative burden 
to each issuer would be € 13,950 and the total aggregate one-off administrative burden to the 
industry would be € 1.7 million (13,950€ x 125 issuers). 

The  main  part  of  the  on-going  costs  would  be  related  to  the  issuer's  or  related  third  party's 
obligations to place on a website all the information on an on-going basis that is necessary for 
investors to make their own credit assessment. In order to quantify the on-going costs for the 
relevant structured finance issuers, we made the following assumptions: 

(1) Based  on  the  data275 used  by  the  US  Securities  and  Exchange  Commission  (SEC) 
which  proposed  a  similar  measure  (SEC  rule  17g-5),  the  Commission  estimated  that 
each  issuer  or  its  related  third  party  would  on  average  disclose  information  with 
respect  to  approximately  125  transactions  on  an  on-going  basis  and  that  the 
information would have to be updated on a monthly basis to allow investors to make 
and monitor their own credit assessment. 

(2) The  Commission  Services  estimated  an  average  of  125  on-going  transactions  each 
month and 30 minutes spent on the monthly disclosure for each transaction, that each 
issuer  would  spend  approximately  750  hours  [125  transactions  ×  30  minutes  ×  12 
months  =  45,000  minutes/60  minutes  =  750  hours]  on  an  annual  basis  disclosing 
information consistent with the representations to be made for a total aggregate annual 
burden of 93,750 hours [750 x 125 issuers = 93,750]. 

(3) The average hourly cost for a Webmaster is 20€. Therefore, the average annual cost to 

an issuer would be 750 hours × 20€ = 15,000€. 

The  Commission  Services  estimated  that  the  average  annual  administrative  burden  to  an 
issuer  would  be  15,000€  and  the  total  administrative  burden  to  the  industry  would  be  €  1.9 
million (15,000€ x 125 issuers). 

2 – Policy options to mitigate the risks of contagion effects from sovereign debt ratings 

Option 1 - No policy change 

Under  this  option  existing  rules  and  corresponding  administrative  burdens  or  compliance 
costs would remain the same. 

Option  2  -  Require  CRAs  to  publish  a  full  research  report  on  sovereign  debt  ratings  and 
allocation of staff 

274  

275  

Based on the data used by the US Securities and Exchange Commission (SEC) when they proposed a 
similar measure under the US rule 17g-5, we estimated that it would take an issuer or related third party 
approximately 300 hours to develop an information system (website), as well as policies and procedures 
to disclose the information. It is estimated that this would entail 150 hours for a Compliance Manager 
and 150 hours for a Programmer Analyst. 
Federal  Register  N°74,  Securities  and  Exchange  Commission,  17  CFR  Parts  240,  243  and  249b 
Amendments to Rules for Nationally Recognized Statistical Rating Organisations; Proposed Rules for 
Nationally  Recognized  Statistical  Rating  Organisations;  Final  Rule  and  Proposed  Rule,  12/2009. 
Available from: http://www.sec.gov/rules/final/2009/34-61050fr.pdf.  

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CRAs  already  today  design  a  full  research  report  which  is  made  available  to  subscribers  of 
this information in combination with other research data provide by CRAs. Making this report 
available to all stakeholders would lead to negligible administrative burden of €13,000 (€520 
per CRA): 8 hours x €65 hourly rate x 25 rating agencies.  

Due  to  making  these  report  public  CRAs  will  lose income  from  the  sale  of  these  reports  to 
subscribers. The following assumptions are made: 

6  CRAs  currently  provide  sovereign  debt  ratings:  3  CRAs  provide  ratings  for 

• 
approximately 120 countries; 3 CRAs provide ratings for approximately 40 countries; 

The sales price of a full research report on sovereign debt ratings is estimated at 1,500 

• 
US$ per report (1 US$ = 0.723 EUR: €1,085); 

For each CRA only a limited number of reports per country are sold separately each 

• 
year. This is assumed to be an average of 10 reports per year. 

Based  on  the  above  mentioned  assumptions,  this  option  could  lead  to  a  loss  of  income  for 
CRAs  estimated  at  €5,208,000  per  year.  This  is  €868,000  per  CRA  (3  large  CRAs  x  120 
Sovereigns rated x 10 reports/sovereign x €1,085; 3 small CRAs x 40 Sovereigns rated x 10 
reports/sovereign x €1,085). 

Option 3 - Require CRAs to publish sovereign ratings after closing of EU trading venues 

This  option  would  not  increase  administrative  burden  or  other  compliance  costs  as  only  the 
timing of publication is modified.  

Option 4 - Require CRAs to conduct the sovereign debt ratings process more frequently 

This  option  would  lead  to  additional  compliance  costs  for  the  CRAs.  Reducing  the  time 
period for regular review of a rating (whether sovereign or not) means that the CRA has to 
undertake  the  full  review  process  in  order  to  determine  ratings  based  according  to  the 
methodologies and the quality expected. In order to quantify the substantive costs for relevant 
CRAs the following assumptions can be made:  

• 
The  CRAs  time  spent  on  each  review  will  stay  the  same.  The  extra  workload  to 
perform the full rating process is estimated at 100 hours. This includes: analysis (40 hours), 
committee meeting, including preparation by committee members (40 hours); preparation of 
the new rating for publication (20 hours). 

• 

• 

There will be one additional full rating process per year. 

The hourly rate of employee of a CRA is estimated at €65. 

The amount of analytical work required is not determined by the size of the country 

• 
being analysed. 

• 
There are 6 CRAs providing sovereign debt ratings: 3 larger CRAs provide ratings for 
approximately 120 countries; 3 smaller CRAs provide ratings for approximately 40 countries. 

Based on the above mentioned assumptions, the substantive additional compliance costs for 6 
CRAs  arising  out  of  this  option  are  estimated  at  €3,120,000  per  year  (3  large  CRAs  x  120 
sovereign  ratings  x  100  hours/rating  x  €65  hourly  rate=  €2,340,000;  3  small  CRAs  x  40 
sovereign ratings x 100 hours/rating x €65 hourly rate = €780,000)   

The  substantive  costs  per  entity  are  estimated  at  €780,000  per  year  for  large  CRAs,  and 
€260,000 per year for smaller CRAs. 

Option 5 - Extend powers of competent authorities (ESMA) to scrutinize rating methodologies 

171/193 

 
 
 
As  rating  methodologies  are  not  frequently  revised,  compliances  costs  for  this  option  are 
difficult to estimate. For the purpose of this impact assessment costs, following assumptions 
were made: 

•  On  average  rating  methodology  changes  once  every  2  years  for  CRAs.  Designing  and 

updating rating methodologies is a business as usual cost for rating agencies. 

•  Additional  costs  to  verify  rating  methodology  would  require  50  working  hours  per  CRA 

per year 

•  25  CRAs  could  be  affected  by  methodological  changes,  which  would  be  checked  once 

every year. 

•  Revision by ESMA would entail a workload of 1 full time equivalent per year for all rating 

agencies which is equivalent to 220 working hours 

This  option  would  not  increase  administrative  burdens.  Compliance  costs  are  estimated  at 
€150,550.  Verification  cost  for  CRAs  would  amount  to  €81,250  (25  rating  agencies  x  50 
working  hours  x  €65  hourly  cost;  verification  costs  incurred  by  ESMA  are  estimated  at 
€69m300 (220 working days x 7 hours x €45 hourly cost). 

Option  6  -  Require  (EU)  sovereigns  to  publish  a  standardized  data  set  on  economic 
performance to improve credit risk assessment 

This option would not lead to administrative burden for enterprises. However it would entail 
compliance costs for sovereigns to republish this already available information. 

Following assumptions can be made to determine compliance costs for sovereigns: 

• 

• 

• 

• 

• 

All EU sovereigns would be subject to this requirement. 

The information to be published is currently available by sovereigns. 

The information would be published on an existing website of the sovereign. 

Hourly rate is assumed to be €45.  

It is assumed that this publication would be quarterly and entail 20 working hours. 

The compliance cost for sovereign issuers would amount to €108,000 per year (30 Sovereigns 
(European Economic Area EEA) x 4 times per year x 20 working hours x €45 hourly rate). 

Option  7  -  Grant  ESMA  the  power  to  restrict  or  ban  temporarily  sovereign  debt  ratings  in 
situations defined by the Regulation 

This  option  could  give  the  ESMA  the  power  to  temporarily  restrict  or  ban  sovereign  debt 
ratings  in  certain  exceptional  situations  where  there  exist  risks  of  financial  stability. 
Exercising  this  power  would  lead  to  compliance  costs,  but  since  an  action  to  ban  ratings  is 
expected to be rare; the related compliance costs are estimated nil.  

Option 8 - Encourage an existing, independent EU structure or a brand new European Credit 
Rating Agency to issue credit ratings 

This option would involve substantial compliance costs in adapting an existing EU structure 
suitable for issuing credit ratings. This would include compliance costs to set up, develop and 
maintain  rating  issuance  by  this  EU  structure.  These  annual  costs  are  estimated  at 
€13,500,000  to  24,300,000  (equivalent  to  the  staff  level;  see  Annex  IX  for  more  detailed 
analysis). 

Option 9 - Prohibit sovereign debt ratings 

172/193 

 
 
 
This option would prohibit sovereign debt ratings and would require issuers and investors to 
develop  and  use  their  internal  models  to  assess  credit  risks.  This  approach  would  entail 
significant  costs.  Since  the  option  is  clearly  not  seen  as  cost-effective,  the  more  précised 
calculations are not made. However, roughly one could estimate that for issuers and investors, 
the costs should be similar to ones estimated under option 3. 

3 – Policy options to improve credit rating market conditions 

Option 1 - No policy change 

Under  this  option  existing  rules  and  corresponding  administrative  burdens  or  compliance 
costs  would  remain  the  same.  The  CRAs  will  continue  to  reach  abnormal  profit  margins, 
which between 2008 and 2010 stayed within a range of 33% - 46% (see annex IV).  

If  effective,  policy  measure  to  increase  competition  could  achieve  significant  savings  for 
stakeholders,  primarily  issuers.  On  the  assumption  that  improved  competition  reduces 
operating profit margins of biggest 3 CRAs to 30% and on the basis of 2008 – 2010 operating 
profit  margins  and  revenues  presented  in  annex  IV,  this  would  lead  to  annual  savings  of 
almost $489 million (€340 million) to business and investors. Assuming that 30% of revenues 
come  from  Europe  and  that  the  profits  are  distributed  proportionally  across  the  regions, 
increased competition would lead to €102 million in annual savings to European stakeholders. 
Whereas if more competitive environment would lead to a decrease in the biggest 3 operating 
profit margins to 20%, this would end up ceteris paribus with 173€ million in annual savings 
to European businesses and investors. 

Option 2 - Encourage the emergence of a network of small and medium sized rating agencies 

This option is not expected to generate any reporting requirements and consequently, does not 
generate  any  additional  administrative  burden.  However,  the  creation  of  a  network  of  SME 
rating agencies will create other substantial compliance costs.  

Based  on  the  recent  public  consultations  and  discussions  with  stakeholders,  15  European 
CRAs may participate in such a network in the medium term (5 years).  

Based  on  calculations  of  external  experts  and  depending  on  the  level  of  integration,  the 
indicative  costs  could  for  the  establishment  and  operation  of  a  network  could  be  the 
following:  

•  One  time  investment  cost:  €3-5  million  (mostly  in  IT  to  develop  a  database  of  best 

practices and underlying data to perform credit ratings; website) 

•  Annual operation cost: €1-3 million (own staff up to 30 in 5 years) 

• 

(optional) annual training cost (analysts, advisors, investors): €3-5 million 

The compliance costs are expected to be substantial and estimated to be in range between €3 
to 5 million as an initial setup costs and between €800,000 to 1,600,000 as annual recurring 
costs. No significant administrative costs are foreseen. 

Option 3 - Encourage the emergence of a new European rating agency 

The costs necessary to set up and maintain such an agency are substantial. These costs amount 
to €300-500 million over a period of 5 years. This estimation is based on a staff level of 350 
up  to  1000  to  develop  and  issue  ratings  depending  on  the  number  of  asset  classes  to  be 
covered by the agency. Depending on the financing model, these costs would need to be born 
fully  or  partly  by  the  private  sector  or  subject  to  a  loan  or  financing  by  the  public  sector 
during  the  start-up  phase  during  the  first  3  up  to  5  years  (see  annex  X  for  more  detailed 
analysis of costs). 

Option 4 - Harmonise ratings scales to improve comparability of ratings between CRAs 

173/193 

 
 
 
Harmonisation of the rating scales would imply compliance costs, since rating agencies would 
need  to  determine  a  mapping  between  the  existing  rating  scales  and  the  new  harmonised 
scales.  Also  users  of  ratings,  including  issuers  and  investors  could  face  some  limited 
compliance cost to adapt to the new harmonised scales (e.g. the costs of changing IT systems). 

In order to quantify the compliance costs the following assumptions are made: 

• 

There will be mainly one-off costs; 

The  standardisation  is  with  respect  to  main  rating  scales  used  for  sovereign  debt 

• 
ratings, corporate ratings and structured finance products ratings 

• 
The  common  standard(s)  to  be  used  shall  be  determined  by  a  technical  standard 
established  by  the  European  Commission  or  by  the  European  Securities  and  Markets 
Authority (ESMA), rather than CRAs. 

The costs would include training of staff concerning the new ratings, informing clients 

• 
about the new system, validation of the scale with the competent authority (ESMA). 

• 

• 

It is estimated that 25 different CRAs would need to adapt rating scales.  

The hourly tariff of employees is set to € 65 

• 
It is estimated that the 3 main large rating agencies have around 1,200 employees. All 
the  other  rating  agencies  together  have  500  employees.  70%  of  employees  would  require 
training.  Therefore,  2.870  analysts  have  to  follow  a  training  of  2  hours  to  understand  new 
rating scales. 

• 

Each rating agency would spend € 25,000 to inform their clients. 

Compliance cost to design and implement rating scales are estimated at €1,079,350, of which 
adaptation costs €81,250 (25 agencies x 50 hours to adapt scales x €65 per hour), education & 
training  €373,100  (2,870  analysts  to  be  trained  x  2  hours  x  €65  per  hour),  information  of 
investors & issuers on the website, which is considered administrative burden €625,000 (25 
CRAs x €25,000 information cost).  

Option 5 - Establish a European Rating Index (EURIX) 

This option would lead to administrative burden as all rating agencies would be required to 
report  any  change  of  rating  to  ESMA.  The  creation  of  a  European  Rating  Index  (EURIX) 
would incur the following substantial compliance costs:  

•  a  database  of  ratings  and  their  publication  on  a  dedicated  website.  Setting  up  such  a 
database and website is expected to cost €300,000 and entail an annual maintenance costs 
of €75,000 (which entail the cost of one full time equivalent to monitor the database and 
website). The EURIX could be an extension of the central repository provided for in article 
11.2 of the CRA regulation. Therefore, such a cost could be covered by the existing ESMA 
budget which provides for IT investments; 

•  Updating of data into the database would be directly performed by rating agencies. Daily 
update of ratings by rating agencies would require one hour of work per CRA. This would 
amount  to  the  total  cost  of  €357,500  (25  rating  agencies  x  220  working  days  x  1  hour  x 
hourly cost of €65). 

Option 6 - Require CRAs to issue joint ratings at the level of the rating committee  

Under this option, small and larger CRAs would be required to work together in order to issue 
a joint credit rating.  

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The  compliance  costs  in  issuing  credit  rating  jointly  by  two  credit  rating  agencies  could 
roughly amount to 10% of overall costs incurred in issuing credit ratings.276 There will be no 
additional administrative burdens from this requirement. 

Option 7 - Ban large CRAs from acquiring small and medium-sized CRAs 

Under this option, the larger CRAs would not be allowed to acquire small and medium-sized 
CRAs. This option will not lead to administrative burden as it will not entail any additional 
reporting obligations.  

Option 8 - Introduce temporary market share ceilings for CRAs 

Under this option, the larger CRAs would introduce market ceilings for CRAs. To ensure that 
ESMA can verify compliance with this option, CRAs would be required to periodically, once 
a  year)  to  provide  information  on  market  volume  and  fees  to  ESMA  in  their  annual 
transparency  report.  Based  on  this,  ESMA  could  evaluate  market  share  and  evaluate 
implementation of this option. 

Based on the above information, the annual administrative burden resulting from this option is 
estimated  at  €13,000  (8  hours  x  €65  hourly  rate  x  25  rating  agencies)  and  an  annual 
compliance  cost  of  €4,500  incurred  by  ESMA  (4  hours  x  €45  hourly  rate  x  25  rating 
agencies). 

Option  9  -  Require  CRAs  to  disclose  pricing  of  ratings  and  ensure  that  prices  are  not 
discriminatory and based on costs  

Since CRAs possess information on the pricing and the actual fees received from individual 
clients, this option would not require CRAs to undertake administrative activities other than 
providing detailed information on fees to ESMA and publishing the summary in aggregated 
format information on fees and actual pricing on the CRA's website, which should not exceed 
16  man-hours  /year  /CRA.  The  hourly  tariff  of  employees  is  set  to  €  65.  It  is  expected  that 
there should be no more than 25 CRAs concerned. 

Based  on  the  above  information,  the  total  cost  of  administrative  burden  for  CRAs  from 
disclosure of fees is estimated at €26,000 per year (16 working hours x  €65 hourly rate x 25 
rating agencies). 

4 – Policy options to ensure the right of redress of investors 

The proposed options on civil liability of CRAs do not place any further burden on CRAs or 
market  participants  in  terms  of  administrative  costs  or  burden.  However,  the  increased 
opportunities for investors to recover their losses from CRAs will result in increased costs for 
CRAs. To continue as a going concern, CRAs would need to insure their civil liability or, in 
the  absence  of  the  insurability,  to  create  a  financial  buffer  to  cover  potential  claims  from 
investors. The exact impact on the costs is difficult to quantify, but are likely to be significant.  

5 – Policy options to reinforce independence of credit rating agencies and improve 
ratings quality 

Option 1 – No policy change 

Under  this  option  existing  rules  and  corresponding  administrative  burdens  or  compliance 
costs remain the same. 

276  

The analogy has been made with joint audits as required in France.  

175/193 

 
 
 
 
 
 
                                                 
Option  2  –  Require  institutional  investors  to  obtain  their  own  ratings  before  they  can 
purchase a particular financial instrument 

Under  this  option,  an  issuer  would  remain  free  to  hire  a  CRA  of  its  own  choice,  but  each 
institutional investor would be required to obtain its own independent rating before investing 
in a particular structured finance product for amounts above certain thresholds (e.g. for clients 
who  may  be  treated  as  professionals  and  where  the  investment  portfolio  exceeds  EUR 
500,000277). 

In order to quantify the compliance costs for the relevant financial institutions for this option, 
we made the following assumptions: 

The  Commission  Services  estimates  that  there  should  be  approximately  973  new 

• 
structured finance deals per year278 in the EU market. 

We assumed that all investments in new structured finance deals in the EU would be 

• 
made exclusively by institutional investors. 

 We  assumed  that  an  average  rating  price  for  structured  finance  instrument  is  € 

• 
200,000.   

• 

There is no business as usual costs. 

Based  on  the  above  assumptions,  the  compliance  costs  for  this  option  are  estimated  at  € 
194,600,000 per year (973 x 200,000). None of this is to be considered as "business as usual 
costs". 

Option  3  –  Require  trading  venues  to  set  up  and  ensure  the  administration  of  the  "Trading 
venues pay" model 

Under this option, trading venues would be required to ensure and organise for the rating of 
their listed / traded companies / instruments. In the case of non-listed companies / instruments 
the  "subscriber  /  investor  pays"  model  could  apply.  The  platform  would  be  required  to 
organise the rating of the pool of loans by one of CRAs. CRA to rate an instrument would be 
selected on the basis of objective criteria. 

In  order  to  quantify  the  compliance  costs  for  the  relevant  stakeholders  for  this  option,  we 
made the following assumptions: 

We  assume  that  under  "trading  venues  pay"  model  the  credit  rating  price  would 

• 
decrease by 5%. 

• 
Turnover  of  the  big  3  CRAs  is  $5.3  billion  (around  €3.8  billion).  Smaller  rating 
agencies together have an estimated turnover of €500 million. Total turnover would be around 
€ 4.3 billion.  

• 

277  

278  

The total turnover should be adjusted because:  

The  investment  portfolio  size  refers  to  professionals  in  all  investment  services  and  activities  and 
financial instruments as defined in Annex II, Professional Clients, II.1, "the size of the client's financial 
instrument  portfolio,  defined  as  including  cash  deposits  and  financial  instruments  exceeds  EUR 
500.000",  Directive  2004/39/EC  of  the  European  Parliament  and  of  the  Council  of  21  April  2004  on 
markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 
2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC, 
OJ L0039, 28.04.2006.  
Commission Services estimated 973 new structured finance deals per year in the EU market. Extraction 
made from Securitisation Data Base on all securities issued worldwide backed by EU collateral for the 
year  2010,  Association  for  Financial  Market  in  Europe  (AFME),  Securities  Industry  and  Financial 
Market Association (SIFMA) and European Securitisation Forum (ESF). 

176/193 

 
 
 
                                                 
o 

o 

the EU-turnover in the total turnover is estimated at 25% (€ 4.3 billion x 25% 
= € 1.075 billion). 

the part of the total ratings admitted by trading venues is estimated at one-third 
(€ 1.075 billion x 1/3 = € 358 million). 

• 
We  assumed  that  one  extra  annual  report  per  trading  venue  is  necessary  and  also 
trading venues have to interact with CRAs. This is estimated at one employee's time for one 
year (1,800 hours) per trading venue. The hourly tariff of employees is set to € 45. 

The total number of trading venues is estimated of 219 (92 Regulated Markets and 127 

• 
MTFs).  

On one hand, based on the above assumptions the costs of ratings via trading venues are lower. 
The reduction is estimated at €17,916,667 (€358 million x 5%). This is a loss of income for 
CRAs. On the other hand, there are extra costs because of one employee's work per year per 
trading venue € 17,739,000 (1,800 hours x € 45 x 219).  

Option 4 – Require CRA selection to be undertaken by an independent board 

In order to quantify the administrative costs for the relevant CRAs for this option, we made 
the following assumptions: 

The Commission Services estimated that there are approximately 125 EU-wide 

• 
issuers there should be approximately 973 new structured finance deals per year.279 

Currently  CRAs  total  turnover  would  be  of  around  €  4.3  billion  and  the  EU-

• 
turnover in the total turnover is estimated 25% of total. 

• 

CRAs earn on average 30% of their revenue from structured finance ratings.  

• 
We assume that this policy option could lead to an average decrease of credit 
rating price by 5%. A potential economy would be of € 16.1 million (€ 4.3 billion x 
25% x 30% x 5%). 

• 
We  assumed  an  annual  budget  of  an  independent  "Credit  Rating  Agencies 
Board" to ensure its proper functioning could be financed by fees resulting from credit 
rating price decrease, as mentioned above.  

Option  5  -  Introduce  rotation  rules  for  the  CRAs  engaged  by  an  issuer  to  rate  its  own 
products and to rate the issuer itself and introduce mandatory separation between them 

Under this option, the requirements would be: 

• 

It is applicable only to solicited ratings;  

Issuer's own credit worthiness should not be rated by the same CRA for more 

• 
than 3 consecutive years; 

• 
Another CRA should take over thereafter and the outgoing CRA and the issuer 
should  make  available  all  information  accessed  in  the  rating  process,  and  hand  over 
appropriately to the incoming CRA to enable it to perform ratings effectively; 

• 
A CRA shall not rate more than 5 consecutive issues of any asset class by the 
same issuer. After a CRA has rated 5 consecutive issues for an issuer, that issuer must 
solicit any ratings for at least its 5 following issues from a different CRA or CRAs; 

279  

See policy options to reduce overreliance on external credit ratings. 

177/193 

 
 
 
                                                 
• 
If fewer than 5 issues are made, a CRA shall not rate the issues of one issuer 
over a period exceeding 3 years. After 3 years have passed or 5 issues have been made, 
whichever is sooner, the issuer can solicit ratings from the first CRA again; 

• 

A CRA shall not simultaneously rate an issuer and its products; 

CRAs  should  only  rate  products  for  which  it  has  the  capacity  to  rate  in 

• 
compliance with the CRA Regulation; 

• 
All  solicited  ratings  and  all  assets  classes  (corporates,  structured  finance 
instruments  and  sovereigns)  will  be  concerned.  The  rated  entities  and  the  issuers  of 
finance instruments would be required to comply with the rotation rules and ensure the 
monitoring and reporting. 

In order to quantify the administrative costs for the relevant stakeholders for this option, we 
made the following assumptions: 

We  assume  that  rating  administration  for  all  entities  or  products  rated  by 

• 
solicited CRAs are business as usual. 

• 
We  also  assume  that  reporting  administrative  burden  for  the  industry  to  the 
regulators/national  competent  authorities  would  be  entirely  compensated  by  a  lower 
price of competing CRA.  

• 
We assume that the regulators/national competent authorities will be required 
to  disclose  quarterly  compliance  reporting  to  ESMA.  We  estimate  that  reporting 
disclosure information will take 2 hours. 

In order to calculate the administrative burden, we use the hourly wages280 of 

• 
managers in EU Member States (see table below). 

Estimates for reporting to ESMA on-going costs: 

280  

The hourly  wages  are based on  standardised  ESTAT data  (the  four-yearly  labour  cost survey  and  the 
annual  updates  of  labour  costs  (ALC)  statistics),  reflecting  2006  figures.  They  already  contain  the 
standard  25%  overhead  costs,  as  required  by  the  Standard  Cost  Model  for  administrative  burden 
measurement. 

178/193 

 
 
 
                                                 
Member State Hourly wage of 

managers
(1)

Reporting disclosure 
cost/year
(2)=(1)*2*4

Austria

Belgium

Bulgaria

Cyprus

Czech Republic

Denmark

Estonia

Finland

France

Germany

Greece

Hungary

Ireland

Italy

Latvia

Lithuania

Luxembourg

Malta

Netherlands

Poland

Portugal

Romania

Slovakia

Slovenia

Spain

Sweden

United Kingdom

TOTAL

51,53

50,63

3,3

31,64

11,52

51,99

8,1

44,75

51,14

46,4

26,98

11,66

49,56

61,5

5,86

7,38

56,63

16,67

36,88

13,02

31

9,73

7,83

18,34

37,11

50,8

52,81

412

405

26

253

92

416

65

358

409

371

216

93

396

492

47

59

453

133

295

104

248

78

63

147

297

406

422
6.758  

Based on the above mentioned assumptions, the on-going costs from this option are estimated 
at € 6,758 per year. 

Option 6 – Introduce specific requirements on CRAs' independence and objectivity in relation 
to their shareholders 

Introduce  specific  requirements  on  CRAs  independence  and  objectivity  related  to  their 
shareholders. Under this option, ESMA would be required to ensure that CRAs cannot issue 
ratings for any firm that holds shares in that CRA, even indirectly281; and that a firm that has a 
shareholding in a CRA should not be allowed to invest in products rated by this CRA.282 

This option will incur only administrative burdens to CRAs in the provision of information to 
ESMA. In order to quantify the administrative costs for the CRAs for this option, we made 
the following assumptions: 

• 

The Commission services estimates that there are 25 registered CRAs in the EU. 

• 
We assumed that CRA will be requested to fill an annual compliance report to ESMA 
related to their shareholders and at any time to inform ESMA when a substantial change was 
incurred under this option.  

281  

282  

The CRA Regulation already includes a specific provision (see Section B, 3.b) related to the operational 
requirements under which a CRA is prohibited from issuing ratings in certain circumstances. However, 
the provision does not contain a specific reference to shareholders and no clear definition of "control". 
This option is in line with existing company law and free movement of capital provisions. 

179/193 

 
 
 
                                                 
The Commission services estimated that the preparation of annual compliance report 

• 
would take approximately 4 hours.  

• 

The hourly tariff of employees is set to € 65. 

Based  on  the  above  mentioned  assumptions,  the  costs  from  this  option  are  estimated  at  € 
6,500 (25 CRAs x 4 hours x € 65) per year. 

Option 7 - Strengthen rules on disclosure of rating methodologies  

Under  this  option  the  existing  rules  on  rating  methodologies  will  be  strengthened  by  (1) 
extending  the  requirement  to  disclose  methodologies  and  underlying  assumptions  behind 
ratings from structured finance products to all asset classes, (2) enhancing the requirement to 
disclose material changes in methodologies by additionally requiring the publication of clear 
reasoning  and  justification  for  the  changes  and  (3)  enhancing  the  requirement  to  disclose 
errors in methodologies or their application by requiring immediate disclosure directly to the 
affected parties including investors, issuers and competent authorities. 

In  order  to  quantify  the  administrative  costs  for  the  relevant  financial  institutions  for  this 
option, we made the following assumptions: 

-   Sub-option  (1)  extending  the  requirement  to  disclose  methodologies  and  underlying 

assumptions behind ratings from structured finance products to all asset classes:  

a)  The  Commission  Services  estimated  that  there  are  25  registered  CRAs  in  the 

EU. 

b)  CRAs earn on average 30% of their revenue from structured finance ratings. 

-   Sub-option (2) enhancing the requirement to disclose material changes in methodologies 
by  additionally  requiring  the  publication  of  clear  reasoning  and  justification  for  the 
changes. 

-   Sub-option  (3)  enhancing  the  requirement  to  disclose  errors  in  methodologies  or  their 
application  by  requiring  immediate  disclosure  directly  to  the  affected  parties  including 
investors, issuers and competent authorities. 

Strengthened rules on the disclosure of rating methodologies in relation to structured finance 
products  will  entail  costs  for  CRA  in  publishing  such  information.  However  since  this 
information will be already available to CRA, the administrative burdens from disclosing this 
information will be negligible. 

Option  8  –  Require  CRAs  to  inform  issuers  sufficiently  in  advance  of  the  publication  of  a 
rating 
Under  this  option  the  disclosure  procedural 283  requirements  for  solicited  and  unsolicited 
ratings  will  be  strengthened.  CRAs  will  be  required  –  sufficiently  in  advance  of  the 
publication  of  the  rating  –  to  inform  issuers  of  the  principle  grounds  on  which  the  rating  is 
based.  This  could  also  include  a  requirement  to  elaborate  on  the  main  assumptions  which 
justify the change of rating and would apply both to solicited and unsolicited ratings. As only 
the  timing  of  information  changes,  this  option  is  expected  not  to  entail  any  substantial 
additional administrative burdens or other compliance costs. 

283  

This  option  would  extend  the  current  requirement  of  12  hours,  provided  for  in  Annex  I  D  (3)  which 
does not reflect the working hours available to perform an assessment. 

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ANNEX XIII. COHERENCE WITH MAIN LEGISLATIVE INITIATIVES 

A  Comprehensive  strategy  to  restore  Financial  Stability  to  underpin  Sustainable 
Growth in the EU 

As  soon  as  the  crisis  broke  in  2007,  the  EU  acted  promptly  adopting  a  series  of  urgent 
measures to prevent the crisis spreading and limit its extent and impact. In particular the focus 
was on coordinating the European economic stimulus package to promote recovery, applying 
the  state  aid  regime  firmly  but  flexibly  so  as  to  avoid  distortions  of  competition  while 
allowing  banks  to  restructure,  and  increasing  the  amounts  guaranteed  by  Deposit  Guarantee 
Schemes (DGSs) up to €100,000 per account.  

Following  this  wave  of  “emergency”  measures,  the  Commission  launched  a  programme  of 
reforms  which  implements  the  commitments  taken  by  the  G20  and  aims  at  tackling  more 
structural issues in the EU financial sector and address the main sources of its vulnerability as 
unveiled by the crisis: 

•  The low levels of high quality capital and insufficient liquidity in the banking sector, 
partly  reflecting  inadequate  and  pro-cyclical  prudential  requirements  and  failures  in 
risk assessment and management;  

•  Supervisory  shortcomings,  particularly  with  regard  to  the  supervision  of  individual 
institutions operating in a cross-border context and to the unregulated financial sector;  

•  Corporate governance failures which contributed to excessive risk taking practices in 

financial institutions;   

• 

Insufficient  market  transparency  and  inadequate  disclosure  of  information  to  the 
authorities  including  supervisors,  particularly  with  reference  to  complex  structured 
financial products; 

•  Lack of adequate regulation and supervision of Credit Rating Agencies;  

• 

Insufficient macro prudential surveillance of the financial sector as a whole to prevent 
macro-systemic risks of contagion;  

•  The absence of a harmonised framework to facilitate the orderly wind-down of banks 
and financial institutions which has contributed to put pressure on Member States to 
inject public money into banks to prevent a general collapse 

The  building  blocks  of  this  programme  were  illustrated  in  the  Communication  of  4  March 
2009,  Driving  European  Recovery,  and  the  Communication  of  2  June  2010  'Regulating 
financial  services  for  sustainable  growth"  which  set  out  the  details  of  the  financial  reform 
package.  

The  first  elements  were  put  in  place  in  the  period  2009-2010.  The  most  important  is 
represented  by 
the 
the  new  architecture  for  financial  supervision  which 
establishment of the  European Systemic Risk Board, which will ensure that macro-prudential 
and macro-economic risks are detected at an early stage, and three new European Supervisory 
Authorities  responsible  for  banking  (European  Banking  Authority  or  EBA),  insurance 
(.European Insurance and Occupational Pensions Authority or EIOPA) and securities markets 
( European Securities Markets Authority ESMA) to ensure reinforced supervision and better 
co-ordination among supervisors.  

involved 

An  important  gap  in  regulation  has  been  plugged  through  the  Regulations  on  credit  rating 
agencies ('CRA I' and 'CRA II') introducing strict authorisation requirements and supervision 

181/193 

 
 
 
for  CRAs,  and  entrusting  ESMA  with  the  supervision  on  CRAs.  Moreover  the  Capital 
Requirements  Directive  (CRD)  was  amended  ('CRD  III')  to  reinforce  capital  rules  for  the 
trading book and for complex derivatives and to introduce binding rules on remuneration and 
bonuses in financial institutions. A further regulatory and supervisory gap has been plugged 
with the Directive on managers of alternative investment funds, including hedge funds (AIFM 
Directive)  providing  robust  and  harmonised  regulatory  standards  for  all  managers  and 
enhancing transparency towards investors. 

The interplay between the persisting fragilities of the financial sector, particularly due to the 
funding conditions for the banking sector, and pressures on governments' public finance and 
sovereign debt markets, the so called twin crisis', became of mounting source of concern in 
the end of 2010 and during the first half of 2011.   

In order to tackle effectively the twin crisis and to restore the EU economy to sustainable long 
term growth, the Commission and Member States have developed a coordinated and gradual 
approach to address both dimensions, i.e. the structural fragilities of the financial sector and 
the vulnerabilities of sovereign markets, in parallel. This requires bringing to completion the 
on-going reform programme to achieve a healthier financial sector along a series of measures 
to deliver a new quality of economic policy coordination to reduce the contagion risks from 
the vulnerable Member States to other sovereign markets and ensure public-debt sustainability. 

The first component is articulated along three dimensions: 

I. Improving stability and governance of financial institutions 

Improved  stability  of  financial  institutions  will  be  achieved  through  the  new  European 
Supervisory  Authorities  which  will  coordinate  the  work  of  national  supervisors,  ensuring 
coherent  supervisory  practices  and  contributing  to  the  establishment  of  a  common  rulebook 
for financial institutions. In July 2011, the Capital Requirements Directive (CRD) was revised 
again in order to implement the “Basel III” agreement, which significantly increases the levels 
of  capital  which  banks  and  investment  firms  must  hold  to  cover  their  risk-weighted  assets. 
The  proposal  includes  provisions  to  improve  risk  control  and  oversight  as  well  as  enhance 
supervisory review of risk governance in financial institutions. 

At the end of 2011, a new legislative proposal on CRAs ('CRA III') will tackle further risks 
related  to  the  functioning  of  the  rating  business,  such  as  the  "issuer-pays"  model,  the 
overreliance on ratings, the lack of competition in the sector, and the specificities of sovereign 
debt.  In  that  respect  the  initiative  will  contribute  also  to  reducing  the  pressure  on  sovereign 
markets. 

A  proposal  for  a  review  of  the  Directive  of  financial  conglomerates  has  been  adopted  to 
simplify and clarify the Directive with respect to a number of current problems (inadequacy 
of thresholds, complexity of supervisory tools etc.), and harmonize its application. 

The publication of the results of the 2011 EU-wide stress test, based on stricter requirements, 
better  coordination  and  peer  review  and  a  significantly  higher  degree  of  transparency,  will 
provide the right incentives for banks to restructure their operations, strengthen their capital 
base, and regain viability. Coordinated back-stop measures, with market based recapitalisation 
in the first place, will be set-up to take remedial action for banks failing the stress test. In last 
resort  case  of  public  interventions,  the  EU  State  aid  rules  will  provide  the  appropriate 
framework to ensure financial stability and a level playing field.  

Market  conditions  permitting,  new  State  Aid  control  measures  based  on  Article  107(3)(c) 
TFEU will be introduced as of 1 January 2012 with a gradual tightening of conditions towards 
a  new  permanent  State  Aid  Regime.  The  continuation  of  the  crisis  regime  under  Article 

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107(3)(b)  could  be  envisaged  for  those  Member  States  that  would  be  subject  to  a 
macroeconomic adjustment programme accompanying financial assistance 

The legislative proposal for a new EU bank resolution regime will establish a series of legal 
arrangements  that  allow  the  relevant  authorities  to  more  easily  restructure  or  resolve  a 
distressed credit institution without recourse to public financial support. The new regime will 
include  certain  tools  ("bail-in")  to  ensure  that  the  objective  of  making  shareholders  and 
creditors of the credit institutions contribute to the restructuring and resolution of the banks. 
The approach of increasing market discipline by clearly setting the  rules for  burden sharing 
between  public  and  private  sector  in  crisis  situation  will  be  a  common  element  also  in  the 
State  aid  framework  and  in  the  European  Stability  Mechanism  created  for  the  sovereign, 
which foresees some private sector involvement. 

II. Enhancing efficiency, integrity, liquidity and transparency of markets 

The  review  of  the  Markets  in  Financial  Instruments  Directive  (MiFID)  will  improve 
transparency, efficiency and integrity of securities markets in several ways. For example, the 
scope of MiFID will be extended to new types of trading platform and financial products, thus 
removing some opaque areas of securities markets. Some derogations will be also removed, 
and transparency requirements will be extended to all kinds of securities, not just shares.  

The  Market  Abuse  Directive  (MAD)  will  also  be  revised  to  provide  for  a  more  effective 
prevention, detection and sanctioning of market abuses.  

A  Regulation  has  been  proposed  on  Over-The-Counter  (OTC)  derivatives  markets 
implementing the G20 commitment that standardised OTC derivative transactions be cleared 
via  central  counterparties  (CCPs).    If  a  party  to  a  transaction  fails  in  mid-transaction,  the 
existence of a CCP would remove the risk and uncertainty as to whether the transaction will 
be completed. A further obligation for OTC derivatives to be registered in trade repositories, 
with access for supervisors in the EU, will provide a better overview of who owes what and to 
whom and to detect any potential problems, such as accumulation of risk, early on.  

A proposed Regulation regarding short selling and Credit Default Swaps (CDSs) will increase 
transparency via a requirement for flagging of short orders on trading venues, and notification 
or  disclosure  of  significant  short  positions  relating  to  shares  and  sovereign  debt  (including 
through the use of CDSs). This will enable supervisors to detect when such transactions are 
reaching dangerous levels and consider intervention on markets.  

Further  security  will  be  provided  by  a  planned  Securities  Law  Directive  (SLD),  which  will 
ensure that intermediaries always posses the securities which they maintain for the account of 
their customers. In addition, envisaged legislation on Central Securities Depositories (CSDs) 
will further secure the post trading handling of securities till their final settlement. 

III. Achieving a greater protection and inclusion of consumers and investors 

The Commission has brought forward proposals to reform Deposit Guarantee Schemes (DGS) 
and  Investor  Compensation  Schemes  (ICS),  on  top  of  recently  agreed  increase  of  the 
guaranteed  amount  (to  €  100,000  under  DGS,  €  50,000  under  ICS).  The  proposed  revised 
Directives  include  improved  payout  times,  better  funding  of  schemes,  and  a  proposal  for 
interlinkages and a mutual support mechanism between schemes (both deposit guarantee and 
investor compensation), to ensure that schemes in difficulties do not fail, to the detriment of 
consumers.  

A legislative proposal on fair practices relating to mortgage credits will improve the way in 
which  mortgages  are  sold  to  consumers,    analogous  to  existing  obligations  in  place  for 

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consumer  credit;  and  ensure  that  all  mortgage  lenders  and  intermediaries  are  properly 
regulated and supervised.  

The  Commission  has  proposed  a  Regulation  setting  an  end-date  for  the  completion  of  the 
Single European Payments Area (SEPA) for direct debits and credit transfers to speed up the 
process  that  will  make  payments  all  over  the  Euro  zone  as  easy  and  quick  as  domestic 
payments.    

For packaged retail investment products (PRIPs), a proposal is planned to make sure that all 
consumers  in  Europe  will  in  the  future  be  able  to  get  short,  focused,  and  plainly-worded 
information about investments in a common format, with risks and costs made much clearer 
and  easier  to  understand,  aiding  comparisons.  In  addition,  EU  rules  governing  those  selling 
the products will be made more consistent and standardised where necessary.  

To  enhance  financial  inclusion  the  Commission  will  table  a  proposal  to  ensure  EU  citizens 
might have access to a basic bank account with electronic payment instruments. 

On  a  macro-financial  level,  the  positive  impact  on  public  debt  sustainability  of  these 
initiatives  will  be  backed  by  implementing  the  decisions  taken  by  the  European  Council  in 
March 2011 on delivering a new quality of economic policy coordination through reinforced 
economic  governance,  including  the  excessive  imbalance  procedure  (EIP),  the  "Pact  for  the 
Euro" and the new European Stability Mechanism (ESM). 

184/193 

 
 
 
 
 
Ultimate objective

intermediate objectives

Immediate objectives 

Policy initiatives (Tools)

1
8
5
/
1
9
3

Restoring financial 
stability as a 
precondition for 
sustainable growth 

Improved efficiency, integrity, liquidity 
and transparency of Markets

Building a healthier financial 
sector: safer, sounder, more 
transparent and more 
responsible

Enhanced stability and governance of 
financial Institutions

MIFID and MAD Directives reviews
Regulation on Short selling/Credit Default Swap (CDS)
Regulation on Central Securities Depositories (CSD)
Regulation on Over-the-counter (OTC) Derivatives
Securities Law Directive

Capital Requirement Directive (CRD) IV/Basel III
Follow-up to Green Paper on Corporate Governance
Bank Resolution framework
Directive on Financial Conglomerates revision
CRA III

Stress Tests (EBA)
Backstop measures (Member States)
Review of the EU State-Aid framework (DG COMP)

Strengthened inclusion and consumer 
protection

Deposit Guarantee Schemes (DGS) 
Investor Compensation Schemes (ICS)
Packaged Retail Investment Products (PRIPs)
Single European Payment Area (SEPA)
Basic payment account
Mortgage credit

Restoring public finances 
(tackling the sovereign 
crises)

Strengthening economic governance 
in the EU

DG ECFIN

Excessive Imbalance Procedure (EIP)
Pact for the Euro                                
European Stability Mechanism (ESM)

 
 
 
 
 
  
 ANNEX XIV – ADDITIONAL TECHNICAL CHANGES 

The European Commission will also suggest some technical clarifications for which no major 
impacts are expected: 

Clarification which requirements apply to rating outlooks  

Rating outlooks are opinions issued by CRAs regarding the likely direction of a credit rating 
over  the  short  and  medium  term.  The  relevance  of  credit  outlooks  for investors  and 
issuers and  their  effects  on  markets  are  comparable to  the  effects  of  any  "normal"  rating 
decision.  Therefore,  also  the  procedural  requirements  of  the  CRA  Regulation  which  aim  at 
ensuring that ratings are accurate and understood by investors should apply. 

A definition of rating outlooks should be added and it should be specified which requirements 
of  the  CRA  Regulation  apply  to  rating  outlooks.  Even  if  under  current  supervisory  practice 
some of the requirements in the Regulation already apply to rating outlooks, the introduction 
of  a  definition  for  rating  outlooks  and  the  clarification  which  specific  provisions  apply  to 
outlooks will clarify the rules and provide legal certainty. 

Application of certain reporting and disclosure obligations to certified credit rating agencies 

It should be clarified that the requirement according to Article 11 (2) of the CRA Regulation 
which obliges credit rating agencies to make available in a central repository established by 
ESMA  information  on  its  historical  performance  also  applies  to  certified  credit  rating 
agencies.  This  understanding  is  justified  because  ratings  issued  by  certified  CRAs  may  be 
used for regulatory purposes by investors in the same way as investors use ratings issued by 
registered  CRAs.  Including  performance  data  from  certified  CRAs  in  the  central  repository 
allows  investors  to  compare  their  performance  (in  comparison  with  other  certified  or 
registered CRAs). This understanding is shared by ESMA, national competent authorities and 
credit rating agencies. 

It should also be clarified that certified CRAs have a regular reporting obligation to ESMA. 
Even  if  certified  CRAs  are  supervised  primarily  by  the  supervisory  authority  of  the  third 
country  where  they  are  established,  in  accordance  with  third  country  rules  that  have  been 
considered  equivalent  to  the  EU  CRA  Regulation,  ESMA  should  have  the  right  to  request 
information from certified credit rating agencies. This understanding is suggested by ESMA's 
role in the certification process according to Article 5 of the CRA Regulation which refers to 
a  role  in  ongoing  supervision  (to  verify  that  the  conditions  for  initial  certification  are 
continuously met). This understanding is shared by ESMA, national competent authorities and 
credit rating agencies.  

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ANNEX  XV.  MEASURES  AGAINST  OVER-RELIANCE  ON  EXTERNAL  CREDIT  RATINGS  IN 
CRDIV  

The following should provide you with an overview of what we do about reliance on ratings 
in CRD IV. 

First,  the  most  problematic  overreliance  on  ratings  takes  place  when  banks  invest  in  rated 
securities without understanding the risks of these securities. Misguided investment decisions 
may create bubbles. The worst of this problem, in the field of securitisation, has already been 
addressed by CRD II. That directive required banks to carry out a range of analysis for their 
securitisation investments, even if they are AAA rated. 

Beyond securitisation, CRD IV will also require that banks' investment decisions must never 
rely solely and mechanistically on ratings but always form their own internal credit opinion 
on every exposure.  

Distinct  from  the  banks'  internal  reliance  on  ratings,  there  is  the  calculation  of  regulatory 
capital  requirements  according  to  the  Basel  II  framework  and  hence,  the  CRD.  Capital 
requirements  are  meant  to  be  risk-sensitive  and  therefore  require  measures  of  credit  risk  as 
inputs. 

Avoiding overreliance in this field does not mean making no references to rating whatsoever. 
References to ratings may still be the best available policy alternative in some instances. For 
instance,  as  an  option  for  banks,  the  CRD  also  allows  the  use  of  internal  ratings  for 
calculating capital requirements. However, the necessary systems are costly to implement and 
to supervise. In some instances, developing internal ratings may be outright impossible (when 
there is a limited number of material counterparties the bank has, for instance). 

The  compromise  that  it  was  therefore  to  propose  with  CRD  IV  is  to  require  banks  with  a 
material number of exposures in a given portfolio (be it sovereigns, banks, or corporates) to 
develop internal ratings for that portfolio. In other words, a clear preference was expressed for 
using  internal  rather  than  external  ratings  where  possible.  This  requirement  on  the  bank  is 
without prejudice to the decision of the supervisors to validate the rating system and allow its 
use for calculating capital requirements. The notion of "materiality" in that context would still 
have to be defined by delegated act, trying to find the right balance in order not to overburden 
smaller institutions. 

CRD IV will however also require (smaller) banks that do not use internal ratings to compare 
their internal credit opinion (as opposed to a more formal and validated rating system) to the 
capital requirement resulting from an external rating. If the internal assessment shows that for 
a  given  loan,  the  external  rating  and  the  resulting  capital  requirement  are  too  favourable 
compared  to  the  internal  credit  opinion,  the  bank  will  be  required  under  Pillar  2  to  hold 
additional capital. 

In addition, CRD IV will require EBA to survey:  

(cid:190)  to what extent banks internally rely on external ratings; 
(cid:190)  what progress is made across the banking sector in implementing internal ratings for 

capital requirements purposes; 

(cid:190)  to  what  extent  other  national  legislating  (ie  not  implementing  the  CRD)  relies  on 

ratings. 

187/193 

 
 
 
 
 
 
 
 
 
 
ANNEX XVI. GLOSSARY 

Term 

ABS (Asset Backed Security) 

AIFMD (Alternative 
Investment Fund Managers 
Directive) 

Asset write down 

Barrier to entry 

Basel II 

Basel III 

Explanation 

An Asset Backed Security is a security whose value and income 
payments are derived from and collateralized (or "backed") by a 
specified pool of underlying assets which can be for instance 
mortgage or credit cards credits. 

The Alternative Investment Fund Managers Directive created a 
comprehensive and effective regulatory and supervisory framework 
for managers of hedge funds and private equity funds in the 
European Union.  
An asset write down recognises that an asset's value has fallen by 
reflecting this new, lower value in accounting treatment.  

A barrier to entry is an obstacle to entering a particular market.  
Barriers to entry could include regulatory requirements or competing 
large, well-established existing market players.  
Basel II is the second Basel Accord issued by the BCBS (see 
separate entry), which is a series of recommendations on banking 
supervision and regulation.  The aim of the Accord was to produce 
an internationally recognised standard approach to the amount of 
capital that banks should hold. 

Basel III is the third Basel accord, currently being developed, by the 
BCBS (see separate entry), which will propose a further series of 
standards on capital and liquidity for banking supervision and 
regulation. 

BCBS (Basel Committee on 
Banking Supervision) 

The BCBS is an institution created by the Governors of the central 
banks of the Group of Ten nations. It was created in 1974 and meets 
on a quarterly basis. 

CDO (Collateralised Debt 
Obligation) 

A collateralised debt obligation is a type of asset backed security in 
which the assets are debt obligations (see ABS). 

CDS (Credit Default Swap) 

CESR (Committee of 
European Securities 
Regulators) 

"cliff" effects 

CMBS (Commercial 
Mortgage Backed Security) 

Contagion effect 

A credit default swap is a contract between a buyer and a seller of 
protection to pay out in the case that another party (not involved in 
the swap), defaults on its obligations. CDS can be described as a 
sort of insurance where the purchaser of the CDS owns the debt that 
the instrument protects; however, it is not necessary for the 
purchaser to own the underlying debt that is insured. 
CESR was the predecessor body to ESMA.  See ESMA. 

"cliff" effect refers to a positive feedback loop, where downgrading a 
single security can have a disproportionate cascading effect. This 
has become pronounced with respect to the assessment of credit 
risk in a bank's portfolio. If a Credit Rating Agency has the 
expectation that the credit risk of a position rises, it will downgrade its 
rating. As a consequence, a bank faces additional capital charges in 
order to comply with national capital requirements. 
A commercial mortgage backed security is a type of asset backed 
security for which the assets are commercial mortgages (see ABS). 

Financial contagion refers to a scenario in which small shocks, which 
initially affect only a few financial institutions or a particular region of 
an economy, spread to the rest of financial sectors and other 
countries whose economies were previously healthy, in a manner 
similar to the transmission of a medical disease. Financial contagion 
happens at both the international level and the domestic level. At the 
domestic level, usually the failure of a domestic bank or financial 
intermediary triggers transmission when it defaults on interbank 

188/193 

 
 
 
Term 

Explanation 

liabilities and sells assets in a fire sale, thereby undermining 
confidence in similar banks. 
Directives 2006/48/EC and 2006/49/EC. These Directives establishe 
the authorisation and pursuit of business of credit institutions along 
with the principle of single passport and home country control and 
further sets out the applicable prudential requirements: supervision 
and disclosure by competent authorities, consolidated supervision, 
capital requirements, reporting of and limits to large exposures and 
non-financial holdings, suitability of managers and shareholders, 
standards for the internal risk management and public disclosure to 
achieve market discipline. It introduced Basel II accord in the EU 
legislation. 
CRD IV is an amendment to the CRD that introduces the Basel III 
accord in EU legislation, creates a single rule book for banks and 
transfers certain part of the CRD to a Regulation.  
Credit risk is the risk that a borrower will default on a debt, i.e. not 
repay the debt. This can also be called default risk. 

A credit write down is where the value of a debt is reduced and the 
new, lower value is recognised (See write down). 

An Act in 2010 was introduced to promote the financial stability of the 
United States by improving accountability and transparency in the 
financial system, to end "too big to fail", to protect the American 
taxpayer by ending bailouts, to protect consumers from abusive 
financial services practices, and for other purposes. 
Due diligence in this impact assessment generally refers to a 
process of investigation and verification before making an 
investment. 

The EBA is the successor organisation to the Committee of 
European Banking Supervisors (CEBS), and was established by 
Regulation (EC) No. 1093/2010 of the European Parliament and of 
the Council of 24 November 2010.  It is one of the three European 
Supervisory Authorities (ESAs); see also ESMA and EIOPA. 

The Eurosystem credit assessment framework (ECAF) defines the 
procedures, rules and techniques which ensure that the Eurosystem 
requirement of high credit standards for all eligible assets is met.  
The framework takes into account credit information assessments 
from four sources 
CRAs recognised by national supervisors to determine the risk-
weights on their rated credit exposures (including securitisation 
exposures) under the Basel II Framework, the standardised 
approach to credit risk requires banks to use credit assessments 
provided by External Credit Assessment Institutions (ECAIs) 
recognised by national supervisors to determine the risk-weights on 
their rated credit exposures (including securitisation exposures). 
National supervisors are responsible for determining whether an 
ECAI meets the eligibility criteria set out in the Framework, so that 
banks incorporated in their jurisdictions can use the ECAI’s risk 
assessment for the calculation of the capital requirement under 
Basel II. 
The European Central Bank is the central bank of the Euro currency, 
based in Frankfurt in Germany.  The ECB's primary role is to 
maintain price stability in the EU. 

CRD (Capital Requirements 
Directive) 

CRD IV 

Credit risk 

Credit write down 

Dodd-Frank Wall Street 
Reform and Consumer 
Protection Act 

Due diligence 

EBA (European Banking 
Authority) 

ECAF (Eurosystem Credit 
Assessment Framework) 

ECAI  (External Credit 
Assessment Institution) 

ECB (European Central 
Bank) 

189/193 

 
 
 
Term 

Explanation 

EEA (European Economic 
Area) 

ESM (European Stability 
Mechanism) [51] 

EIOPA (European Insurance 
and Occupational Pensions 
Authority) 

EMEA (Europe, Middle East 
and Africa) 

ESMA (European Securities 
Markets Authority) 

Euro Debt Crisis 

EUROSTAT 

FSB (Financial Stability 
Board) 

G20 

Herd behaviour 

IMF (International Monetary 
Fund) 

Investor-pays model 

IORP (Institutions for 
Occupational Retirement 
Provision) 

The Agreement creating the European Economic Area (EEA) 
entered into force on 1 January 1994. It allows the EEA European 
Free Trade Association (EFTA) States Norway, Iceland and 
Liechtenstein (Switzerland has not joined) to participate in the 
Internal Market on the basis that they adopt all EU single market 
legislation except that relating to agriculture and fisheries. 
The European Stability Mechanism (ESM) is a permanent rescue 
funding programme to succeed the temporary European Financial 
Stability Facility and European Financial Stabilisation Mechanism. 
The European Stability Mechanism (ESM) is due to be launched in 
mid-2013. 
The European Insurance and Occupational Pensions Authority 
replaced the Committee of European Insurance and Occupational 
Pensions Supervisors (CEIOPS). It is established under EU 
Regulation 1094/2010. 
The abbreviation EMEA designates the geographic region of Europe, 
the Middle East and Africa. 

ESMA is an independent EU Authority that contributes to 
safeguarding the stability of the European Union's financial system 
by ensuring the integrity, transparency, efficiency and orderly 
functioning of securities markets, as well as enhancing investor 
protection. In particular, ESMA fosters supervisory convergence both 
amongst securities regulators, and across financial sectors by 
working closely with the other European Supervisory Authorities 
competent in the field of banking (EBA), and insurance and 
occupational pensions (EIOPA). More information on ESMA can be 
found at www.esma.europa.eu. 
This refers to the budgetary and funding difficulties facing parts of 
the EU following the first part of the financial crisis. 
Eurostat is a Luxembourg-based Directorate-General of the 
European Commission with the main task of providing the European 
Union with Europe-wide statistical information. 
The Financial Stability Board (FSB) is an international body that 
monitors and makes recommendations about the global financial 
system. It was established after the 2009 G-20 London summit in 
April 2009 as a successor to the Financial Stability Forum. The 
Board includes all G-20 major economies, FSF members, and the 
European Commission. It is based in Basel, Switzerland. 
The Group of Twenty Finance Ministers and Central Bank Governors  
is a group of finance ministers and central bank governors from 20 
major economies: 19 countries plus the European Union. 
A tendency of market participants to conform in their behaviour with 
that of their peers 
The International Monetary Fund (IMF) is an intergovernmental 
organization that oversees the global financial system by taking part 
in the macroeconomic policies of its established members, in 
particular those with an impact on exchange rate and the balance of 
payments. 
The investor-pays model is a model which was formerly used by 
CRAs and which is no longer in widespread use.  Under this model, 
investors (often in groups) paid for credit ratings rather than the 
currently prevalent issuer-pays model (see separate entry). 
Institutions for Occupational Retirement Provision Directive 
2003/41/EC is a European Union Directive designed to create an 
internal market for occupational retirement provision. It lays down 
minimum standards on funding pension schemes, the types of 
investments pensions may make and permits cross-border 
management of pension plans. 

IRB (Internal Ratings Based)  Advanced approach by which a bank can use its own credit 

190/193 

 
 
 
Term 

model 

Issuer-pays model 

Junk status 

Liquidity 

Lock-in effect 

Market concentration 

Market risk 

MiFID (Markets in Financial 
Instruments Directive) 

NCB (National Central Bank) 

NRSRO (Nationally 
Recognized Statistical 
Ratings Organisation) 

Oligopoly 

Procyclicality 

Prospectus Directive 

Public utility model 

QIS5 (Five Quantitative 
Impact Studies) 

Rating downgrade 

Explanation 

assessments to calculate its regulatory capital requirements for 
credit risk. Depending on the risk factors the bank is allowed to 
estimate, a distinction is made between a foundation IRB and an 
advanced IRB approach 
The currently prevalent model under which issuers pay CRAs directly 
to be rated or for their issuances to be rated. 

Junk status refers to a level of credit rating at which an instrument is 
no longer considered to be 'investment grade'. 

Liquidity is a complex concept that is used to qualify market and 
instruments traded on these markets. It aims at reflecting how easy 
or difficult it is to buy or sell an asset, usually without affecting the 
price significantly. Liquidity is a function of both volume and volatility. 
Liquidity is positively correlated to volume and negatively correlated 
to volatility. A stock is said to be liquid if an investor can move a high 
volume in or out of the market without materially moving the price of 
that stock. If the stock price moves in response to investment or 
disinvestments, the stock becomes more volatile. 

The lock-in effect refers to the difficulty for issuers to change the 
CRA they are using for a rating. 

Market concentration is a term, referring to a way of measuring the 
relationship between the number of firms in a market and their 
respective share of it.  In a more concentrated market, fewer firms 
will have a larger market share; in a less concentrated market, a 
greater number of firms will have smaller market share. 
Market risk is the risk of losses due to price fluctuations of financial 
instruments in the trading book 
Directive 2004/39/EC that lays down rules for the authorisation and 
organisation of investment firms, the structure of markets and trading 
venues, and the investor protection regarding financial securities. 
A national central bank is a public institution that is normally tasked 
with issuing currency, controlling supply of money and setting 
interest rates. 
NRSRO is a designation by the United States Securities and 
Exchange Commission that enables a CRA's ratings to be used for 
regulatory purposes. 
An oligopoly is a market which is dominated by only a few large and 
dominant players.  Oligopolies can be characterised by low 
differentiation between market participants, high barriers to entry and 
high profits over a long period. 
Procyclicality refers to the tendency to increase the effect of 
variations in the economic cycle.  This is often applied to something 
that increases the effect of a negative economic impact, such as 
"cliff" effects. 
Directive 2003/71/EC of the European parliament and of the Council, 
which lays down rules for information to be made publicly available 
when offering financial instruments to the public. 
The model which would require transforming the credit rating agency 
into a public utility and funding it with government revenues. 
In order to assess its impact the development of "Solvency II" was 
accompanied by five Quantitative Impact Studies. In these studies 
insurance and reinsurance undertakings as well as insurance groups 
under the scope of "Solvency II" determine their eligible own funds 
and capital requirements according to preliminary specifications of 
the new rules. 
A rating downgrade refers to a credit rating being revised by a CRA 
to a lower rating. 

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Term 

Rating upgrade 

Ratings action 

Ratings and Securitisation 
working group 
RMBS (Retail Mortgage 
Backed Security) 

SEC (Securities and 
Exchange Commission) 

SME (Small to Medium 
Enterprise) 

Solicited rating 

Solvency II 

Sovereign debt 

Spill-over effects 

Spread (bond spread, CDS 
spread, yield spread) 

SPV (Special Purpose 
Vehicle) 

Standardised approach 

Structured finance product 

Subprime mortgage 

Subsriber pays model 

Systemic 

TFEU (Treaty on the 
Functioning of the European 

Explanation 
A rating upgrade refers to a credit rating being revised by a CRA to a 
higher rating. 

A ratings action means a review of a credit rating leading to a 
change.  This might be a rating upgrade or downgrade (see separate 
entries) or another action such as placing on positive or negative 
watch (a status of review while the CRA is deciding whether or not to 
upgrade or downgrade), or even affirming the current rating. 
A working group established by the Basel Committee to review the 
Basel framework’s reliance on ratings  
A retail mortgage backed security is a type of ABS (see separate 
entry) in which the assets are retail mortgages. 

The US regulatory body responsible for the regulation of securities 
and protection of investors. 

On 6 May 2003 the Commission adopted Recommendation 
2003/361/EC regarding the Small and medium sized enterprise 
definition. While 'micro' sized enterprises have fewer than 10 
employees, small have less than 50, and medium have less than 
250. There are also other criteria relating to turnover or balance 
sheet total that can be applied more flexibly. 
A rating requested by the issuer or another party. 
The Solvency II Directive 2009/138/EC is an EU Directive that 
codifies and harmonises the EU insurance regulation. Primary this 
concerns the amount of capital that EU insurance companies must 
hold to reduce the risk of insolvency. 
Sovereign debt (also known as government debt or public debt) 
refers in this impact assessment to money that a central government 
borrows.  The debt is usually raised by the government issuing 
bonds by auction. 

Spillover effects are externalities of economic activity or processes 
those who are not directly involved in it. 
The difference between the bid and the ask price of a security or 
asset. 
A special purpose vehicle (also called special purpose entity) is a 
legal entity that is set up to fulfil a specific purpose.  SPVs are widely 
used in the creation of ABS, in which the assets will be held by an 
SPV set up with the purpose of owning those assets and receiving 
and distributing income streams from them.  In this sense, SPVs are 
usually distinct from the legal entities that create them (so that its 
creditors have no claim over the assets of the SPV). 
The standardised approach to credit risk and the standardised 
approach to market risk are methods of assigning credit risk 
weightings to assets for regulatory capital calculation purposes, 
proposed by the Basel Committee on Banking Supervision. 
A structured finance product, also known as a market-linked product, 
is generally a pre-packaged investment strategy based on 
derivatives, such as a single security, a basket of securities, options, 
indices, commodities, debt issuance and/or foreign currencies, and 
to a lesser extent, swaps. 
Subprime mortgages are those lent to parties who have limited or 
impaired credit history or a lower ability to repay the loan.  They 
usually carry a higher interest rate to reflect the increased risk. 
A model under which payment for ratings is made by investors 
subscribing to a service, rather than the issuer (see entry for issuer 
pays model). 
Systemic, in this impact assessment, describes the quality of having 
an significant impact across the whole financial system. 
Primary source of EU law, together with the TEU (Treaty on the 
European Union), as modified by the "Treaty of Lisbon amending the 

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Term 

Union) 

UCITS (Undertakings for 
Collective Investments in 
Transferable Securities) 

Unsolicited rating 

Volatility 

WBS (Whole Business 
Securitisation) 

Working Group on Liquidity 

Yield spread 

Explanation 
Treaty on European Union and the Treaty establishing the European 
Community", signed at Lisbon, 13 December 2007. 
Undertakings for Collective Investment in Transferable Securities 
Directives, a standardised and regulated type of asset pooling. 

A rating issued without being requested by an issuer. 
Volatility refers to the change in value of an instrument in a period of 
time. This includes rises and falls in value, and shows how far away 
from the current price the value could change, usually expressed as 
a percentage. 

A whole business securitisation is a type of ABS in which the assets 
are a business.  This is typically used by a parent company 
transferring a portion of its revenue-generating assets to an SPV 
(see separate entry), which in turn uses the revenue to loan funds to 
the parent company. 

The Working Group on Liquidity is a working group that reports to the 
Policy Development Group of the Bank for International Settlement's 
Basel Committee on Banking Supervision (see 
http://www.bis.org/bcbs/).  The Policy Development Group is one of 
the Committee's four main sub-committees.  The Working Group on 
Liquidity has published a set of standards for liquidity management 
and supervision (see http://www.bis.org/publ/bcbs144.htm). 
The yield spread is the difference between the quoted rates of return 
on two different investments, usually of different credit quality. 

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