COMMISSION STAFF WORKING PAPER EXECUTIVE SUMMARY OF THE 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) 1355 final 

COMMISSION STAFF WORKING PAPER 

EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT 

Accompanying the documents 

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) 1354 final} 

 
 
 
 
  
 
 
 
 
COMMISSION STAFF WORKING PAPER 

EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT 

Accompanying the documents 

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 

INTRODUCTION 

Regulation (EC) No 1060/2009 on credit rating agencies1 (CRA Regulation) entered into full 
application  on  7  December  2010.  It  sets  out  rules  of  conduct  for  credit  rating  agencies 
(CRAs). Furthermore, on 11 May 2011 an amendment to the CRA Regulation2 was adopted, 
entrusting  the  European  Securities  and  Markets  Authority  (ESMA)3  with  exclusive 
supervisory powers over CRAs registered in the EU in order to centralise and simplify their 
supervision at European level. 

However, a number of issues related to credit rating activities and the use of ratings are not 
addressed in the existing CRA Regulation. Many responses to the consultation4 carried out by 
the Commission and at the roundtable5 organised by the Commission in June 2011 confirmed 
the need to address some remaining issues. These relate notably to the risk of overreliance on 
credit ratings by financial market participants, the high degree of concentration in the rating 
market and, to a certain extent, the way by which CRAs are remunerated. 

Although there are a number of smaller CRAs, the rating market is dominated by three major 
CRAs  (Fitch,  Moody's  and  Standard  &  Poors),  with  a  combined  market  share  above  95  % 

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5 

Regulation  of  the  European  Parliament  and  of  the  Council  on  credit  rating  agencies  of  16  September 
2009, OJ L 302, 17.11.2009. 
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, p. 84. 
Public  Consultation  on  Credit  Rating  Agencies  launched  by  the  European  Commission  services  on  5 
November 2010 and closed on 7 January 2011. More than 100 responses were received. 
Roundtable on Credit Rating Agencies of 6 July 2011 organised by European Commission services. 

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globally.6 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 
related  to  sovereign  debt  instruments,  are  not  sufficiently  addressed  either.  In  particular, 
during the recent Euro debt crisis7, 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 
interests linked to the shareholder structure of CRAs and civil liability of CRAs are also not 
sufficiently addressed in the current CRA Regulation. 

PROBLEM DEFINITION 

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

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• 

• 

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Overreliance on external credit ratings leading to "cliff" effects8 in capital markets; 

"Cliff" and 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 

from: 

Finance  –  FAZ.NET,  S  &  P,  Moody’s  and  Fitch:  Brussels’  battle  against  the  rating  oligopoly,  June 
2011.  Available 
http://financesjournal.com/finances/moodys-fitch-brussels-battle-rating-
oligopoly-5972.html. 
A  description  and  detailed  analysis  of  the  Euro  debt  crisis  can  be  found  in  Annex  VI  of  the  Impact 
Assessment. 
"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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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 

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

Contagion effects of 
sovereign debt rating 
changes 

High market concentration in the credit rating market 

Limited choice and 
competition 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 

Insufficient 
right of 
redress for 
investors 

Undermined independence 
of credit rating agencies 

Insufficiently sound credit rating 
methodologies and processes 

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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.  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. 

OBJECTIVES AND PREFERRED POLICY OPTIONS 

The general objective of the proposal is to contribute to reducing the risks to financial stability 
and  restoring  the  confidence  of  investors  and  other  market  participants  in  financial  markets 
and ratings quality. The set of policy options presented in this section aims at addressing the 
problems  and  reaching  the  corresponding  specific  objectives.  The  preferred  options  on  the 
basis of their effectiveness and efficiency are highlighted in bold. 

Policy options to diminish the impact of "cliff" effects9 on financial institutions and markets 
by reducing reliance on external 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. 

The Impact Assessment shows that measures to enhance internal credit risk management and 
the use of internal models for regulatory purposes and specifically improving disclosures by 
the  issuers  on  structured  finance  products  are  the  most  cost-effective  options  in  the  current 
situation.  Good  quality  ratings  are  helpful  and  should  continue  to  be  used;  however  it  is 
important  to  incentivise  the  development  of  internal  credit  rating  capabilities  for  firms  with 
sufficient resources. Therefore, it should be ensured that a principle preventing over-reliance 
on credit ratings in line with the principles of the Financial Stability Board applies across the 
board to all actors in the financial markets. The first set of policy measures to limit reliance on 
credit ratings has already been included in the new Commission proposal for the modification 
of the Capital Requirements Directive (CRD IV).10 Need for adaptation, at this stage, remains 
in  particular  in  the  areas  of  undertakings  for  collective  investment  in  transferable  securities 
(UCITS)  and  of  Alternative  Investment  Funds  (AIFs).  Double  ratings  for  structured  finance 
products could allow a further reduction in reliance on ratings for these complex products.  

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10 

"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. 
COM (2011) 453 final. 

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The  preferred  options  are  consistent  with  stakeholders'  views  that  removing  rules  triggering 
mechanistic reliance on ratings from legislation is just one step and is not an immediate cure. 
Stakeholders also noted that it is a challenge to find suitable measures to replace the current 
use of external ratings. Using market measures instead of ratings was seen as inappropriately 
pro-cyclical and volatile by many, including industry groups and governments, but they could 
be  taken  into  account  alongside  other  measures.  Some  stakeholders,  particularly  issuers, 
opposed  the  idea  of  requiring  multiple  ratings  as  a  measure  to  reduce  overreliance,  while 
some smaller CRAs welcomed a requirement for multiple ratings. 

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 the closure of EU trading venues. 

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

5. Extend powers of competent authorities (ESMA) to ensure rating methodologies comply with legal requirements. 

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 issuance of sovereign debt ratings temporarily in exceptional situations. 

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

9. Prohibit sovereign debt ratings. 

In the Impact Assessment, nine options were identified to mitigate the market stability risks 
resulting  from  sovereign  ratings,  out  of  which  five  options  have  been  assessed  as  preferred 
ones. It is suggested that CRAs publish full research reports on sovereign ratings (option 2) – 
a  measure  which  was  also  supported  by  some  governments  and  industry  stakeholders.  The 
sovereign  debt  ratings  process  should  also  be  conducted  more  frequently  (option  4)  and 
ESMA should have the necessary powers to ensure the compliance of methodologies with the 
requirements  of  the  Regulation,  but  also  to  be  in  a  position  to  ban  issuance  of  sovereign 
ratings  temporarily  in  well  defined,  exceptional  circumstances  (options  5  and  7),  although 
some stakeholders opposed this idea. In the Impact Assessment, it is furthermore considered 
preferable that sovereign ratings are published after the closure of EU trading venues (option 
3). The impact analysis concludes that for reasons of objectivity and credibility, as perceived 
by the market, it would not be appropriate to use an existing independent EU structure or to 
establish  a  brand  new,  public  European  Credit  Rating  Agency  to  issue  sovereign  credit 
ratings. Many stakeholders also raised concerns, in particular, with respect to the credibility of 
such ratings. 

Policy  options  to  improve  credit  rating  market  conditions  with  a  view  to  improving  ratings 
quality 

Policy Options 

1. No policy change. 

2. Encourage the emergence of a network of small and medium-sized 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. 

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

8. Introduce temporary market share ceilings for CRAs. 

Policy Options 

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

The  Impact  Assessment  analyses  a  wide  range  of  options  to  improve  credit  rating  market 
conditions  that  should  be  conducive  to  ensuring  independence  of  CRAs  and  high  quality 
ratings. Improved transparency (options 5 and 9) and comparability of ratings (option 4) are 
considered to be cost-effective options. Moreover, fostering the creation of a network of small 
and medium-sized rating agencies is seen as a preferred option to reduce the barriers to entry 
into  the  market.  The  creation  of  a  European  rating  agency  as  a  public,  rather  than  private, 
initiative  has  not  been  assessed  as  a  preferred  option.  A  vast  majority  of  stakeholders  were 
also  against  this  measure.  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. 

Policy options to ensure right of redress for investors 

Policy Options 

1. No policy change. 

2. Introduce civil liability of CRAs into EU legislation. 

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

To  ensure  the  right  of  redress  for  investors,  the  Impact  Assessment  recommends  option  3 
which would introduce a general obligation to ensure civil liability of CRAs before national 
courts. There is a general view from the stakeholders (with the notable exception of the CRAs 
themselves) that it should be possible to pursue civil action against rating agencies but only 
for gross negligence or intent. 

Policy  options  to  improve  ratings  quality  by  reinforcing  independence  of  CRAs  and 
promoting sound credit rating processes and methodologies 

1. No policy change. 

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

Policy Options 

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  Impact  Assessment  identifies  eight  options  to  reinforce  independence  of  CRAs.  Other 
models  that  could  be  alternatives  to  the  "issuer  pays"  model  are  not  entirely  free  from 
potential  conflicts  of  interest.  In  this  regard,  the  Commission  will  continue  to  monitor  the 
appropriateness  of  credit  rating  agencies'  remuneration  models  and  will  submit  a  report 
thereon  to  the  European  Parliament  and  the  Council  by  7  December  2012,  as  required  by 
Article  39  (1)  of  the  CRA  Regulation.  The  preferred  options  in  the  Impact  Assessment 

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encompass the measures to further mitigate independence risks under the "issuer pays" model. 
Indeed,  many  stakeholders  believed  that  the  risks  under  the  "issuer  pays"  model  are 
manageable.  To  this  end,  the  Impact  Assessment  recommends  mandatory  rotation  of  CRAs 
(option 5), including the requirement to have different CRAs to rate an issuer and its products 
(not applicable in respect to sovereigns), and rules to deal with ownership interests (option 6). 
Moreover,  rules  on  transparency  and  publication  of  ratings  are  assessed  to  be  preferred 
options (options 7 and 8) to further address conflicts of interest and contribute to high quality 
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. 

OVERALL IMPACT OF THE PACKAGE 

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  institutions,  insurance  undertakings,  investment  funds 
and  the  asset  management  sector.  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  help  investors  to  make  their  own  credit  risk 
assessment, rather than leaving them to rely solely on external ratings. 

Furthermore,  the  preferred  options  will  improve  the  transparency  and  quality  of  sovereign 
debt ratings through verification of underlying information with a sovereign. A first measure 
will  require  CRAs  to  verify  the  accuracy  of  information  with  sovereigns  to  ensure  that 
potential  errors  of  sovereign  ratings  are  avoided.  Moreover,  the  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 the closure of European 
trading  venues  aims  at  enabling  all  market  participants  to  have  the  new  rating  information 
before  the  trading  venues  are  opened  and  it  would  thus  contribute  to  limiting  major  market 
disturbances. Additionally, to mitigate the risk of contagion effects of sovereign downgrades 
ESMA, in specific situations determined by the regulation, would be granted the power to ban 
sovereign ratings temporarily. This measure should be temporary, exceptional and subject to 
very strict conditions. 

The preferred policy measures are also expected to improve choice and optimise the structure 
of  the  rating  industry.  Small  and  medium-sized  rating  agencies  would  be  encouraged  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  and  a 
European  Rating  Index  (EURIX).  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 

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familiarity threat to CRA independence resulting from a long business relationship between a 
CRA and an issuer, but would also have a significant positive effect on improving choice in 
the 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.  This  would  also  provide  strong  incentives  for 
CRAs to comply with legal obligations and to ensure high quality ratings. 

Independence of ratings will 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  provide  solicited  ratings  for  an  issuer  and  its  products 
simultaneously.  Furthermore,  independence  will  be  improved  by  enhancing  the  ownership 
structure  of  CRAs.  In  addition,  transparency  and  quality  of  ratings  would  be  improved  by 
strengthening the rules on the 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,  the  quality  of  ratings  would  be  enhanced  by  requiring  CRAs  to  inform  issuers 
sufficiently in advance of the publication of a rating. 

Assessment of Administrative Burden and Compliance Costs 

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 effects linked to sovereign ratings, would also 
lead  to  additional  recurring  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  for  the  rating  industry is  expected  to  be  around  EUR  1.38  million). 
The costs would only relate to promoting the emergence of a network of small and medium-
sized  CRAs  that  could  range  annually  between  EUR  0.9  and  1.95  million,  for  which  the 
Commission would explore possibilities for EU funding. 

The  policy  option  related  to  civil  liability  of  CRAs  towards  investors  is  expected  to  cause 
compliance  costs  due  to  the  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. 

Choice of Legal Instrument 

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

• 

measures requiring amendments to the current CRA Regulation; 

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• 

• 

• 

measures requiring amendments to the current CRA Regulation coupled by technical 
standards to be developed by ESMA; 

measures  requiring  amendments  to  sectoral  legislation  (Directives  on  UCITS  and 
managers of AIFs); 

measures  building  on  an  existing  Union  funding  program  in  order  to  promote  a 
network of small and medium sized CRAs. 

MONITORING AND EVALUATION 

If  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 a range of indicators to feed into a monitoring system 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. 

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