REPORT FROM THE COMMISSION TO THE COUNCIL AND THE EUROPEAN PARLIAMENT on the feasibility of a network of smaller credit rating agencies
Date: 2014-05-05
Institutions: European Commission
Subjects: claim, financial analysis, financial legislation, financial solvency, public debt













EUR-Lex - 52014DC0248 - EN











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52014DC0248

REPORT FROM THE COMMISSION TO THE COUNCIL AND THE EUROPEAN PARLIAMENT on the feasibility of a network of smaller credit rating agencies /* COM/2014/0248 final */









REPORT FROM THE COMMISSION TO THE
COUNCIL AND THE EUROPEAN PARLIAMENT
on the feasibility of a network of smaller
credit rating agencies
1.    Introduction
Credit
Rating Agencies (CRAs) play an important role in today’s capital markets in
terms of access to capital and long term financing of the world’s economy.
Since a credit rating reflects the rating agency’s opinion, as of a specific
date, of the creditworthiness of a particular state, company, security, or
obligation, it represents an important input to investors and other market
participants influencing their strategic decision-making. The role CRAs played
in the recent financial crisis illustrates their importance for the globalised
financial markets, with credit ratings affecting securities markets in many
ways, including an issuer’s access to capital, the structure of transactions
and the ability of fiduciaries and others to make particular investments. This
is even more important for long term investments, where CRAs have an impact on
the way savings are channelled to long-term investment needs[1].
A
number of distinctly smaller CRAs have emerged in Europe (their number has
further increased after the introduction of European legislation on CRAs in
2009[2]),
operating with a clear focus on specific industry sectors (e.g. the insurance
industry), financial market segments (e.g. municipal bonds) or specific
geographical area, thus responding to specialised market needs. 
The
established regulatory framework of the Regulation on credit rating agencies in
the EU requires them to be registered, authorised and supervised by the
European Securities and Markets Authority (ESMA). The legislation also subjects
them to stringent independence rules as a pre-condition for the provision of
rating services. Compliance with this regulatory regime has played a role of
quality assurance for their services on the market and has, in this way, helped
them to evolve over time as serious market actors. Nevertheless, despite their
good potential to grow, to date these new market players often remain small in
terms of scope and geographical orientation.  
1.1.
Objective of the report
Improving
the conditions for effective competition on the concentrated market for credit
rating agencies and thereby creating the pre-conditions for the emergence and
growth of new market players is a key objective of the policy work of the
European Commission in this area.  
This
objective is also well enshrined into the efforts made at international level
(G20, Financial Stability Board (FSB) and the International Organisation of
Securities Commissions (IOSCO)) to enhance transparency and strengthen the
competition in the credit rating agencies’ market[3]. 
With
the aim to further increase competition, the European Commission envisaged
additional measures in its proposal for a third CRA Regulation, which has
recently been adopted and entered into force,[4]
hereafter referred to as the CRA III Regulation. Pursuant to Article 39b(3) of
the CRA Regulation, “the Commission shall, by 31 December 2013, submit a report
to the European Parliament and to the Council regarding the feasibility of a
network of smaller credit rating agencies in order to increase competition in
the market. That report shall evaluate financial and non- financial support for
the creation of such a network, taking into consideration the potential
conflicts of interest arising from such public funding. In light of the
findings of that report and following ESMA’s technical advice, the Commission
may re-evaluate and suggest amending Article 8d[5]"
of the CRA III Regulation.[6]
The
overall objective of an establishment of such a network aims at strengthening
the smaller CRAs and thereby facilitating their growth to become more competitive
market players. 
Section 2 of the report identifies and analyses
the feasibility of all possible policy options, through which such network
could be established in order to fulfil the above stipulated objective. The
analysis covers operational and financial aspects of such establishment. 
Section 3 draws
some conclusions based on the findings in section 2 and proposes short as well
as medium/ long term steps to achieve the overall objective. 
1.2.
Stakeholder Consultation 
In
the process of analysing the feasibility of a network of smaller credit rating
agencies the Commission established a comprehensive stakeholder consultation
process in order to analyse the concerns of smaller CRAs.
A
first meeting on this subject took place in January 2013 with the members of
the European Association of Credit Rating Agencies (EACRA), an association of
smaller credit rating agencies, to better understand the willingness among
stakeholders to establish a network of smaller credit rating agencies. The
issue of the creation of a network of smaller credit rating agencies was also
discussed at meetings with individual representatives of smaller CRAs.  
Furthermore,
on 2 July 2013 the Commission organised a Roundtable with smaller CRAs in order
to obtain detailed views on the feasibility of a network of smaller CRAs. The
Roundtable was attended by representatives from 13 CRAs, EACRA, a
representative from the ESMA and the European Economic and Social Committee[7]. The
Roundtable allowed for a fruitful discussion with participants on market
developments and trends for smaller CRAs relevant for the purpose of the
Commission report. Useful feedback was also provided to the Commission through
written contributions before and after the Roundtable. 
In
addition, the Commission requested and received technical advice on the report
from ESMA, which offered valuable input for the establishment of this report[8]. 
1.3. Definition of
smaller CRAs for the purpose of this report
In
accordance with the CRA Regulation, this report assesses the feasibility of a
network of "smaller credit rating agencies".
The
CRA Regulation contains a number of thresholds regarding turnover, number of
employees and market share in provisions which aim to increase competition on
the market for smaller CRAs (described in further detail below). However, the
Regulation does not contain a definition of "smaller credit rating
agencies" as such. 
For
the purpose of this Report, based on the analysis of the market provided by
ESMA in its technical advice, 19 out of 22 registered CRAs and the 2 certified
CRAs (see Annex for the full list of registered and certified CRAs) are
considered "smaller credit rating agencies". This assessment takes
into account the large divergence between the "larger" and
"smaller" CRAs with regard to the following factors: number of
employees, scope of operations (as regards the types of ratings issued), group
structure and financial turnover. 
2.    Feasibility
of a network of smaller CRAs
The
Impact Assessment accompanying the CRA III Regulation made an initial analysis
on the potential impact of the creation of a network of smaller CRAs on
competition in the CRA market. It concluded, based on a stakeholder
consultation, that there is some support for the creation of such a network.
Building on this work within the preparation of this Report, the European
Commission has further assessed the added value of the creation of a network as
well as the different possible options of the type of network which would best
serve its purposes and be feasible to implement. 
Taking
the above into consideration, two types of networks have been envisaged,
depending on the scope and nature of the proposed cooperation. The pros and
cons of each option are presented below together with reflections on the
logistical side of its implementation. 
2.1. An integrated network 
An
integrated network would have a wider scope and deeper level of cooperation. The
Commission has assessed, with contributions from representatives of smaller
CRAs, a number of possible areas which could be covered.  
As
a result, the following issues have been identified by this assessment as areas
where an integrated network could potentially have an added value: the
development of a common data platform for underlying information used for
developing ratings, design and use of common methodologies, sharing of expert
knowledge and best practices on a wide range of topics such as internal
controls, investor education, communication, methodologies and legal
compliance. 
However, the feedback received from
smaller CRAs has been mixed with regard to the creation of such a network. At
the Roundtable organised by the Commission, only a minority of participants
were in favour of an integrated network, as described above an initially been put
forward by the Commission for discussion. 
The analysis of the option of an
integrated network showed as well that there are number of obstacles for smaller
CRAs to create a network with deepened cooperation. First of all, they often
have very distinct business models and objectives, which makes it difficult to
integrate such a large number of players under one umbrella. Furthermore, they
operate in distinct market niches and apply distinct methodologies and
strategies in terms of geographical scope. This would make it difficult to
create a network that fits their needs. Smaller CRAs which operate in a
competitive environment consider it also difficult to participate in a network
with competitors having the same geographical and/or niche market focus.
Therefore, it was pointed out by stakeholders that networks (including networks
composed of a limited number of smaller CRAs) would emerge from market forces
rather than be formally established by the European Commission.
In
addition, the establishment of such an integrated network at this stage could
be considered a big investment with no clearly visible returns. A clear and
viable business case for networks of CRAs to perform as separate entities on
the market is absent at this stage. The introduction of a special regime for
networks, allowing the participants in them to be registered with ESMA as CRAs
under a new network brand name, while maintaining their individual brand names,
could facilitate the process. The current regulatory
regime allows for networks to be established but only under the same brand
name. Such a special regime could facilitate the establishment of ad hoc
networks by several CRAs pooling resources to issue ratings in specific rating
class or geographical area.
Finally,
there is a risk that any such integrated network could lead to increased
anti-competitive behaviour. This would be contrary to the European Union's objectives
to enhance diversity in the rating industry. Moreover, EU competition law would
under all circumstances need to be respected. The scope and type of information
exchange would need to fully respect Article 101 of the Treaty on the
Functioning of the European Union (TFEU)[9].
Concerning
the establishment of such a fully integrated network of smaller CRAs, this
would require extensive financing and corresponding project follow-up by the
European Commission to get the project "up and running". Depending of
the scope of the network the financing, based on the participation of 15 CRAs,
were estimated in the range of EUR 900.000-1.950.000 annually[10]. 
If
it were to be decided to pursue such an initiative, it could potentially fit
within one of the two programmes which are part of the multiannual financial framework
of 2014-2020. More specifically, the programmes "Horizon 2020"- or “COSME"-
could cover a possible initiative. A pre-condition for successful project
funding would be strong ownership from industry stakeholders to assist in
drafting the project request to be submitted to one of these EU programmes,
wherein the scope and design of the project must be clearly outlined. Granting
of such financing is conditional on the positive assessment by the respective
Commission Service of the project application, in line with the legal
requirements for such applications. Such an EU-funded project would equally
require extensive follow up from the European Commission with respect to the
submission of the funding application and consequent implementation of the
project. In addition, the Commission was also required to evaluate in this
report the potential conflict of interest arising from a financial and
non-financial support for each policy option. However, as far as this
particular option is concerned the analysis did not cover such assessment
taking into account that the option was rejected because of the several major
obstacles identified together with competition concerns regarding the type of
information, which could be potentially exchanged. Such analysis is made only
for the preferred policy option. 
2.2. A cooperative network 
The
creation of a cooperation network was assessed as an alternative to the integrated
network approach described above. This would entail a lighter form of
cooperation. . It could take the form of a forum for smaller CRAs, which would enable
the establishment of a structure for regular exchange and cooperation among
smaller CRAs. 
The
analysis aimed at showing to what extend this forum could be a platform to advance
issues of interest to smaller CRAs as well as exchange of information and best
practices, specifically on the potential difficulties in implementation of the
CRA III Regulation and on strategic issues of common importance. An assessment
was made as well as regards the potential of such a forum to contribute to the
reduction of barriers to entry and enhanced growth for smaller CRAs as
presented in Section 3 by contributing to the assessment of the impact of the
CRA III measures and potentially identify additional means/ tools to implement
in this area. It was also considered whether a cooperation network could be
useful in order to find further ways to facilitate the disclosure of
information by issuers to CRAs with a view of facilitating issuance of
unsolicited credit ratings for corporate issuers, including smaller issuers. The
work of the network could also cover discussions around lifting barriers to
cross-border growth for smaller CRAs as regards non-EU countries. 
The
Commission could participate in the work of the network for example by setting
the agenda and chairing the meetings. In this
way the cooperation network could also function as a regulatory dialogue
between smaller CRAs and the European Commission. This dialogue would provide
the Commission with feedback on potential problems smaller CRAs are facing and
be instrumental to the further Commission Reports to be presented as a
follow-up of the CRA III Regulation. Specifically, the CRA III Regulation
requires the Commission to assess the requirement to use a small CRA when
employing more than one CRA on a “comply or explain basis”, the extension of
the rotation rule to other instruments and need for additional initiatives to
promote competition in the rating market.[11]
Reflecting
on how to progressively deepen or widen the scope and nature of cooperation was
also considered in the context of the work of a potential network. This would
allow the network to evolve over time, as needed.. In this respect, the network
could aim at identifying the potential obstacles for developing further
cooperation among smaller CRAs and make proposals to address these obstacles. However,
as mentioned above, EU competition law would have to be fully respected at all
times.
From
the feedback of discussions with smaller CRAs, although they did not seem fully
against a cooperative network they have indicated that they are mainly
interested in an ongoing regulatory dialogue with the Commission to discuss
proportionate regulation which takes into account the specificities of smaller
CRAs. 
With
regard to the format of meetings, the network could work in a plenary format,
while working groups could be established to focus on individual topics and which
subsequently report to the plenary. 
The
financial support needed to set up the cooperation network would be limited to
the organisation of meetings. The Commission could ensure the organisational
and logistical support of the forum. 
3.
Conclusions and next steps
The
analysis of the feasibility of the options for the creation of a network of
smaller CRAs has identified multiple market obstacles for the establishment of
an integrated network as well as some obstacles limiting the potential scope of
a cooperation network. In addition, the stakeholder consultation has revealed
that there is no support and ownership among industry representatives to
establish, under the current conditions, any form of network of smaller CRAs.
Smaller CRAs have rather expressed the need for a structured dialogue or forum
with the European Commission to discuss the state of the CRA market and
regulation, in particular, issues affecting smaller CRAs. Therefore although
the establishment of a cooperation network with limited exchange of information
could be feasible, it seems not to fully correspond to the identified needs of
smaller CRAs. 
Furthermore,
as also presented in the Report, a set of measures has already been introduced
with the entry into force of the CRA III Regulation which aims at boosting
competitiveness and supporting the growth of smaller CRAs on the rating market.
However, a number of these measures require further delegated and implementing legislation
to be drafted by the European Supervisory Authorities and adopted by the Commission.
This process is currently ongoing. At the same time, for those measures which
have become applicable as of the date of entry into force of the CRA Regulation
on 20 June 2013, the time period since then is not sufficiently long to allow
an assessment of the effect of these measures on competition.
Such
an assessment of the impact of these measures should be carried out before the
establishment of any form of cooperation of smaller CRAs could be properly
assessed and respective policy option proposed. Once the impact of these
measures and thus the outstanding needs of smaller CRAs can be analysed, this
will, in turn, allow for considering if a network is still a viable option and
in a positive case scenario will help to determine its scope and type, taking
into account competition law considerations. At the same time, the setup of a regulatory
dialogue with the industry can contribute and facilitate this process.  
Taking
this into account, this Report proposes a step by step assessment of the need
to establish a network within the medium/long term. 
3.1
Short term policy options
The
Commission proposes as an alternative to creating a network, the establishment
of a regulatory dialogue as the most proportionate solution within the short
term. The analysis of the market and stakeholder's views have shown that there
is an identified need among smaller CRAs at this stage for the creation of such
form of exchange on the state of the CRA market and in particular issues that
affect smaller market players. This
dialogue could consist of a periodic follow up of market developments in the
rating industry and allow discussing on regulatory issues relating to the CRA
regulation. 
Such
regulatory dialogue could take the form of one or more events per year, where
stakeholders will have the opportunity to express their views of the state of
the market and discuss with the European Commission regulatory issues of
particular interest for smaller CRAs in a similar way as described under the
option of cooperation network. 
3.2
Medium/ long term policy options
Reflecting
on the results of the work of the regulatory dialogue and the assessment of the
effect of the measures adopted under the CRA III Regulation, the Commission Services
will at a later stage assess the added value of a network of smaller CRAs and
if considered feasible define the measures to take in order to create the
regulatory framework for networks to function effectively. 
[1] See also Green Paper Long-term financing of the European Economy,
COM(2013) 150 final,
http://ec.europa.eu/internal_market/finances/financing-growth/long-term/index_en.htm
[2] Regulation (EC) No 1060/2009 of the European Parliament and of the
Council of 16 September 2009 on credit rating agencies, OJ L 302, 17.11.2009,
p.1, hereafter: CRA Regulation
[3] Following the G20 communiqué resulting from its 4-5 November 2012
meeting encouraging IOSCO to work further "to enhance transparency of and
competition among credit rating agencies", IOSCO reported to the G20 on
"Transparency and Competition among Credit Rating Agencies" in April
2013 as well as its ongoing work (available at: http://www.iosco.org/library/briefing_notes/pdf/IOSCOBN01-13.pdf).
In addition, IOSCO launched the revision of the Code of Conduct Fundamentals
for Credit Rating Agencies of December 2004 (available at: http://www.iosco.org/library/pubdocs/pdf/IOSCOPD180.pdf)
foreseen to be concluded by the summer of 2014, in order to reflect on those
issues. In August 2013, the FSB submitted to the G20 a Progress Report on its
work with regard to Credit Rating Agencies, also covering the work done by
IOSCO in this area.
[4] Regulation (EU) No 462/2013 of the European Parliament and of the
Council of 21 May 2013 amending Regulation (EC) No 1060/2009 on credit rating
agencies, OJ L 146, 31.5.2013, p.1
[5] Article 8d CRA
Regulation on the use of multiple CRAs provides that:
"1. Where an issuer or a related third party
intends to appoint at least two credit rating agencies for the credit rating of
the same issuance or entity, the issuer or a related third party shall consider
appointing at least one credit rating agency with no more than 10 % of the
total market share, which can be evaluated by the issuer or a related third
party as capable of rating the relevant issuance or entity, provided that,
based on ESMA’s list referred to in paragraph 2, there is a credit rating
agency available for rating the specific issuance or entity. Where the issuer
or a related third party does not appoint at least one credit rating agency
with no more than 10 % of the total market share, this shall be documented.
2. With a view to facilitating the evaluation by the
issuer or a related third party under paragraph 1, ESMA shall annually publish
on its website a list of registered credit rating agencies, indicating their
total market share and the types of credit ratings issued, which can be used by
the issuer as a starting point for its evaluation.
3. For the purposes of this Article, total market
share shall be measured with reference to annual turnover generated from credit
rating activities and ancillary services, at group level."
[6] Article 39b(3) CRA Regulation
[7] See minutes from the roundtable at: http://ec.europa.eu/internal_market/rating-agencies/docs/130702_minutes_en.pdf
[8] ESMA, "Technical Advice on the feasibility of a network of
small and medium-sized CRAs", 21 November 2013, available at: http://www.esma.europa.eu/system/files/2013-1703_technical_advice_on_the_feasibility_of_a_network_of_small_and_medium-sized_cras_0.pdf

[9] See
also Guidelines on the applicability of Article 101 of the Treaty on the
Functioning of the European Union to horizontal cooperation agreements, OJ C
11, 14.01.2011, pages 1-72, from paragraph 55. 
[10] Impact Assessment
accompanying the CRA III legislative proposal, Annex X, p. 161
[11] Article 39(4) and (5)