Transparency at the forefront of CRA debate

Panellists at SCI's recent London conference discussed the implications of credit rating agency (CRA) regulation in Europe. While they welcomed the increased competition and transparency brought by CRA 3, some issues remain outstanding.

Andrew Currie, md of structured finance at Fitch, believes that CRA regulation has not been the biggest driver of the way rating agencies are managed. "The financial world has changed dramatically since the crisis and where changes or improvements have needed to be made, we made them quickly and decisively. But rating agency regulation has not been the main driver of those changes."

He continues: "We regularly review our ratings and methodology to ensure they are robust and reflect market dynamics as a natural course of our business, so I do see the regulation as the framework for monitoring the changes that had already been made."

Currie adds that the most effective barometer for rating agencies is their reputation in the investor community. "There is more interest in Fitch's opinion and research now than at any point in the past. Agencies should be judged by the quality of their credit output and not just regulations."

Richard Hopkin, head of fixed Income at AFME, notes that several important issues remained outstanding in the CRA 3 discussions, with one being the controversy surrounding the application of disclosure requirements to private transactions. "If private contracting parties want to make deals between themselves, then there is no reason why they should not, and set their own terms for disclosure," he says. "It is reasonable that commercially sensitive, confidential information - which is often used in private transactions - should not be required by law to be publicly disclosed."

In the public markets, however, he stresses that disclosure and transparency are key. "Standards of disclosure are already very good in securitisation; much better than in many other forms of finance. Despite this, transparency is one of those issues that politicians, in particular, tend to grab onto whenever the subject of securitisation comes up. So it is important for the industry to stay ahead of the game on this."

One approach espoused by the authorities is a platform for new rating agencies to enter the market, thus providing an avenue for shadow ratings to be placed on deals. The European Commission adopted a report in May assessing the feasibility of a network of smaller credit rating agencies in the EU (SCI 6 May).

Currie believes there are both positive and negative implications to this. "Incumbents should welcome attempts to create competition, because a wider set of views adds value to the market. However, shadow ratings can create confusion and problems for investors where there is a lack of consistency in the ratings provided."

Rob Ford, a founding partner at Twenty Four Asset Management, agrees that a wider choice is healthy for the market, but stresses caution against a continuous outpouring of regulatory solutions to CRA issues. He explains: "Continuing to create regulation for regulation's sake is unnecessary. We had simple structures before and that is something we should vie for again."

Ford elaborates: "It's great that newer agencies are coming to the market, particularly given new rules about rating rotation, but actually some of the other new stringent criteria is effectively working against them - such as how some assets are treated within a rated fund. I have a triple-A rated fund and so I should be able to buy bonds rated triple-A by any agency. However, the agency that rates that fund is forced to ignore the ratings of any other agencies on bonds it doesn't rate and initially must assign it a double-C rating."

As a result, Ford admits he would have no choice but to leave the bond out of his portfolio, as it would adversely affect the rating of his fund. "No rated fund investors would touch any bonds not rated by their fund-rater when the shadow ratings place them on such a lower scale," he adds.

In terms of of alternative approaches to tackling CRAs, Ford says that it is market players themselves who continue to keep the current system alive and well, and does not expect this to change soon. He says: "Investors are so tied to CRA restrictions. Their investment criteria is so heavily motivated by and ingrained into them."

Currie concludes: "It seems to me that the current system and its conflicts of interest are manageable. On the other hand, the alternative options would have more conflicts of interest and would be less manageable. Therefore, I wouldn't expect any dramatic change soon."

JA