Regulation Of Credit Rating Agencies Research Articles

Interactions between regulatory realms: new administrative law and credit rating agencies in a globalized society

This article examines European legislation and academic literature concerning the regulation of Credit Rating Agencies (CRAs) during times of crisis, focusing on the perspective of administrative law in global governance. To this end, it proposes a perspective that considers a communicative process to minimise negative consequences for society within the context of CRA regulatory activity. Existing regulations, reports from European, American, and international authorities, as well as relevant literature, are reviewed to understand how regulatory challenges are addressed in the era of globalization.

International credit rating agencies in Africa: perceptions, trends and challenges

This research examines the perceptions, trends and challenges of the influence of international rating agencies on national economic affairs in African states. A descriptive analysis of independent reports published on international sovereign credit ratings and a survey on the financial bodies of the African Union as well as consultations with the three international credit rating agencies show that there is diminishing confidence in operations rating agencies in Africa. However, despite the criticisms of deficiencies in methodologies, operations and regulation of credit rating agencies, results show that they significantly remain as the best available source of credible of risk information for emerging economies to access international capital. It is therefore concluded that the information manufacturing and opinion-leading role of rating agencies remain critical to capital flow and economic development. Thus, the study recommends that African countries implement a multi-stakeholder approach to engagement rating agencies on reviewing the methodologies, indicators and the rating process as traditional methods and indicators are discounting the potential embedded in emerging economies resulting in poor credit ratings.

Information disclosure and the feedback effect in capital markets

Are more informative credit ratings always preferred and how should regulators intervene to promote investment efficiency? To answer these questions, we develop a model in which a manager seeks financing for a project. The main frictions are that the manager is privately informed about the project’s quality and cannot commit not to divert resources away from it. This setting gives rise to a feedback effect in which creditors’ beliefs about whether the manager diverts resources can become self-fulfilling. A critical consequence of this feedback effect is that more precise ratings can be detrimental for investment efficiency. Intuitively, by revealing that a firm is of worse quality and increasing its cost of finance, more informative ratings strengthen the manager’s incentive to withdraw resources away from the project and default. We show that the regulation of credit rating agencies should be lenient during good times and strict during bad times.

Appropriating rhetoric: a beginner’s guide

This paper examines the importance of the speaker – the agent – in the construction of dialogue. Within the rhetoric used by each agent are power constructs which display the speaker’s position in society (role). The rhetoric used by that agent in the process of fulfilling that social role is particular to that setting in spacetime. However, what happens when another agent in a different social position appropriates that rhetoric? The framing of the dialogue changes and the hidden power structures revealed and altered. To what extent does the new agent appropriate the first speaker’s normative authority? What impact does this have on the rhetoric itself ? In this discussion I take a real-life example of the appropriation of rhetoric from the ongoing Eurozone downgrade debates. I use McCloskey’s theory of rhetoric, or ‘sweet talk’, to uncover the normative bias of the discourse, and set the dialogue within Giddens’ structuration framework to highlight the importance oflanguage, locale and the agent. The analysis highlights power differentials that are indicative of conflicts of interest in the regulation of credit-rating agencies and the debate asks what this means for future action.

International Credit Rating Agencies in Africa: Perceptions, Trends and Challenges

This research examines the perceptions, trends and challenges of the influence of international rating agencies on national economic affairs in African states. A descriptive analysis of independent reports published on international sovereign credit ratings and a survey on the financial bodies of the African Union as well as consultations with the three international credit rating agencies show that there is diminishing confidence in operations rating agencies in Africa. However, despite the criticisms of deficiencies in methodologies, operations and regulation of credit rating agencies, results show that they significantly remain as the best available source of credible of risk information for emerging economies to access international capital. It is therefore concluded that the information manufacturing and opinion-leading role of rating agencies remain critical to capital flow and economic development. Thus, the study recommends that African countries implement a multi-stakeholder approach to engagement rating agencies on reviewing the methodologies, indicators and the rating process as traditional methods and indicators are discounting the potential embedded in emerging economies resulting in poor credit ratings.

Regulation of Credit Rating Agencies - Different Views and Solutions

Credit rating agencies are an important element of the informational financial infrastructure, which is essential for the stability of the financial system. In the absence of conflicts of interest and the importance of the established reputation for the rating agencies, self-regulation is sufficient to guarantee high-accuracy ratings. The payment for ratings by issuers and their use in financial regulations create distorted incentives to pursue higher profits at the expense of the quality of ratings. The demonstrated failures of the rating agencies confirm the need for strict regulations to restore investor confidence in the ratings.

Role and Regulation of Credit Rating Agencies: The European Way

Credit Rating Agencies (CRAs) play a key role in the financial markets: credit rating provides useful information to investors, and it is also widely used for regulatory purposes. Nevertheless, after the subprime meltdown, CRAs have been strongly criticized for worsening the crisis by overrating structured products. Consequently, regulators are reforming the rating industry, worldwide. Therefore, this article investigates the changes regarding the role and regulation of CRAs, focusing on the European Union. To achieve this investigation, the study explores existing literature and examines the European reforms. The research contributes to the ongoing debate on the innovation in financial regulation, by highlighting the key-characteristics of the European approach to CRAs’ regulation and supervision. The results note distinct phases of regulation and highlight that certain gray areas relating to business model, overreliance and civil liability should not be ignored.

The Impact of Credit Ratings on Capital Markets

We develop a model of investment financing which is characterized by the interplay of information asymmetry regarding the project's productivity and lack of commitment about the allocation of productive resources. This environment gives rise to a feedback effect between managerial actions and the creditors' beliefs about them. We find that informative credit ratings alleviate the information asymmetry between the manager of a rm and its creditors, but strengthen (on average) the incentive to withdraw productive resources from the project, and subsequently default. We characterize the conditions under which informative credit ratings worsen financing opportunities and lead to a higher expected probability of default and cost of capital. Finally, we study the implications for the regulation of credit rating agencies.

Credit Rating Agency Regulation in the UK If and When Article 50 is Invoked: Round Holes for a Square Peg?

The decision taken by British voters to leave the European Union has created uncertainty in all walks of life, ranging from everyday concerns to professional anxiety. In this article, the focus is on the UK’s regulation of the Credit Rating Industry after the invocation of Article 50. The aim of the article is to examine some potential options available to policymakers and legislators in terms of their validity for taking on such an important task. Whilst it is not guaranteed that the UK will take sole responsibility for the regulation of credit rating agencies in its jurisdiction, it is a possibility. Therefore, assessing the credentials of the relevant agencies is a worthwhile endeavour. Yet, each option comes with its own set of issues, as will be discussed, so the article concludes by offering an option that may negate such issues whilst continuing to regulate the credit rating agencies efficiently and effectively.

Do credit ratings affect spread and return? A study of structured finance products

AbstractAlthough the previous studies investigating the relationship between credit ratings and spread or return in the financial market are normally restricted to noncausal measures, this paper uses structural equation modelling to test the possibility of causal links from ratings to spread and return in the context of structured finance products. Our analyses are split into 2 stages: First, we search for causality between ratings and spread at the issuance stage (primary market) based on a sample comprising all tranches of asset‐backed securities issued in the United States by American and foreign institutions from December 1999 to December 2015. Then, we consider all ABS rating changes from February 2001 to December 2015 to check whether the assumption of causal connection between ratings and return at the trading stage (secondary market) is reasonable. After testing all pertinent combinations among the variables in our database, we find evidence of causality at the issuance stage but very little support to causality at the trading stage. This study contributes to the debate on the regulation of credit rating agencies as our findings suggest that ratings may have an effective influence on decisions made by investors at the time structure finance products are issued. As this effect is very weak when those assets are traded in the secondary market, in principle, regulators should focus their attention on the credit rating agencies' activities regarding the issuance of new structured products.

The regulation of credit rating agencies: A realistic view

There is a widespread agreement on the proposition that the performance of the credit rating agencies has not been that great and that their ratings and downgrades played pivotal roles in the global financial crisis and the European sovereign debt crisis. Yet most of the regulatory proposals to deal with them are no more than tweaks around the edges because of the belief that it is difficult to disentangle the regulatory process from the views of the rating agencies in a framework that was put in place in the 1930s. In this paper it is argued that taking the rating agencies out of the regulatory framework is not as problematic as it is portrayed to be and that the task should not carried out without other fundamental regulatory changes.

Efficient, commonsense actions to foster accurate credit ratings

In July 2008, the US Securities and Exchange Commission (SEC or Commission) identified flaws in credit rating agencies’ (CRAs) models and practices that had produced inaccurate structured finance (SF) ratings. 1 Afterwards, the SEC and the Permanent Subcommittee on Investigations (PSI) of the US Senate released, respectively, a report and a memorandum that helped illuminate how and why CRAs had failed in their roles as debt-market gatekeepers. 2 These documents provided the basis for Title IX, Subtitle C (‘Improvements to the Regulation of Credit Rating Agencies’) of the Dodd–Frank Act of July 2010. Nevertheless, 4 years later, 11 US senators wrote to SEC Chair Mary Jo White bemoaning the fact that the Commission had not yet put into place ‘critical investor and systemic risk protections related to securitization and structured finance markets’ as set out in the Dodd–Frank Act. 3 The senators’ letter—which openly questioned the SEC’s willingness to regulate CRAs—spurred this article. 4 After examining the factors that induce CRAs to underestimate credit risk, we analyse measures to date that ostensibly address this shortcoming and propose more effective alternatives for fostering rating accuracy. 5

Eurozone Debt Crisis and Regulation of Credit Rating Agencies

The credit rating agencies (CRAs) have received a great deal of media, political, and regulatory attention since the early summer of 2007. With 2008 financial crisis, there was a common argument that CRAs had not been held accountable for the poor performance that resulted in flawed outcomes. Literature review on CRAs' role in the Europe sovereign debt further strengthened this argument. Through an in-depth study of extensive literature available, we focus on how the rating announcements affected the markets. We also highlight the EU regulations that came into force after a series of downgrades in the Eurozone.

IOSCO and the Spreading of a US-Like Regulatory Philosophy around the World

The objective of this article is to describe the International Organization of Securities Commissions - IOSCO, its internal procedures, normative product and implementation process, and to test the role played by the US Securities and Exchange Commission - SEC since the Organization's birth. The pervasiveness of the US Securities Laws will be tested both on the most important document IOSCO has ever adopted, the Objectives and Principles of Securities Regulation, representing the regulatory philosophy of the Organization; and, as a more detailed case study, on the documents concerning the regulation of Credit Rating Agencies, a very hot topics for international finance. Moreover, it will be analyzed the position of the US in the crossborder enforcement cooperation process established under the auspices of IOSCO in the last twenty years and how this has recently changed. The results seem to suggest that IOSCO's has been deeply affected by the US Securities Laws even if, more recently, the emerging of new important markets is progressively turning the Organization into a multipolar forum where the US is no longer the only "regulatory" superpower.

Regulating Credit Rating Agencies in the EU: In Search of a Coherent Regulatory Regime

This paper argues that the EU Regulation of credit rating agencies is concurrently pursuing two objectives that conflict with and would undermine each other. One is the objective of enhancing rating accuracy, and the other is the objective of restoring market discipline in the wholesale investment markets for credit ratings as information goods. The Regulation places more emphasis on regulating for rating accuracy which has the effect of instituting a form of product regulation for credit ratings, raising the public interest profile of credit ratings. This paper argues that this is undesirable and is contrary to policy-makers' endeavours to enhance market discipline for rating quality and the private accountability of credit rating agencies. EU policy-makers would eventually need to confront the underlying conflicting objectives in the Regulation so that a normatively coherent and consistent regulatory regime can be designed and implemented.

Regulatory Governance of Credit Rating Agencies in the EU: The Perils of Pursuing the Holy Grail of Rating Accuracy

This paper argues that the EU Regulation of credit rating agencies is concurrently pursuing two objectives that conflict with and would undermine each other. One is the objective of enhancing rating accuracy, and the other is the objective of restoring market discipline in the wholesale investment markets for credit ratings as information goods. The Regulation places more emphasis on regulating for rating accuracy which has the effect of instituting a form of product regulation for credit ratings, raising the public interest profile of credit ratings. This paper argues that this is undesirable and is contrary to policy-makers’ endeavours to enhance market discipline for rating quality and the private accountability of credit rating agencies. EU policy-makers would eventually need to confront the underlying conflicting objectives in the Regulation so that a normatively coherent and consistent regulatory regime can be designed and implemented.

Civil Liability of Credit Rating Agencies – Regulatory All-or-Nothing Approaches between Immunity and Over-Deterrence

Civil liability of rating agencies has to strike a balance between over-deterrence and overly lax behavior control. The resulting problems of a capital market freeze and difficulties of proof, as they become apparent in most legal systems and the European Commission’s Draft Proposal to amend the EU-Rating Regulation, could possibly be eliminated by procedural presumptions or liability caps. The paper was prepared for the Seminar on the regulation of Credit Rating Agencies in Oslo 10 December 2012, organized by The International Financial Market Regulation, Institutions and Efficiency Projects at the Department of Private Law and supported by the Finance Market Fund. The paper is accepted for publication in European Business Law Review, and will be published in a special issue edited by Mads Andenas and Gudula Deipenbrock.

Credit rating agencies: are they credible?

This paper examines the ongoing reputational crisis of credit rating agencies (CRAs) and asks if the CRAs are playing a credible role in financial markets. The current crisis supports the proposition of scepticism on the credibility of CRAs which did not properly disclose risk and thus contributed to pushing the global financial system to the verge of collapse. There may be a need to restrict the role of CRAs in rating sovereign debt and for increased regulation of CRAs. Credit rating agencies need to be held accountable for their ratings and provide transparency for their methodology. There needs to be more competition for Standard & Poor’s, Moody’s and Fitch which form an oligopolistic market structure.

Taming the Beast? New European Regulation for Credit Rating Agencies

This paper discusses the proposal of the European Commission for further regulation of Credit Rating Agencies (CRAs), focusing on what the proposal will imply for: (1) the large concentration in the market for credit ratings, (2) the overreliance of investors and regulators on credit ratings, (3) the conflicts of interest that arise due to the business model of CRAs, (4) the lack of transparency and liability, and (5) the role of CRAs in rating sovereign debt. It is concluded that the political agreement on this proposal as a result of the trilogue between the European Parliament (EP), the Council of the European Union and the European Commission can hardly be considered breaking ground on any of the major issues identified in this contribution.

The Financial Crisis and the Response of the United States: Will Dodd Frank Protect Us from the Next Crisis?

In July of 2010 Congress enacted the Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd Frank Act”). The Dodd Frank Act is the primary legislative response in the United States to the financial crisis of 2007-09. It makes wide-ranging and significant changes to a number of aspects of financial services regulation. This article examines the eight most significant initiatives undertaken in the Dodd Frank Act; initiatives which are intended to avoid the next financial crisis, to give regulators the tools to deal with a future crisis when it occurs and to substantially increase the levels of protection provided to U.S. consumers of financial services. The Act creates a new Financial Stability Oversight Council with the broad responsibility to anticipate and to take measures to avoid the next financial crisis. It gives to the Federal Deposit Insurance Corporation the authority to liquidate very large financial services companies in an orderly manner in the event they fail. It creates a new National Insurance Office in the Department of the Treasury to provide limited oversight of our state-regulated insurance industry and, more importantly, to collect information on the risk to the U.S. financial system generated by the failure of the largest insurance companies. It provides for more intensive and effective regulation of credit rating agencies, overseen by a new Office of Credit Ratings at the Securities and Exchange Commission. It imposes registration requirements on hedge fund advisers and provides a process for collecting information on the risks posed to the U.S. financial system by the investment activities of hedge funds. It mandates significant new regulation at the Commodities Futures Trading Commission and the Securities and Exchange Commission over the trading of derivatives, requiring exchange-based trading for some classes of derivatives and for transparency in the trading of customized derivatives not suitable for exchanges. It requires a variety of corporate governance reforms for publicly traded companies, including a “say on pay” (a shareholders’ advisory vote on executive compensation plans), increased disclosures to shareholders, independent board compensation committees and consultants, and board risk committees for large financial services companies. Finally, it creates a major new agency, the Bureau of Consumer Financial Protection, located in the Federal Reserve System with significant powers to protect consumers in their purchases of a broad range of financial products. Each of these eight initiatives undertaken in Dodd Frank is complex and dependent to a significant degree on the promulgation of regulations for its implementation. It remains to be seen if these regulations will reflect the spirit of Dodd Frank’s ambitious and serious approach to avoiding or, at least, to providing the tools to survive the next financial crisis. This article offers a summary and some comments on the Dodd Frank initiatives outlined above. The ultimate effect of the Dodd Frank Act will depend to a large extent upon how it is implemented by U.S. financial regulators.