EU Authority Leading Investigation Into Ratings Agencies

The Cheat Sheet

The European Securities and Markets Authority is leading an investigation into how rating agencies rank sovereign bonds and other debt, and could impose heavy sanctions if the probe uncovers any wrongdoing by the highly influential institutions.

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Officials from the authority have been visiting offices of the big three agencies — Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings — as well as their smaller rivals, since the start of last month, and will continue to do so throughout December.

The investigation takes on added significance in light of Standard & Poor’s decision to put 15 euro nations on downgrade watch yesterday, an unprecedented move that rattled markets ahead of a key summit later this week.

Some euro-zone officials say the rating agencies have worsened the crisis. Among them is European Central Bank governing council member Christian Noyer, who said the S&P’s methodology had become more political and less connected to economic fundamentals.

The ESMA will publish a report on the outcome of their first on-site inspections of rating agencies, which should come no later than April.

“Our inspectors are examining how the rating agencies conduct their business and arrive at ratings. If we were to find wrongdoing, ESMA has the power to fine agencies, suspend their ratings and we could even withdraw their license,” an ESMA spokesman said on Tuesday.

The Paris-based watchdog was set up only this year to be the chief European supervisor for ratings agencies, and its audit marks the first for the industry, which has until now gone unchallenged.

To carry out their investigation, regulators can ask ratings agencies for documentation outlining how they arrived at their decision to downgrade a country. Though ESMA cannot question specific decisions like a credit downgrade, it can penalize a ratings agency if it were to find flaws in the way it works.

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“They have to prove they have a sound rating procedure such as avoiding conflicts of interest, as well as having proper internal rules,” the ESMA spokesman said. “We are not watching every single rating decision. ESMA’s job is to ensure raters comply with the rules.”

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