European banks and other financial services companies will be able to use credit ratings issued in the US, Canada, Hong Kong and Singapore for calculating risk-weights and other regulatory purposes, the European Securities and Markets Authority has decided, heading off fears of a market disruption.
Esma, the pan-European Union markets regulator, said on Thursday that it had decided that the regulatory regimes for credit rating agencies in those countries were “as stringent” as the rules in the 27-nation bloc. The authority also reached agreements to work with its overseas counterparts in case problems developed in connection with the ratings.
“This is good news for the industry and alleviates much of the impending market disruption,” said Mark Bearman, a director at the Association for Financial Markets in Europe.
European banking groups had warned that a failure to treat the US regulatory system for ratings as equivalent could have caused a breakdown in the securities markets because so many ratings worldwide come out of the US arms of Standard & Poor’s, Moody’s and Fitch.
If the decision had gone the other way, banks and insurers would have faced an April 30 deadline to stop using ratings to calculate their capital requirements. That, in turn, would have forced already-fragile EU banks to find more equity and cash. Investment managers also rely on the ratings to determine which investments are appropriate for retail funds.
Steven Maijoor, Esma chairman, said: “It was very important to get these countries in. We now have the far majority of the ratings issued outside the EU within our system. It’s a great example of how international co-operation can work.”
Esma began regulating credit rating agencies last autumn, under new directives aimed at making ratings more transparent and reliable. The agencies have repeatedly drawn criticism on the one hand for overstating the safety of complex products and failing to revise ratings downwards in falling markets and on the other for questioning the stability of government debt from EU countries.
The authority was created following the financial crisis and many in Brussels see it as the first step towards a more unified financial regulatory system. Legislation is pending to give Esma the power to regulate trade repositories and it will write the technical standards for a wide-ranging set of securities laws.
The authority has already given the go-ahead to ratings from Japan and Australia and it said it was working toward similar agreements for ratings issued by agencies in Brazil, Argentina and Mexico. Esma was due to issue its first inspection reports on the EU-based agencies in April.
Esma’s decision on how to treat overseas credit rating agencies has been seen as an important first test of the willingness of the EU to recognise the work of its overseas counterparties. A similar question of equivalence is expected to come up for US-based hedge funds and private equity when the new alternative investment fund manager directive takes effect. Critics of the process have feared that both laws would be interpreted in a protectionist way that would exclude US and other “third country” funds.
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