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Home > Blogs > Anthony Harrington > Ratings agencies under notice from Europe, part 1

Ratings agencies under notice from Europe, part 1

Ratings Agencies | Ratings agencies under notice from Europe, part 1 Anthony Harrington

It has been an interesting week, in the full sense of the Chinese curse, for the big ratings agencies. They have had their cages publicly rattled by two European heavyweights, the President of the European Central Bank, Jean Claude Trichet, and the President of the European Union, José Manuel Durão Barroso.

Part 1 of this blog focuses on Barroso’s attack. Part 2 will consider remarks made by the ECB president. President Barroso made it quite clear on May 5, in a speech to the European Parliament, that he did not think that the ratings agencies were doing a good job. In fact he argued that they were doing very little more than reflecting the momentary mood of the market, no matter how out of key that mood might be. This being so, particularly where sovereign debt was concerned, there was now a real case, he said, for the EU taking the ratings agencies in hand and remaking them so that they—or some replacement—delivered sounder, better-grounded ratings in future.

It is worth giving the text of his speech in some detail here, for he was amazingly plain spoken on this point for a man in his position:

“The crisis has also once again brought the role of credit rating agencies to the fore. These agencies play a pivotal role in the functioning of financial markets. But ratings appear to be too cyclical, too reliant on the general market mood rather than on fundamentals - regardless of whether market mood is too optimistic or too pessimistic. Because credit rating agencies have such a key role and influence over the markets, they also have a special responsibility to ensure their assessments are both sound and comprehensive.

That is why in 2008 the Commission quickly put forward new legislation for these agencies, which will come into force in the next few months.

These rules will ensure that credit rating agencies act more transparently, publish their methodologies, and avoid conflicts of interest. But we need to go further. To strengthen the supervision of these actors of Europe-wide dimension, the Commission believes they should be put under the direct supervision of the future European Securities Markets Authority (ESMA). And that is exactly what we will propose.

We have also launched a reflection on whether further measures may be needed to ensure the appropriate rating of sovereign debt in particular.

We must get our house in order while pushing others to do the same.

The Commission will do whatever necessary to ensure that financial markets are not a playground for speculation.”

This is very strong stuff indeed. In an earlier blog post I pointed out that S&P knocked the markets for six two days on the trot when it downgraded Greece and then Spain. Arguably the train of events that was then set in motion is still trucking—with three dead so far and billions wiped off share prices across the world.

Alternatively, instead of blaming S&P, which is uncomfortably like shooting the messenger, one could argue (and many have, see Ian Fraser’s blog, for example) that there was always a strong possibility that the markets would not be completely comforted by the combined EU and IMF bailout of Greece. Their lack of comfort comes from at least two major sources. First, there is still no certainty that any government, Greek or otherwise, can impose dire austerity on a restive population (even the Chinese government gets twitchy when the people get restless). The rioting in Athens simply underscores this point. Second, the point has been made again and again that there are structural flaws in the European Monetary Union which manifest themselves very visibly in the case of Greece, but are almost as self evident in several other European economies. It will be fascinating to see how Barroso develops this theme in the months to come.

Further reading on ratings agencies and sovereign debt

Tags: Barroso , credit rating agencies , EU , European Central Bank , Greece , IMF , sovereign debt
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