131202 - The European Securities and Markets Authority (ESMA) has published a Report identifying a number of deficiencies in the processes for producing and issuing sovereign ratings at the three largest credit
rating agencies (CRAs), Fitch Ratings, Moody’s Investors Service and Standard & Poor’s.
The Report follows an investigation carried out by ESMA into the sovereign rating processes at the three CRAs, between February
and October 2013. The investigation was prompted by concerns about potential conflicts of interests, the impact of sovereign
ratings on other types of ratings, CRAs’ capacity to cope with the number of rating actions during a period of high
volatility, the use of bulk rating actions, and issues around
the confidentiality and timing of rating actions.
The investigation focused on the governance and organisation
of sovereign rating activities, the adequacy and expertise of allocated human resources, the disclosure of rating information
to the public, and ensuring its confidentiality before disclosure.
ESMA identified deficiencies and issues
for improvement in the following areas:
- Independence and avoidance of conflicts of interests;
- Confidentiality of sovereign
- Timing of publication of rating actions; and
- Resources allocated to sovereign ratings.
ESMA has not determined whether any of the Report’s
findings constitute a breach of the CRA Regulation, and may take action as appropriate in due course.
Maijoor, ESMA Chair, said:
“ESMA’s investigation revealed shortcomings in the sovereign ratings process which could pose risks to the
quality, independence and integrity of the ratings and of the rating process.
“The focus on the sovereign
rating process in this investigation stems from their increased volatility over the past few years, the importance of sovereign
ratings from a credit market and financial stability perspective, and their impact on other rated entities and products.
“The impact which changes in these ratings can have on financial markets, and sovereign states, can
be significant. Therefore, it is imperative that users can have confidence that the CRAs have adequate systems and controls
in place to ensure that ratings are rigorous, free from conflicts of interest and timely.
who were subject to this investigation still need to make improvements in their working practices to ensure their full compliance
with the CRA Regulation and to eradicate inadequate practices from the past.”
The key areas where
ESMA identified deficiencies requiring remedial actions by the CRAs included the following areas and related issues:
1. Independence and avoidance of conflicts of interests:
ESMA has concerns that in a number of areas associated with conflicts of interest and independence, the actual failings
or potential risks identified might compromise the independence of the ratings process and the quality of the credit ratings.
·the type of involvement
of senior management in sovereign rating activities;
·the independent review function’s participation in
the sovereign rating process;
·the research publication activities carried out by CRAs;
by certain non-rating functions (e.g. communication) in the rating process; and
·the implementation of the appeal procedure.
2. Confidentiality of sovereign rating information
The investigation identified deficiencies in the way confidential rating information is managed, in particular how access
to information on upcoming rating actions on sovereigns is controlled. These include:
- the disclosure of upcoming rating
actions to an unauthorised third party;
- inadequate controls in place for the circulation of rating information within the
- the controls around the use of external communication consultants; and
- inappropriate permissions
and controls to secure access to rating information.
3. Timing of publication of rating actions:
The investigation found that there had been instances of significant and frequent delays in the publication of sovereign
ratings. ESMA also observed deficiencies in the advance notification to rated entities about upcoming rating actions.
4. Resources allocated to sovereign ratings:
ESMA has concerns on the resources dedicated to sovereign ratings, in particular:
- the lack of an adequate mechanism
to assess the adequacy of resources;
- assigning lead analyst responsibilities to junior or newly hired staff;
on junior support staff; and
- unclear definitions of functions and responsibilities.
A number of good practices were also identified amongst the surveyed firms including
analytical training programmes, practices designed to improve challenge in rating committees, and to ensure continuity in
the allocation of analysts to sovereign portfolios.
ESMA has required the CRAs to put in place remedial
action plans to address the issues identified, and will monitor their progress against these plans as part of its on-going
1. 2013/1775 Credit Rating Agencies – Sovereign Ratings Investigation.
2. 2013/87 ESMA 2013 CRA Supervision and Policy Work Plan.
3. ESMA is an independent EU Authority that was established on 1 January
2011 and works closely with the other European Supervisory Authorities responsible for banking (EBA), and insurance and occupational
pensions (EIOPA), and the European Systemic Risk Board (ESRB).
ESMA’s mission is to enhance the
protection of investors and promote stable and well-functioning financial markets in the European Union (EU). As an
independent institution, ESMA achieves this aim by building a single rule book for EU financial markets and ensuring its consistent
application across the EU. ESMA contributes to the regulation of financial services firms with a pan-European reach,
either through direct supervision or through the active co-ordination of national supervisory activity.