FR04/11 Regulatory Implementation of the Statement of Principles Regarding the Activities of Credit Rating Agencies

Regulatory Implementation of the Statement of Principles Regarding the Activities of Credit Rating Agencies Final Report TECHNICAL COMMITTEE OF THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS FR04/11 FEBRUARY 2011 2 Contents Chapter Page 1 Executive Summary 3 2 Background 6 3 Scope and Purpose of Report 11 4 Components of CRA Regulatory Programs 13 5 The Various Ways CRA Regulatory Programs Promote the Objectives of the IOSCO CRA Principles 19 6 Conclusion 38 3 Chapter 1 Executive Summary This Final Report of the Technical Committee (TC) of the International Organization of Securities Commissions (IOSCO) addresses several of the recent regulatory initiatives that impact or will shortly impact credit rating agencies (CRAs) that are active in multiple jurisdictions. In particular, the paper reviewed CRA supervisory initiatives in Australia, the European Union (EU), Japan, Mexico, and the United States (US) in order to evaluate whether, and if so how, these regulatory programs implemented the four principles set forth in the 2003 IOSCO paper Statement of Principles Regarding the Activities of Credit Rating Agencies (IOSCO CRA Principles)1. The four principles address: 1) quality and integrity in the rating process; 2) independence and conflicts of interest; 3) transparency and timeliness of ratings disclosure; and 4) confidential information. The Technical Committee Standing Committee on Credit Rating Agencies (TCSC6) undertook the evaluation work that underlies this paper. TCSC6 is a newly formed permanent standing committee of the TC that is continuing the work of the Task Force on Credit Rating Agencies created by the TC in 2003 (CRA Task Force). TCSC6‘s evaluation reveals that although the structure and specific provisions of CRA regulatory programs may differ, the objectives of the four IOSCO CRA Principles are embedded into each of the programs. Indeed, the principles appear to be the building blocks upon which CRA regulatory programs have been constructed, as illustrated in the following examples. The first principle – quality and integrity in the rating process – is given effect in the regulatory programs through, for example, explicit requirements on CRAs to adopt, implement and enforce measures to ensure that credit ratings are based on a thorough analysis of all available and relevant information and that the information they use in developing credit ratings is of sufficient quality and from reliable sources. The regulatory programs reviewed also give effect to the first principle through provisions that implicitly mandate measures designed to promote quality ratings by providing authority to the supervisor to deny or revoke the registration of, or to impose remedial measures on, a CRA that does not have adequate financial and managerial resources to consistently produce credit ratings with integrity. The second principle – independence and conflicts of interest – is given effect in the regulatory programs through, for example, provisions that require a CRA to implement 1 IOSCO Statement Of Principles Regarding The Activities Of Credit Rating Agencies, Statement of the Technical Committee of IOSCO September 2003 available at http://www.iosco.org/library/pubdocs/pdf/IOSCOPD151.pdf. 4 procedures designed to identify and eliminate conflicts of interest inherent in its business activities. Another provision that is common to the jurisdictions reviewed, requires a CRA to manage and publicly disclose to the market the conflicts of interest inherent in its business activities. Several jurisdictions‘ regulatory programs also identify certain conflicts that a CRA is prohibited from having under any circumstances. For example, CRA analysts generally are prohibited from participating in determining credit ratings for securities that they directly own. The third principle – transparency and timeliness of ratings disclosure – is given effect in the regulatory programs through, for example, provisions that require a CRA to publicly disclose to the market information about the methodologies it uses to determine credit ratings. Another common provision across the jurisdictions is the requirement to disclose statistics and other information about the performance of a CRA‘s credit ratings. The fourth principle – confidential information – is given effect in the regulatory programs through, for example, provisions that require CRAs to protect confidential information obtained from entities being rated so that the information cannot be used for inappropriate purposes