Regulation from the Perspective of Market Participants

From the outset, market participants have had reservations about state regulation of CRAs. They believe it is first and foremost the responsibility of the rating agencies themselves to remedy the shortcomings that came to light in the financial crisis and repair their damaged reputation. This calls, in particular, for modifications to rating procedures, improved transparency, and a review of internal processes in the interest of high quality.

This is seen as the key prerequisite for ensuring that the securitizations market will function smoothly over the long term. In the view of market participants, the financial crisis does not change the fact that securitization has contributed significantly to the efficiency of the financial markets. Securitization allows risk to be spread more broadly and enables many categories of investor to diversify their investments more widely. It also facilitates improved risk management among issuers. This presupposes that risks have been accurately assessed.

The CRAs were aware of this problem and responded swiftly. They revised their models and the rating of originators, insurers, servicers, and law firms. They also expanded their disclosure practices, launched various consultations with market participants on methodological issues, subjected their internal structures and processes to a thorough analysis, and made certain adjustments. As a result, the risk of a repeat of the developments in the credit rating industry that led to the subprime crisis has doubtless fallen.

Market participants have nevertheless recognized that the rating process unquestionably contains incentive structures that can—at least in theory—encourage misconduct by agencies. Owing to the lack of competition in the ratings market, the pressure that clients can potentially exert is not, on its own, enough to force rating agencies to behave properly.

Even so, regulative action should be taken with care. It should always be capable of achieving the twin objectives of ensuring financial market stability and promoting the efficiency of the financial markets. No one will be helped by tight regulation that stifles innovation and growth in the financial sector. Regulation is not an end in itself.

It should also be borne in mind that national responses to these challenges will not suffice. Even the EU would be a suboptimal stage for action because ratings are usually addressed to investors worldwide. For these reasons, the supervision of CRAs should be globally consistent; on no account should ratings be influenced by having to meet differing regulatory requirements. This would destroy the international comparability of ratings, which is one of their key contributions to financial market efficiency, and there would be competitive distortions between issuers and financial centers.

In the absence of an international regulator, a consistent approach to regulating CRAs can be achieved only by coordinating the rules at international level. The IOSCO Code of Conduct represents such an internationally coordinated set of rules. This should therefore be the basis of any state regulation.

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