By Tobias Buck in Brussels
The European Commission is to investigate credit ratings agencies amid growing dismay over their slow response to the subprime mortgage crisis.
Officials in Brussels and many other critics, believe the ratings agencies failed to act quickly enough to warn investors about the risks of investing in securities backed by US subprime mortgages – the sector whose troubles triggered the recent global market volatility.
Banks first warned about a potential crisis in subprime last year. But it was only this spring that S&P and Moody’s started downgrading the ratings of mortgage-backed securities on a significant scale.
“If the rating agencies believe this is going to be business as usual, they are very wrong,” one Commission official said.
“The securitised subprime mortgage market would not have grown to the extent that it did without the favourable ratings given by some agencies. This was one of the roots of the problem.” Charlie McCreevy, the EU internal market commissioner, met senior S&P executives last month and expressed his concern about developments in the subprime mortgage sector and the apparently slow reaction of some agencies. Mr McCreevy has invited European securities regulators to meet in September to discuss ratings agencies and the problems that have surfaced with regard to rating structured products.
The ratings agencies have changed parts of their methodologies in response to the rapid rise in subprime mortgage payment problems. But they say downgrades and other actions follow once evidence has accumulated that mortgages or other assets are underperforming rather than on a speculative basis.
They also emphasise that ratings address default risk rather than valuation risk, and are only one of the tools at investors’ disposal.
The agencies have previously defended themselves from legal action by maintaining that their ratings are simply opinions, covered in the US by constitutional free speech protections.
The Commission is not committed to any course of action and is likely to await the outcome of a review of the International Organization of Securities Commissions’ code of conduct for ratings agencies, expected by April, before considering new regulation at the EU level.
The Commission adopted a policy paper last year that dismissed the need for new EU regulation on ratings agencies.
However, the paper did warn that “the position of credit rating agencies must not be compromised by the relationships which they have with issuers”, highlighting the fact that agencies are paid by the issuers, not the users, of their ratings. Another worry relates to the fact that credit ratings agencies also offer consultancy and other supplemental services to issuers, potentially creating conflicts of interest. In the US, the Securities and Exchange Commission introduced new rules in June requiring credit ratings agencies to register with the markets regulator and give it audited financial statements, credit analysts’ qualifications and procedures for preventing misuse of information.
The French watchdog has also cited potential conflicts.
Additional reporting by Richard Beales in New York, Jeremy Grant in Washington and Paul J Davies in London